Today’s subject does have historical echoes as who can consider this sort of topic without thinking at least once of Weimar Germany with its wheelbarrows full of bank notes and Zimbabwe with its trillion dollar note? These days we need to include Venezuela which cannot even provide a water supply now. There are three good reasons therefore why central bank Governors should tread very carefully around this particular subject. So it was curious to see the Governor of the Bank of England long jump into this particular pit yesterday in a Sky News podcast.
The government would have struggled to fund itself if the Bank of England had not intervened during the market “meltdown” of COVID-19, the Bank’s governor has told Sky News.
In an exclusive interview, Andrew Bailey said that in the early stages of the virus, Britain came within a whisker of not being able to sell its debt – something many would characterise as effective insolvency.
There are elements of the first paragraph which are true but “came within a whisker of not being able to sell its debt” is a curious thing to say and if we are being less kind is in fact outright stupid. We are also guided by Sky News to this.
While there was an uncovered gilt auction in 2009 – in other words, the government was unable to find buyers for all of the debt it was selling to investors – it was widely seen as a one-off.
They are trying to make this sound a big deal but it isn’t really. For example over the past few years I can recall Germany having several uncovered bond or what they call bund auctions. Nobody considered them to be within a whisker of being unable to sell their debt, in fact Germany had a very strong fiscal position. Here as an example id CNBC from the 21st of August last year.
The bund, set to mature in 2050, has a zero coupon, meaning it pays no interest. Germany offered 2 billion euros worth of 30-year bunds, and investors were willing to buy less than half of it, with a yield of minus 0.11%.
What was it about having to pay to own the bond and do so for around 30 years that put investors off? That of course provides the clue here which both Sky and Governor Bailey either have not figured out or are deliberately ignoring. The debt did not sell because of the price at which it was offered was considered too expensive. Germany could have sold its debt if it was willing to pay more,
How did the Bank of England respond?
Mr Bailey warned that the dislocation in markets in March was even more serious, prompting the Bank to intervene with £200bn of quantitative easing – the biggest single cash injection in its history.
Actually it also cut Bank Rate to 0.1% and there is significance in the date which was the 19th of March. That is because the price of our debt was rising which has been summarised by the Governor like this.
The governor said: “We basically had a pretty near meltdown of some of the core financial markets.
“We had a lot of volatility in core markets: the core exchange rate, core government bond markets.
“We were seeing things that were pretty unprecedented, certainly in recent times. And we were facing serious disorder.”
If we look at the UK we were seeing a rise in Gilt yields as the benchmark ten-year yield rose quickly from an all-time low of 0.12% on the 9th of March to 0.87% on the 19th. We have seen much worse in the past and I have worked through some of them! In historical terms we still had very low Gilt yields and so it looks as if we are seeing another case of this from a central bank.
Panic on the streets of London
Panic on the streets of Birmingham
I wonder to myself
Could life ever be sane again? ( The Smiths)
The job of calming down world financial markets was a dollar issue and was dealt with the next day by the US Federal Reserve.
The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve, and the Swiss National Bank are today announcing a coordinated action to further enhance the provision of liquidity via the standing U.S. dollar liquidity swap line arrangements.
We will never know now how much things would have improved in response to this as a panic stricken Bank of England fired as many weapons as it could. As a technical factor overseas QE bond buying helps other markets via spread and international bond buyers. Whether that would have been enough is a moot point or as central bankers regularly try to point out, the counterfactual! We do know from experience that it is a powerful force exhibited in say Italy which only saw bond yields rise to 3% and that only briefly recently as opposed to 7% last time around.
Anyway even the relatively minor rise in UK Gilt yields has the Governor claiming this.
Asked what would have happened had the Bank not intervened, Mr Bailey said: “I think the prospects would have been very bad. It would have been very serious.
“I think we would have a situation where in the worst element, the government would have struggled to fund itself in the short run.”
Okay so he is in effect claiming to have funded the government although not long afterwards he claims that he is not.
The Bank’s decision to create so much money and use it to buy government bonds, including an extra £100bn only last week, has prompted some to ask whether it is in effect financing the government’s borrowing. Mr Bailey rejected the accusations of “monetary financing”.
“At no point have we thought that our job was just to finance whatever debts the government issue,” he said, pointing out that the objective was to ensure economic stability.
Ah so not inflation targeting then?
The situation here was explained back in the day in an episode of Yes Prime Minister and the emphasis is mine.
We believe that it is about time that the Bank ( of England) had a Governor who is known to be both intelligent and competent. Although an innovation it should certainly be tried. ( Treasury Permanent Secretary Sir Frank)
As you can see this was a topic in the 1980s and it still is. The present Governor was in such a rush to indulge in “open mouth operations” to boast about his role in the crisis that he not only overstepped the mark he made some factual errors. The UK government could have funded itself but it would have to have paid more for the debt. It could have activated the Ways and Means account earlier than it did as well if needed ( we looked at this on the 9th of April). So we see several of my themes at play. The Bank of England is implicitly but not explicitly funding the UK government right now just like the Bank of Japan, ECB and US Federal Reserve,something I pointed out on the 6th of April.
Let me finish off on the subject of monetary financing. The simple truth is that we have an implicit form of it right now.
This means that it is about as independent as a poodle (another theme). It tends to panic in a crisis and new Governor’s tend to reward their appointment with an interest-rate cut. I cannot take full credit for the latter as that was in Yes Prime Minister as well.
Also in the podcast was a reference to this.
The governor signalled that the government may need to consider finding a vehicle to resolve the many bad debts left by companies that fail over the COVID-19 period.
“If (a bad bank) were to be contemplated, it would be as a sort of an an asset management vehicle: how do we manage small firms through a problem that they would get as a result of the loans that they’ve taken on to deal with the crisis?”
Somebody needs to tell him the UK taxpayer has one of those and it is called Royal Bank of Scotland with a share price of £1.24 as opposed to the Fiver we “invested” at.
Let me finish by giving Governor Bailey some credit for a burst of much needed honesty.
“We’ve been mis-forecasting the labour market for some time because the traditional models just didn’t seem to hold.
We can add that to his apparent enthusiasm for changing policy on the subject of any QT in a direction I have been recommending since September 2013.