The Bank of England and the ECB Have a Credibility Problem
Mainstream media are worried about 2017 shocks. So they should be. If you had gambled a pound (or euro) this time last year on a triple accumulator; Leicester City to be English football champions, Brexit, and then Trump, you would have redeemed your betting slip for a million. Bookmakers are not offering odds anywhere like that on a ‘quad’ bet now popular; i) Geert Wilders (Netherlands, March 15th), presently polling at 20%, ii) Marine Le Pen, (France, April 23rd), 25%; iii) Frauke Petry and Jorg Meuthen (Germany, August 27th), 13.5%; iv) Beppe Grillo of 5 Star (Italy, date uncertain, perhaps October), 28%.
For the ECB and Bank of England, already struggling with separate credibility problems discussed below, any such shocks might prove rather welcome. How so, you may ask, given that they lobbied for ‘Remain’ and obviously would have been delighted with Clinton?
Since quelling Bundesbank objections to QE at end 2014, the ECB has had a free run to apply whatever monetary policies it likes. However, unemployment levels (although declining for several quarters) are still worrying, and sections of Europe’s banking system do not feel particularly safe. However, many hedge funds and other highly leveraged investors have had another decent year making fairly obvious bets on the increasingly predictable policy responses to various events (Brexit and Trump, perhaps not Leicester City). The ECB has always had one eye on protecting its reputation.
Since the first of the sovereign bailouts (Greece, 2010) it pushed hard at first for ‘structural reforms’ from national parliaments. When ‘austerity’, the term’s synonym, became a dirty word (in 2012/13) the ECB changed tactics and strove for banking union. Now that Germany has blocked that (with no chance of any common deposit fund), the ECB has flipped back onto its structural reform hobby horse. But its calls fall on deaf ears. In November, ECB board member Benoit Coeure appeared to worry about the future of the euro itself:
[E]ven in a fiat money system impaired creditworthiness of governments ultimately creates the risk of an eroding trust in the ultimate safe asset: central bank money.
However, the ECB’s credibility problem is modest compared to the Bank of England’s. A recent book All Out War: The Full Story of How Brexit Sunk Britain's Political Class by Sunday Times political editor Tim Shipman, records that the stakes on both sides of the Brexit battle were so high that the Geneva Convention was almost breached, despite of course the veneer of politeness being meticulously observed by all actors at all times. Patrick Minford played a small but significant late part. Many had been sceptical when the Bank of England’s ‘gravity model’ based forecasts for a Brexit sparked recession were published. Minford knew these were not only wrong but carefully constructed ‘fixed’ models intended to influence the referendum. He formed a group of only perhaps ten economists who called themselves “Economists for Brexit,” and enjoyed substantial airtime. Now, more than six months later, the modelling is discredited and Carney has faced resignation calls, the charge not being any lack of competence, but of breaching the political neutrality of the Bank. Early in January, Andrew Haldane, the former head of Financial Supervision, gave a speech at which he conceded that the Bank of England is incompetent at making economic forecasts. Even worse than its Brexit forecasts, Haldane emphasised, was the Bank of England’s failure to spot any signs of problems in the banking system on 2007, even after the failure of Northern Rock. Given his present role as Chief Economist, the media headlined as if Haldane was playing the mea culpa card. Given the pressure facing Carney, and the public put down suffered by Haldane in 2013 for criticising Basel risk weighted asset measurements of bank solvency, it is perhaps also a careerist move, the subtext being ‘my boss made me do it’.
Less well reported, but a far more serious threat to the Bank’s already damaged credibility are its actions concerning British banks’ minimal regulatory capital buffers immediately after the referendum. This point does bring incompetence into play. As we reported given the choppy waters into which the UK economy was headed, the Bank decided to reduce each bank’s capital hurdle by 0.5%. It reset to zero the Countercyclical Capital Buffer, or CCyB. The actual text:
The [Bank] was concerned that banks could respond to these developments by hoarding capital and restricting lending. The reduction of the CCyB rate was intended to reinforce the FPC’s expectation that all elements of capital and liquidity buffers are able to be drawn on to support the real economy.
There is a serious problem here. The Bank seems to have applied the CCyB the wrong way round. As Kevin Dowd has recently explained:
The purpose of the CCyB is to counter the financial cycle: as aggregate credit builds, markets boom and risks build up; then the boom breaks, markets fall and the risks are realised and subsequently fall. The CCyB should rise in the first phase to help slow the euphoria, and then fall in the second phase to ameliorate the distress.
If the problems the Bank feared were in the future, the July decision should have been to increase the CCyB. The only justification for lowering it would have been if the UK was already in phase two (a recession) in June 2016. Given that it wasn’t and isn’t now, and furthermore that the Bank of England is far less worried about the outlook, it should immediately increase the CCyB’s of each bank.
The only possible reason for not so doing is the fear that this would expose capital shortfalls in UK banks. This reason makes sense. It would also explain why these two powerful central banks lobbied feverishly against Brexit. The banking system is strained now so near its breaking point, they feared that even a ripple in the millpond might trigger Niagara Falls. For the ECB and Bank of England one or more of the four shocks might be rather welcome. There is nothing like a new crisis to encourage the media to move on from the last one.
Adapted from a longer article at the Cobden Centre.