The signpost to further action was provided in what was arguably the gloomiest speech to date by Bank of England Governor Sir Mervyn King at the Mansion House dinner. References to a “large black cloud of uncertainty” and an “ugly picture” for the global economy left no doubt that, however bleak the economic outlook might seem on the business frontline, the apprehension is if anything deeper at the central bank.
Between the lines of the Governor’s speech was a bleak text. Not only have we entered a dark place indeed for the economy, but we have also passed the point at which it is responsive to conventional fiscal and monetary correction. The best that can be expected are stop-gap, ameliorative measures to tide us over until the global economy moves to a new phase. Meanwhile, as the euro crisis intensifies, conditions are likely to get worse.
So why has it taken so long for the Bank to respond? There has been an evident reluctance by Sir Mervyn King to be dragged down the road of forced commercial bank lending. Too eager a push towards lending into a recession, whether for businesses or home owners, lays the central bank open to the charge of moral hazard. It feeds an expectation of on-demand loans at ultra-low rates regardless of conventional risk appraisal. It also exposes the central bank to losses, with no assurance that the loans will be guaranteed by the government (aka the taxpayer). Sound familiar?
There may also have been resistance within the Bank to a distinct change in its role and responsibilities. The more it is encouraged down this route, the more the central bank ceases to be independent and becomes instead a de facto instrument of economic policy – fiscal stimulus by other means. The boundaries between government fiscal policy and independent central bank monetary policy become increasingly blurred. A few years ago such corrosion would have brought charges of political interference and manipulation. Today, so bleak are our prospects, such objections now seem precious.
Will the lending boost this week work in the manner intended? After all, much hope was vested in quantitative easing. This, it was said, would kickstart bank lending to the non-financial business sector. Some £325 billion of QE has already been pumped in, the bulk of it used by the banks to buy government bonds and replenish reserves. There has been little evidence of a step-up in bank lending to business, particularly the SME sector.
The lending stimulus plan takes two forms. There is an opaquely entitled Extended Collateral Term Repo (ECTR to add to the collection of acronyms). This will see £5bn a month made available to the banks in the form of six month loans. The key difference to similar existing schemes is that there is a broader category of assets that the banks can put up as security.
The second component is “Funding for Lending”. This will see the Bank of England lending money with the specific aim of getting it passed on into the real economy. The three to four year loans will be provided on the condition that the commercial banks on-lend to households and businesses. The total amount being made available is as yet unclear. But indications are that it would see a five per cent increase in lending, equivalent to some £80bn of new loans.
But will this work? Our biggest financial problem at present (after the chronic overhang of public and household debt) is not in fact a cash shortage. It’s an all-pervasive hoarding of cash. The banks say they have had little option to add to their cash hoarding to meet regulatory requirements on prudential reserves. Similar constraints across Europe have added to the economic slowdown. And, given the exposure of UK banks to stricken Eurozone economies such as Spain and Italy, they are in deep fear that further massive provisioning may lie ahead.
The other cash hoarders are companies themselves. Cash on company balance sheets is now at historically high levels. The total across Europe (including the UK) is now reckoned at more than $1 trillion. At the same time, UK business investment has slumped to just eight per cent of GDP, the lowest since data began in 1965. Andrew Milligan, head of global strategy at Standard Life Investments, says it is “hard to see a sustained revival in any of these major economies unless companies start to release this cash”.
This brings us to the single biggest doubt over the efficacy of the lending boost plans: a dearth of confidence, evident not just within banks but across the entire business sector. The appetite for borrowing has shrunk because companies do not see much prospect of a recovery in domestic or consumer demand any time soon. On this perspective, the low level of bank lending is not a cause of our economic standstill, but a symptom of a greater problem: a deepening demand collapse that is going to require another Plan A revision: tax cuts to boost spending.
The Eurozone made simple
As a background to the Greek vote today, the following guide doing the rounds on the blogosphere may help put the crisis in context:
1. “Spain is not Greece.”
Elena Salgado, Spanish finance minister, February 2010.
2. “Portugal is not Greece.”
The Economist, 22 April 2010.
3. “Ireland is not in ‘Greek territory.’”
Irish finance minister Brian Lenihan.
4. “Greece is not Ireland.”
George Papaconstantinou, Greek finance minister, 8 November, 2010.
5. “Spain is neither Ireland nor Portugal.”
Elena Salgado, Spanish finance minister, 16 November 2010.
6. “Neither Spain nor Portugal is Ireland.”
Angel Gurria, secretary-general OECD, 18 November, 2010.
7. “Spain is not Uganda”
Rajoy to Guindos... last weekend!
8. “Italy is not Spain”
Ed Parker, Fitch MD, 12 June 2012.
So glad to have cleared up any confusion.