Anthony Hilton: Central bankers peddling dangerous medicine
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It is generally a mistake to assume that because someone is in charge, they know what they are doing.
David Cameron called the EU referendum without thinking through what would happen if he lost; the leaders on the other side — Boris Johnson, Michael Gove and Nigel Farage — equally gave no thought to what would happen if they won.
It is not just politicians we should worry about, however. The same can be said of technocrats, many of whom wield as much power.
This list comprises many business leaders but, most of all in today’s world, it also includes central bankers.
For the past eight years, we have by and large assumed these figures of authority knew what they were doing, even when they pursued ever more extreme and experimental policies — always with the best of intentions, but with no real idea of how they might pan out.
Unlike politicians, however, bankers are prepared to admit — at least to each other — that they don’t know for sure what they are doing.
One might think this would be of considerable interest to the world at large, but no one paid much attention last time it happened.
Luckily, one who did was Hans Hoogervorst, the one-time Dutch politician who now chairs the International Accounting Standards Board.
In a speech earlier this month, he drew attention to the reservations expressed by Jaime Caruana, general manager of the Bank for International Settlements — the central bankers’ club.
Caruana said with refreshing honesty: “At this stage, we don’t fully understand the implications of low or even negative interest rates for the financial system and the economy as a whole.”
Think about that for a moment. If your doctor said before administering a drug that he did not fully understand how it would affect your system, either for good or ill, would you take it?
If an architect proposing to build something as dramatic as the Shard or the Walkie Talkie said he did not fully understand the effect the various stresses would have on the structure he had designed, would he be allowed to build it?
If an airline said its new planes did not have an airworthiness certificate, would it be allowed to fly them?
Clearly, central bankers operate to different rules. It is not as if we do not know some of the negative side-effects of ultra-low interest rates, which are at the core of current unconventional monetary policies.
Hoogervorst even quotes the 82nd BIS annual report, which talks about how low rates increase leverage in the system.
The 2008 blow-up was a classic credit crisis caused by the excessive build-up of debt in the economy. But thanks to low interest rates, leverage today is now even higher than it was then.
McKinsey has done the sums. In 2007, the combined worldwide debt of households, governments, corporations and the financial sector was an astonishing 269% of global GDP.
By the end of 2014, it was an even more astonishing 286%. Add in the unfunded pension liabilities of various governments round the world, which Citigroup estimated in March to be $78 trillion (£59 trillion) for the 20 leading OECD economies, and the overall indebtedness of the world’s economy today comes to more than 400% of global GDP.
As Hoogervorst says, it is hard to see how this is going to end well or how these obligations can be met in an orderly fashion.
There are other problems. Cheap debt allows crippled businesses to survive as zombies. That can ease the pain of recession for a while but it should only be temporary.
There comes a time when it would be better if they were laid to rest so everyone can adjust and move on. If this does not happen, recovery takes much longer.
There is a social cost, too. Unconventional policies such as quantitative easing fuel asset-price inflation in stock markets and property.
This contains the seeds of future instability and, with expensive housing in particular, can have huge negative consequences for society, accentuating inequality and intergenerational unfairness. London housing is now 50% higher than it was before the 2008 crash.
“To be in bubble territory again so soon after one of the worst credit crunches in history defies common sense,” Hoogervorst says.
It can even weaken the system it is supposed to strengthen. Persistently low rates are putting extreme pressure on the business models of banks, insurance companies and pension funds — in effect making them potentially insolvent.
Banks can’t charge enough on loans to cover their costs. Pension funds and insurance companies can’t get a return on their investments high enough to generate the money they need to fulfil the promises they have made to past customers.
They still have enough reserves to keep going but it is an open question as to how many more years they can go on before the strains become impossible to ignore.
All this is out there and is widely understood in the financial world. Bank of England Governor Mark Carney has alluded to it.
Yet it has not stopped many in the markets looking eagerly towards the Bank of England monetary policy committee, which starts its two-day meeting today with Carney in the chair, in the hope it will cut rates even further.
We need to be weaned off unconventional monetary policies because the more we have of them, the less effective they have become.
But the markets are like an addict — they want another fix even if they know it is slowly killing them.
The MPC decision will be announced tomorrow and, while it is finely balanced given the uncertainty the referendum result has piled on an already faltering economy, the arrival of a new Prime Minister may make a difference.
The Government and the Bank are trying to create the impression of competence and a return of stability. Greeting a new Prime Minister with an immediate cut in interest rates hardly conveys respect, and might be seen as an unhelpful kick in the teeth.
In contrast, given the uncertainty over the long-term effects of these policies, delay might be no bad thing.
