Former Bank of England Governor Mervyn King - interviewby Stephen Jewell
We’re right to feel nervous about the state of the world economy, according to the UK’s former top banker.
"Many good ideas have originated in New Zealand, going back to the 19th century with pensions and voting rights,” says former Bank of England Governor Mervyn King.
He even borrowed the idea of inflation targeting – where a central bank aims to keep inflation within a band over a specific period – from David Lange’s Labour Government, which in 1990 was the first in the world to introduce it. Now more than 30 countries and all the big central banks are using inflation targeting, King says.
“We learnt a lot from New Zealand when we introduced our own inflation targeting in 1992,” King told the Listener, “but I like to think that we took it further.”
The world has moved on since those days, having experienced the worst financial crisis since the Depression. And the effects are still lingering.
“We’re still feeling the effects of the crisis in the banking system that ended in 2008, and the reason for that is that there is a basic disequilibrium where the policies that have been adopted, while helpful in the short term, have not actually resolved anything. Until we face up to the fact that we need to solve those problems, we’re going to see a continuation of slow growth.”
Echoing the quote from Charles Dickens’ A Tale of Two Cities that prefaces the introduction of his new book, The End of Alchemy, he really did experience the best and the worst of times in his two decades at the UK’s central bank. Having arrived at the height of the 90s boom as chief economist and rising to the top post of governor in 2003, his job was to navigate the UK out of the financial storm that gripped the globe in 2007 and 2008.
However, he describes it as merely “the latest in a long series of crises in the way that we manage money and banking”, maintaining that the majority of the world’s advanced economies have still not completely recovered from the downturn, with many continuing to experience a period of what he terms “secular stagnation” caused by a significant imbalance between savings and spending linked to ongoing low interest rates. Recovery in the US and UK has ebbed and flowed, he says, China has been slowing, Japan is struggling and the euro zone is relying on the stimulus from a lower exchange rate.
“If real interest rates remain close to zero, the disequilibrium in spending and saving will continue and the ultimate adjustment to a new equilibrium will be all the more painful.”
Retiring from the bank in 2013, the now Baron King of Lothbury, who turns 68 this month, was inspired to write the book by a conversation he had with his opposite number at the People’s Bank of China. “He said that the Chinese had learnt a lot from the West about competition and market economies, but he thought we still hadn’t got the hang of money or banking,” recalls King. “I thought that was a very astute remark because it made me think about the fact that while we don’t have periodic crises in the steel industry, we actually have quite regular crises with money and banking.”
CRISES A WAY OF LIFE
Banking crises are endemic to a market economy, King writes, but over the past 50 years, the size and concentration of banks and the risks they undertake has increased astronomically. JP Morgan today accounts for much the same proportion of US banking as the top 10 banks put together in 1960. At the same time, banking is now at the heart of the payments system, enabling salaries and bills to be paid and loans and other transactions to be fulfilled. “Because of [banking’s] critical role in the infrastructure of the economy, markets correctly believed that no government could let a bank fail.” Creditors were also willing to lend “at lower interest rates than would otherwise have been on offer because they were confident – correctly as it turned out – that even if things went wrong, taxpayers would see them right.”
If there is a future crash, however, blame shouldn’t necessarily be attributed to some apparently greedy, wicked bankers, King says. “The reasons for that go rather deep, and are more to do with the fundamental problem of a market economy that cannot provide all the price and investment signals that are needed,” he says, suggesting that there is an inherent problem linking a known present to an essentially unknowable future as the effects of events such as the Berlin Wall’s fall can never be predicted.
“People don’t know what they’re going to want to buy in the future, and so producers have no idea if there will be any future demand for their goods,” he adds, noting that technological developments often render many long-standing goods obsolete as consumers have turned to buying many previously “unimaginable” products such as airline flights, cars and antibiotics.
And then there’s the problem of achieving the best outcome when it’s difficult to co-operate, commonly called the prisoner’s dilemma. In its basic form, two prisoners who have been arrested and kept apart are offered a deal: if they incriminate each other, they receive a light sentence; if only one incriminates, they receive a stiff sentence; and if neither incriminates, they are set free. “Clearly, the best outcome is for both to remain silent,” he writes. “But the only way to guarantee the avoidance of a severe sentence is to incriminate the other.”
In the global financial crisis, bankers “tried to behave in what they saw as a rational manner, but the collective outcome was disastrous. Because they could not affect the behaviour of others, all the key actors in the drama were understandably acting in their own self-interest. Since for one reason or another they could not co-operate with the other players, they all ended up worse off – an example of the prisoner’s dilemma.”
King is also far from confident about the future of Europe’s Economic Monetary Union, calling it “the most ambitious project undertaken in monetary history”. Some countries entered the union with a higher rate of wage and cost inflation than others, he says, and “a single interest rate leads inexorably to divergences in competitiveness”.
The inevitability of restructuring Greek debt means taxpayers in Germany and elsewhere will have to absorb substantial losses, and the country may choose instead to exit the union. King points out that Germany paid little of its own reparations following World War I and defaulted on some overseas loans. Monetary union, meanwhile, has created a conflict between “a centralised elite on the one hand and the forces of democracy at the national level on the other”. Such “creeping transfer of sovereignty to an unelected centre is deeply flawed and will meet popular resistance”.
Insisting on a wider scale that “we’re all in it together”, King expresses concern that the good work done by the G20 nations in 2009 to tackle the devastating events of the previous year has not continued. “They worked very closely together to reassure people that they would take steps to deal with the problems, not just in the banking sector but in economies as a whole,” says King. “But by 2010, that degree of co-operation was starting to leak away, and frankly, we’re now back to the old world of rather meaningless communiqués.”
Few families have the following conversation, he writes: “Darling, I’m worried that domestic spending in the economy is too high and that at some point real interest rates will have to rise and the trade deficit come down. At that point, domestic spending will fall and we’ll be part of that adjustment.” The Federal Reserve argued that an increase in house prices should increase consumer spending. But King says a rise in house prices increases the wealth of the homeowner as landlord but also increases the implicit rent paid by the owner-occupier as tenant – higher prices don’t mean you can afford a new car or big holiday.
PRESCRIPTION FOR A CURE
So, what does he recommend? Believing that boosting productivity is one of the best ways for individual countries to increase growth, King maintains that the Trans-Pacific Partnership agreement that New Zealand has entered into with Australia, the US and other Asia-Pacific nations can only be beneficial. “We always need to improve the outlook for productivity, which is easy to talk about but much harder to actually achieve,” he says.
“Enhancing trade is one of the best ways of boosting productivity and growth, so if there are opportunities around the world to reduce any further barriers to trade, especially in services, then we must take them.”
He also advocates reinvigorating the International Monetary Fund (IMF) and reforming its voting system, including an end to a veto by any one country, and putting in place a system of swap agreements. Resentment towards conditions imposed by the IMF and the US has, he says, led Asian countries to create their own institutions and last-resort lenders, such as the Chiang Mai Initiative, bilateral swap arrangements and the Asian Infrastructure Investment Bank.
Although reform has been necessary, King maintains that central banks still have an important role to play if any future financial crisis is to be averted. “When times are normal, they have to continue making sure that the right amount of money is being created to allow the economy to grow, but not too much because that creates inflation. Then in bad times or a crisis, if there is demand for extra liquidity, the bank can provide it. But they need to work out the right amount of money to put in during both good and bad times, which was one of the weaknesses before the 2008 crisis as there were at least two different versions of what a central bank should be doing.”
However, King doesn’t approve of exchange-rate fixing, which is often associated with inflation targeting. “One of the things that has gone wrong in the past 15 years is that people have been mistakenly persuaded that by doing that you solve lots of problems,” he says. “But the future is inherently unknowable, so there will always be radical uncertainty, and all kinds of shocks can come along that we cannot easily anticipate.
“The great advantage of a flexible exchange rate is that it’s extremely easy to co-ordinate the movement in prices of domestic costs in terms of overseas currency rather than having to push down the wages of every person in every company and occupation in the country.”
END OF ALCHEMY: BANKING, THE GLOBAL ECONOMY & FUTURE OF MONEY, by Mervyn King (Little, Brown, $39.99).
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