Never since Thomas Becket has a man been more filled with resentment at being given the job he wanted than Mervyn King, following his re-appointment as Bank of England Governor by Gordon Brown.
In the 6 months following the failure of Northern Rock, Brown dithered over whether to replace King, only to discover that there were few suitably qualified professionals for the role. The damage to their personal relationship was done.
At the height of the financial crisis that followed, Downing Street formed the conclusion that the Governor was feeding information on the details of the bank bailout to Shadow Chancellor George Osborne, in order that Osborne could speak publically about the details and claim to be one of the architects. See Video.
Gordon Brown and Alastair Darling were infuriated when King began to undermine their economic policy through public criticism, while Osborne and Cameron were delighted.
The Tories blamed Gordon Brown’s Tri-Partite System of regulation for the Credit Crunch, and promised to reward the Governor, by returning regulatory powers to the Bank of England. This ignored the fact that the BCCI scandal and the Barings collapse had happened on the Bank of England’s watch.
The question this raises is the commitment that the Governor has to his statutory responsibility to control inflation, against his obligations to the Tory administration and their potentially differing objective.
Governor King was hawkish in controlling inflation when the clouds of the banking crisis were gathering. Brown would have preferred the central bank to have loosened monetary policy to see off the pending crisis. This is one of the chief conflicts that soured their relationship.
However, in recent times, the Governor seems to have pursued the opposite objective. Minutes of the MPC demonstrate him to be instinctively at odds with inflation Hawks on the committee. This change of tack is a curious inconsistency.
The current Chancellor, George Osborne, is obsessed with reducing the deficit at all costs. No growth plan runs alongside this policy to detract from the central purpose. No plan B exists to question the resolve. The considerable risk of throwing the British economy back into recession, has been brushed aside as a distraction. His policy is singular and focused. The deficit will be removed, period!
Inflation as a tool to reduce government debt is as old as economics. It has often been openly used as an economic tool. Prior to joining the Euro, the Italian economy regularly stimulated inflation as a back-door form of taxation. Few Italians paid their taxes, so by causing inflation, the government would reduce the value of the cash under their mattresses, while consequently reducing the value of the government’s debt.
This is the problem with using inflation to tackle the deficit. Ordinary working people would see their wages reduced in real terms, while cash savers would see their capital reduced. Those with their capital in the stock market would be little affected.
So the policy would be good for reducing the state deficit, good big business, and also good for anyone with debt such as a large mortgage, as long as they have the power to increase their wages to offset the inflation.
The pain though, would be felt by ordinary working people, and the elderly living on their savings. Since Mr Osborne has publically stated that, “We’re all in this together,” I ask the reader to consider whether he would be willing to make the poor pay for the deficit?
George Osborne has persistently justified his economic policy by claiming that failure to act on the deficit will cause the markets to collapse, but as the British economy shrunk in the final quarter of last year, his high risk strategy looks to be the wrong gamble. If he has co-opted the Bank of England Governor to stimulate moderate inflation as a tool to reduce the deficit, then his actions are symptomatic of the losing gambler who doubles the stakes to regain his deposit.
As the price paid for failing to tackle the deficit, Osborne paints a picture of market collapse. But the redemption on UK debt is 15-25 years away, so his sense of urgency is misplaced. His hypothesis that our debt will be unmanageable if the market increases our interest rates nonsensical. Government bonds, though index-linked to inflation, are of fixed interest to the issuer.
The real market damage that would be done to the British economy, is if our reputation for controlling inflation was lost due to the gambling instincts of an incompetent chancellor, in cahoots with a resentful and compromised Bank of England Governor.
If this were the outcome of the Tory economic policy, then the markets would punish the UK for generations to come.