Prudent Savers to be the Biggest Losers – Mervyn King

In a speech last night in Newcastle-Upon-Tyne the head of the UK’s central bank continued on his admirable path of admitting that the banking bailout and policy of currency debasement have simply transferred the cost of the bank bailout onto the shoulders of ordinary families and, in particular, has drained the funds of those foolish enough to support our economy and banking system by saving in sterling.

How embarrassed do the Bank of England’s senior officials feel this morning on rereading their own confident and optimistic misrepresentation of money printing (quantitative easing) less than two years ago? The Bank of England’s own website still displays the following assurance that QE is a well conceived tool of monetary policy that has been implemented to stimulate the economy and control inflation:

The instrument of monetary policy shifted towards the quantity of money provided rather than its price (Bank Rate). But the objective of policy is unchanged – to meet the inflation target of 2 per cent on the CPI measure of consumer prices. Influencing the quantity of money directly is essentially a different means of reaching the same end.

The latest official CPI number is 3.7%.

As Jesus Huerta de Soto explained in his Hayek lecture in October 2010

The spontaneous reaction of the market against the effects of credit expansions: first the financial crisis and second the deep economic recession.

De Soto again from the same lecture:

The financial crisis begins the moment the market, which as I have said is very dynamically efficient (Huerta de Soto 2010a, 1-30), discovers that the true market value of the loans granted by banks during the boom is only a fraction of what was originally thought. In other words, the market discovers that the value of bank assets is much lower than previously thought and, as bank liabilities (which are the deposits created during the boom) remain constant, the market discovers the banks are in fact bankrupt, and were it not for the desperate action of the lender of last resort in bailing out the banks, the whole financial and monetary system would collapse.

Let us consider the UK format of this rescue: a transfer of wealth from savers and ordinary taxpaying workers, to banks.  Surely this can only conceivably be justified if the bailed out banks cease to behave as independent profit seeking businesses with vast direct stakes in so many limbs of the UK economy (via massive leveraged loan portfolios and direct private equity stakes, SIV and securitisation holdings in almost all industries with predictable cash generation – utilities, PFI, social housing rental streams) that they treat other businesses in similar industries as competitors to be shunned, or worse, crushed.

Surely the direct investments should be sold to enable the banks to act as genuine engines of economic recovery by allocating resources to understanding and supporting UK businesses?

If banks returned to lending to businesses, rather than effectively buying so many, a behavioural shift might start to occur.

But there has been no such behavioural shift.  In a paper which I am drafting for the Adam Smith Institute, I will focus on three trends which evidence the contrary:

  1. The continued increase in derivative and repo market activity driven by the ease of declaring as profit years of hoped for income which, against the banking crisis background is, unlikely to materialise;
  2. The brittleness of bank balance sheets caused by abuse of mark to market rules regarding illiquid transactions (both parties to transactions marking them at wildly differing prices in each case to favour the reporting bank)
  3. The enormous rise in Basel 2 regulatory arbitrage, highlighting the staggering incompetence of these regulations and their authors.