Bank Of England In Trouble And The Pound Is In Peril?
Adrian Ash - Thu 20 Sep, 2007
The Old Lady's in danger and the Pound is in peril. Or so we guess today. The gold market seems to agree. It's risen by 9% against Sterling in the last month alone. And as a cartoon by Gillray reminds us each morning, hung by the door here at BullionVault, the Bank of England's virtue has come under attack before. James Gillray's etching, Political Ravishment, nicknamed the Bank as the "Old Lady of Threadneedle Street". The tag has stuck ever since and in Gillray's cartoon, the young prime minister, William Pitt, tries to assault her virtue and get his mitts on her gold.
The Old Lady's in danger and the Pound is in peril. Or so we guess today.
The gold market seems to agree. It's risen by 9% against Sterling in the last month alone. And as a cartoon by Gillray reminds us each morning, hung by the door here at BullionVault, the Bank of England's virtue has come under attack before.
James Gillray's etching, Political Ravishment, nicknamed the Bank as the "Old Lady of Threadneedle Street". The tag has stuck ever since — and in Gillray's cartoon, the young prime minister, William Pitt, tries to assault her virtue and get his mitts on her gold.
"Murder! Murder!" cries the Old Lady in horror, using more exclamation marks than even the Mogambo Guru. "Rape! Murder! O you villain! What, have I kept my honour so long to have it broke up by you at last? O murder! Rape! Ravishment! Ruin! Ruin! Ruin!!!"
Fast forward 210 years, and now Mervyn King — that self-effacing career academic from the Midlands — is wearing the dress. The current prime minister is after the Old Lady's honour, too. And on Wednesday this week, he got it.
The Bank of England now "plans to provide funds at a 3-month maturity against a wider range of collateral, including mortgage collateral, than in the Bank's weekly open market operations," it said yesterday morning.
Mortgage-backed bonds, in other words, are deemed worthy collateral for borrowing cash from the Bank of England. Thus the nationalisation of the housing market begins.
"Looks like the Bank is now being run from Whitehall," says Charles Pretzlik for the Financial Times. Mervyn King had refused all through this crisis to take mortgage-backed bonds as security when lending the Bank's cash. Now the first auction will be held next week, with three further auctions to follow, putting up £10 billion for grabs each time.
"This is exactly what the Bank said it would rather not do [last week]," notes Alan Clarke at BNP Paribas. "Clearly the financial market situation has deteriorated to the point that the slowdown implied for the economy is more severe than the Bank had seen as desirable."
Put another way, politics demands that the Old Lady make free and easy with her virtue. Sacrificing the Pound to defend the economy — a gambit that may not actually work, remember — will damage those very savers that Alistair Darling has used taxpayers' money to bail out.
The only other winner here, besides over-geared mortgage firms who've found the flow of cheap cash dried up in London, is moral hazard. Mervyn King himself picked up the story last week:
"If central banks underwrite any [financial borrowing] that threatens to damage the economy as a whole," he wrote to the Treasury Select Committee — knowing full well that Northern Rock was in crisis — "it encourages the view that as long as a bank takes the same sort of risks that other banks are taking then it is more likely that their liquidity problems will be insured ex post by the central bank."
Put another way, "The provision of large liquidity facilities penalises those financial institutions that sat out the dance, encourages herd behavior and increases the intensity of future crises."
Now moral hazard has hit London — and it's being funded by the Old Lady herself.
"Can the governor stay in these circumstances?" Charles Pretzlik goes on in the Financial Times. "Does he want to? Surely this is one U-turn too many... unless the governor knows something new that we don't."
Your correspondent admits it; after four years ribbing the poor Trimmer, we feel almost sorry for him today. Mervyn King played the Old Lady as he tip-toed the nation away from its cheapest interest rates in more than four decades. But you can't fault his "sound money" record — not given the politics and placemen that he's faced while wearing the frock!
Mervyn King kept voting for tight money even as the Greenspan Fed slashed US rates to their emergency low of 2003. He remained out of step with his colleagues even after he became governor, as well, happily outvoted twice by his own team when he pushed for higher rates in August 2005 and in June 2007.
Yes, the Trimmer might have moved faster. Yes, he might have banged his fist on the oak table... pinned David Blanchflower to the wall by the throat... or screamed at the passing traffic about the debt-deflation we're now hitting. And no, he didn't prevent soaring inflation of the UK's supply of Pounds Sterling.
Just today, new data shows 13.5% growth in the broad M4 money supply from August last year. New lending rose by more than 14% at the fastest clip in three months. Given the Old Lady's sudden loss of false modesty, this inflation can only grow worse.
But with King gone — and gone soon — the Pound Sterling risks being left with just political "yes men" to defend it on the Monetary Policy Committee. That will prove no defence at all.
Because an independent Old Lady is no use at all if she won't do as she's told.
Regards
Adrian Ash
For The Daily Reckoning
Adrian Ash is head of research at BullionVault.com the world's fastest-growing and best-value gold ownership service.
http://www.bullionvault.com/from/dailyreckon
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