Who will protect us from the central bank?

Earlier this week, John Redwood MP posed some difficult questions for Mervyn King:

Why did the Bank so misread the cycle 2005-9? Why did it encourage or allow dramatic overheating, when the smell of scorching was powerful enough for outsiders to notice it?

Why is inflation still at 4.7% (RPI) and 3.1% CPI when the target rate is 2% on the CPI? Why has it been persistently above target for so many months?

How can we have confidence that the Bank is now reading the cycle better?

Why does the Governor think sovereign debt is a risk free asset class for banks to hold, and why do the authorities now demand that banks hold so much more sovereign debt?

Still, one gets the impression that Redwood thinks the problem is simply that the wrong person was wielding the levers of power; that someone else, in King’s place, would have done a better job:

Why did they ignore the strong advice some of us gave to ease money markets earlier to avoid the worst of the crash?

Does the Governor think now is a good time to demand more cash, capital and caution from the banks?

Could it be that the economy still needs a more generous approach to money and bank credit to help it out of the deep hole recent policy forced it into?

We need to believe the Bank will this time listen to their critics, instead of drawing on a narrow group of economists who all agree they are right and end up with a slump and 5% inflation at the same time.

The problem is more fundamental: nobody is qualified for the job of Central Banker. As Jamie Whyte noted in The Times a year ago, it is absurd to trust a team of ‘wise men’ to manage monetary policy:

Mervyn King, Governor of the Bank of England, complained recently that he lacked the powers required to fulfil his new statutory role of ensuring stability in the banking system. A more powerful Bank of England would do a better job.

He is wrong. The economy would benefit from a weaker Bank of England, stripped of its principal power: namely, the power to set interest rates. This is not intended as a criticism of Mr King or of the other members of his Monetary Policy Committee. No one should be allowed to set interest rates.

Interest rates are simply prices for borrowing. As with all prices, they should be determined by supply and demand in a free market. When they are fixed by a wise man, or by a wise committee, they no longer carry information about the preferences of consumers and the scarcity of resources. On the contrary, no matter how wise the dictator, interest rates set by diktat are sure to be a kind of misinformation, leading those who act on them into error.

To believe that the likes of King and Bernanke can know the “right price” for borrowing, the “right level” of risk for banks, or the “right time” to open and close the money taps, is to place undue faith in the kindness of geniuses:

You should be sceptical of those who claim to be giving away something very valuable, including their extraordinary knowledge or skills. Yet that is precisely what our political leaders are now asking us to believe of financial regulators.

The big new idea in banking regulation is that regulators should force banks to hold more capital when their lending is causing the price of assets (such as houses) to get too high: that is, to reach levels from which they must crash. The Obama administration now has a similar idea concerning commodities, such as oil. They want regulators to intervene in commodity markets to counteract speculation that they believe is making prices too high or too low.

Let us not argue about whether it makes sense to say that a price can be too high when people are willing to pay it, nor whether any human, even computer-assisted, could possibly know that it is. Suppose that some people really do know such things. Why would they work for the government on a salary of less than £50 million?

The fact is that no one person, or team of people, can effectively manage the economy. Despite occasional “irrational exuberance”, prices will be more accurate, and adjustments less painful, when the free market is allowed to work its magic. The intervention of Philosopher Kings will always do more harm than good.

2 Comments

  • Exactly: the economy can NOT be ‘managed’. But what could be controlled is the QUALITY of money that is put in circulation.

    And just as notes and coins require ‘quality control’, so should “credit” require control, for “high interest” means “bad credit money”.

    But nothing will change fundamentally, as long as

    * credit is accepted as “money” just as Cash is

    * everybody knows that 3% of the money supply consists of Cash and 97% of Credit

    * nobody creates the interest that is required to pay for credit.

    Sabine
    Organiser, Forum for Stable Currencies
    http://forumforstablecurrencies.info

  • Manuelgar says:

    Hello,

    Regarding setting interest rates, well the fact that central banks are in control is, fortunately, an illusion:

    http://www.elliottwave.com/images/marketwatch/fedfollows.gif

    The problem is not to have a monetary theory that soundly differentiates Money, Credit and Currency.

    Credit/Debt should never be treated as money, because they are completely different assets (almost opposite). If we treat credit as money, then the creation of credit is unlimited.

    It could be ok to use credit as currency (medium of exchange), but it should circulate as currency backed by debt. A summary of this Monetary Theroy structure would be:

    Currency: medium of exchange

    Currency types:

    * Money: When the currency is a present good
    * Credit: When currency is not a present good, is credit

    Types of credit currencies:

    * Regular: It specifies the quantity and quality of the future good with which the arising liability is to be canceled. (i.e. gold certificate).

    * Irregular: It does not specify the quantity and quality of the future good. (i.e. most irremedable currencies we use today).

    For more information on this Monetay Theory take a look to page 19 of this book:

    http://www.carlosbondone.com/pdf/Capitalism_and_Currency_(Carlos_Bondone).pdf

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