To Infinity and Beyond!18th August 2013

shutterstock_94602286Not since Buzz Lightyear hit the big screen has so much anticipation erupted over the capabilities of one character. With his exciting new space-ranger feature set seemingly consigning more conventional toys to the cupboard, Buzz even believed that he could fly – and if you have wings, well why not believe it to be so!

The dashing Mr Carney has now arrived at the Bank of England, and has been busy displaying his very own space-ranger feature set. Such is the excitement over forward guidance that all our troubles are seemingly behind us, as each new small piece of economic data is greeted with the cheers of the gathered throng. This man has wings!

We have waited almost 18 years since the release of Toy Story for such a hero, but the budgets at the Bank of England dwarf the $30m budget that Disney and Pixar had to play with, and the implications of flying – or failing to fly – are that much greater for us all. So what are we to make of the apparent gift of Carney to our nation?

For the last few decades the “growth” of the nation has been determined by GDP, that curious construct that has little to do with genuine economic progress[1]. As politicians and economists have chased GDP, massaged unemployment statistics and tampered with official inflation, society has become more fragmented as real median earnings fall and too many rely upon vast debt and benefit systems to chase the dreams of home ownership and consumerism. Pity the young.

With banks and governments across the Western world believing in their folly, a few years ago they found that they had over-reached themselves. Retrenchment would be painful, as we have seen in the Eurozone, with debt-driven economies suddenly paying the price for over-indulgence. Bank re-capitalisation could be achieved, but at huge and continuing cost. Governments, many of which (unlike the UK) rely heavily on short-term borrowings, just had to force interest rates down to avoid busting their budgets even more. Governments (like the UK) taking on fresh debt to fund deficits also have to keep rates low, using a back-door to buy-up their debt (QE) on which, in the short-term, they can even pretend to be making a profit!

So dependent upon low interest rates and QE has economic survival apparently become, that pundits have become fearful of the withdrawal of QE, to the extent that the mighty US Fed, and now the Bank of England, must pick their public words very carefully. Any good doctor would warn against such dependency. Yet the questions has become “how big a fix, how often, and for how long”.

Now the Bank of England in seeking stability with growth by providing extended low interest rate guidance based on many indicators reflecting slack in the economy. Up for starters is the official unemployment rate which must fall from 7.8% to 7.0% before official rates might change, although surely total employment and employment participation (with due allowance for those relying on part-time work who seek full-time work) and changes in median earnings is equally critical.

With inflation statistics pretty meaningless anyway[2], and the BofE’s record in tracking targets pretty dismal, one can easily see that measure being adjusted again in the future. It could easily break-out, and arguably already is with property, but could become especially painful as the £ falls and imported energy and essential goods become more costly.

For savers, the future looks bleak as returns below inflation erode their attempts to preserve purchasing-power. For now holders of other assets like houses and shares are rejoicing. But the market has a habit of correcting bad behaviour, as it rations funding in search of higher or safer returns … and this could manifest itself at any point in the interest rate and exchange rate markets when perception turns.

Whilst a Central Bank can set a price for Government debt and bank reserves, it cannot control the real rates and lending margins out in the wider economy … the rates that real people and businesses pay. This could really change debt-servicing capability, consumer behaviour and investment asset prices. An adverse change here would also hit the banks, hard, on their holdings of government debt; holdings which have been so greatly encouraged by the rule-makers.

As an example of unjustified euphoria, just take the UK Trade figures announced in August, for June, which were widely celebrated as being, well, the best figures since as far back as … January. Talk about clutching at straws! Even so in June our exported goods of almost £27bn (a record) were exceeded by our imported goods of £35bn (also a record), a difference of 30% of £8bn in one month. Thankfully our services reduced the overall deficit to £1.5bn. But that is still a deficit, and no better than many results in our recent past.[3]

So what else has happened in the world over the Summer months? At a modest level, the Church of England is to encourage credit unions. More significant is that Barclays discovered that it has to find £12.8bn more capital as the new Prudential Regulation Authority changed the rules. But even this need is dwarfed by the Eurozone banks which still, according to an RBS report, must shrink by a further Euro 2.7 Trillion (so far they have achieved Euro 2.4 Trillion, so not even half way yet). Sadly, credit remains the most important feature of our economies.

So how will our Buzz Lightyear do?

At best he can influence investment behaviour with his forward guidance, and he might even get lucky. Or he may get fed up and leave. Perhaps over time more credit-users within the political economy will understand that Central Banks cannot – and should not – seek to control the economy, for in doing so they sow the seeds of future disruption.

For now, extending the ultra-loose monetary policy does nothing to fix the systemic problems of our credit-driven economy, and it will surely fall to others in the future, perhaps with a humbler feature-set, to get back to basics and provide the cure.

[1] For more on GDP, see here

[2] For more on Inflation, see here

[3] I will prepare a full blog on this topic in the future. For now you’ll wish to know that in 2012 our largest deficit imbalances were amongst fuel (where imports exceed exports by 52% or £22bn), food beverage & tobacco (where imports exceeded exports by 52% or £18bn). Even in the EU our imports exceed exports by 38% or £56bn.