The sun was shining on Mark Carney this week as he took up his position as Britain’s top bank manager. As predicted on Friday, the markets are having a right old jolly. It’s as if the nation just signed a hot new football manager: Carney has star power, exciting new strategies, and the crowd’s getting behind its man.
Over the last few years, central banking really has come into its own. These guys are undoubtedly the biggest hitters in global finance, and now they’re household names to boot. As the Carneys took up residence in a plush £3m pad, the press even dedicated column inches to Mrs Carney’s choice of teabag!
The thing is, though, Carney must be secretly worried. Because there’s a problem at the heart of the British economy that he just can’t solve…
The headlines have been going on about how lucky the new Bank governor is. How fortunate he is that so many economic indicators are pointing up at the same time. Well, I’m not sure that Carney is happy about any of that. Call me a cynic, but I suspect Carney doesn’t even want a healthy economy. He’s got more of a political agenda…
Carney wants to control the market price of certain assets, such as UK government debt and sterling. But more than anything he wants to control the level of UK private debt. And the government is right behind him. The last thing the government wants is for the economy to ‘normalise’. That would mean higher interest rates… and if the private debt pile in the UK is a bomb, then higher interest rates are the fuse.
So a ‘normal’ economy (one where the Bank of England can’t get away with rigging the debt market) is Carney’s big worry. Higher rates will sink a lot of Britons, and they’ll pull the economy down with them.
So how’s Carney going to keep rates low? Well last week, he introduced a new, political policy…
Quantitative easing (or QE, printing money to buy government debt) has boosted this struggling government. But it can only go so far. Ultimately, it stretches the credibility of the financial system. I mean, if they can just print money to buy government debt, it makes a mockery of the whole system. Why on earth would anyone else want to invest in bonds paying out next to nothing, yet face the massive risk of anyone calling into question the credibility of these things?
Because there are limits to the markets’ credulity, central banks have to tread carefully with QE. But as well as QE, the planners use low interest rates to stimulate the economy… effectively to spur borrowing… which helps the economy over the short run. But, as I say, that’s just the short run. And the short run is now over.
That’s why Carney’s coming out with his new policy of ‘forward guidance’. All it is is a promise that rates will stay low for a long time. It’s supposed to help induce long-term debt. And last week, the European Central Bank’s head, Mario Draghi, came out with similar guidance.
Of course, I’ve been saying that this is what they’d do for years now. Frankly, there’s no way the central bank is going to raise rates. They’re too afraid of the consequences of changing the price of all that debt.
The markets jumped all over the news – looking for an excuse to go up. But there’s no doubt that the politicisation of the central banks brings big dangers.
Inflation is sneaking up on us
It’s as if we’ve forgotten the main purpose of these supposedly independent central banks. Let me remind you: the Bank of England’s job is to regulate the banks; and most importantly, to make darned sure inflation doesn’t go above 2%.
But of course, nothing could be further from Carney’s mind. Notice how the pound plunged when Carney announced his new forward guidance strategy.
Now, you don’t need me to tell you what that means… it means more inflation down the line. And as for the banks, lower rates for longer means they can make bigger profits from an inflated loan book. But the thing is, more lending adds risk to banks’ balance sheets. This is the last thing the Bank of England should be encouraging!
A weak pound, high inflation, and pumping up risk in the financial system… hardly great news!
Where do we go now?
This year, I’ve already reduced my bond allocation and upped my equity weighting. In fact, recently I talked about how to find value in the FTSE.
I’m not wild about equities… but then again, I don’t have to be. It’s a case of digging out the cleanest shirt from a dirty laundry pile. At least equities offer some protection against long-term niggling inflation.
As for protection against the rising risk in the banking system, you could do worse than to try out the long/short banking pair I described last week.
Ultimately, we’re facing a global game of politicised central banking and escalating risk to the financial system. And it won’t work out well for a lot of people. Forewarned is forearmed![xyz_lbx_custom_shortcode id=10]