BRITAIN has a credibility problem – and no, I’m not only talking about the government’s hypocritical and self-serving protectionist rhetoric on Cadbury. Yesterday’s inflation figures were even more damaging.
The consumer price index (CPI) rate jumped to 2.9 per cent from 1.9 per cent in November; when the Vat hikes kick in, inflation is bound to rise above 3 per cent, triggering a sixth explanatory letter from Bank of England Governor Mervyn King, as previously predicted in this space. Even worse, the retail price index excluding mortgage interest payments (RPIX) measure of inflation, formerly the official target, rose to 3.8 per cent – this would already have required a letter under the old rules.
We are not about to lurch into hyperinflationary territory, despite all quantitative easing and near-zero rates. But all prices are now going up together, at a faster rate than most forecasters had expected: consumer prices, house prices, commodity prices, equity prices and so on. This is a clear indication that monetary policy is too loose, especially given that the economy started growing again in the fourth quarter.
Investors will soon start to build in an inflation and bubble risk premium when dealing with the UK, further damaging what’s left of our international credibility. It is time to end quantitative easing and to hike interest rates – there is no time to lose.
MARKETS BEST DISCIPLINE OF ALL
Few people realise that the discipline exercised by real free markets tends to be much stricter than anything regulators ever muster. In 1840s America, before the introduction of government-provided deposit insurance, banks had a capital buffer in excess of 50 per cent of assets (they needed to reassure their depositors, who stood to lose everything, they would never go bust). High capital ratios were also the norm in 19th century Britain.
Following the onset of regulation – but prior to the savings and loan debacle of the 1980s – US commercial banks had a capital ratio of 7.0 per cent and savings and loan institutions a minimum of 5.0 per cent, according to the Cato Institute.
On the face of it, the Basel I international standards, adopted in 1988, were tough. They put the base ratio at 8.0 per cent – but this varied depending on the class of asset. Banks needed only 4 percent for mortgages and 1.6 per cent for AAA-rated asset-backed securities. Basel II reduced the capital set aside for mortgages to 2.8 per cent and decreed that AAA tranches of a collateralised debt obligation funded by mortgages would be 0.56 per cent. Basel III’s final proposals will be more realistic, one must hope.
Remember that next time someone tells you that there were no international banking rules before the crisis. There were plenty – yet they actually promoted more riskiness than would have been the case in a free market. Ultimately, there is only one kind of pressure that works: the fear of total failure, of going bankrupt and of being wiped out. That is why all of this talk of too big to fail is nonsensical. It must be replaced instead with a system where even the biggest banks can be wound down in the event of insolvency. Forget about super-taxes or global insurance levies: we need new bankruptcy and resolution laws as well as living wills of the sort the government and others are working on. It sounds boring but it is crucial to the City’s long-term soundness.