Investor Misgivings Disallowed
The central banking superhero the UK imported from Canada (where he helped create one of the biggest housing and consumer credit bubbles anywhere, ever), is letting us know that monetary bureaucrats definitely know better than the market at what level interest rates should be. And since the one thing he evidently knows best is to 'provide stimulus' by cutting rates, this is what he is threatening to do:
"Bank of England Governor Mark Carney said officials are ready to add stimulus if investor expectations for higher interest rates undermine the recovery.
"The upward move in market expectations of where bank rate will head in future could, at the margin, feed into the effective financial conditions facing the real economy," Carney said in a speech to business leaders in Nottingham, England today. "If they tighten, and the recovery seems to be falling short of the strong growth we need, we will consider carefully whether, and how best, to stimulate the recovery further."
Carney introduced forward guidance this month to help the economic recovery, saying that policy makers plan to keep the benchmark interest rate at a record-low 0.5 percent for at least three years. Indications of strengthening U.K. growth and the U.S. Federal Reserve's signals it may begin trimming its monthly purchases have prompted investors to raise bets that rates will rise sooner and push up gilt yields.
"Our forward guidance was clear that, although we would not reduce the stimulus until the recovery is secure, we would if necessary provide more," Carney said. "We are focused on doing what we can to reduce uncertainty and build resilience so that the recovery can be sustained despite the inevitable shocks ahead."
In short, Mr, Carney plans to suppress any attempt by market forces to raise interest rates. If he were attempting to suppress the market price for apples, economists would chastise him for implementing price controls, since every economist knows they can never work. Curiously, they are silent when the same is proposed in connection with interest rates. We were not there when Mr. Carney delivered his speech, but we are fairly certain that no-one present objected to his plans.
Interest Rates Are too Important to Be Left to Central Planners
Readers may have noticed that whenever we get one of these pronouncements, there is never a word about what interest rates actually are. Let us refresh memories: the originary, or natural interest rate expresses the time discount of future against present goods. Or putting it differently: it conveys information about people's time preferences on a society-wide basis. Market interest rates contain additional components: a risk premium reflecting the creditworthiness of borrowers, a price premium reflecting the expected decline of money's purchasing power, and an entrepreneurial component – the profit margin of the lender, often a financial intermediary.
The most important component however is the time discount that reveals time preferences. It tells us what consumers' preferred ratio of saving and investment relative to consumption is, and what type of capital structure is therefore best suited to fulfill consumer wants. In other words, it conveys extremely important information that will be falsified if an entity like the central bank manipulates interest rates.
The result of keeping rates lower than they would otherwise be – precisely what Carney proposes to do – is not to create a 'sustainable recovery'. It creates an illusory recovery, as investment projects that are not in keeping with the wishes expressed by consumers seemingly become profitable. While these projects are inaugurated, the aggregate economic data will in most cases improve in the short term, in spite of the fact that what is going on is actually capital malinvestment. Although real savings are not sufficient to support these projects, they can be funded for a while by capital consumption as well as forced saving (the latter is a result of wages not keeping up with the speed at which money is devalued, which is lowering consumption coercively). An illusory prosperity ensues – ironically, while things appear to be getting better on the surface, there is actually gradual impoverishment.
By artificially lowering rates, all the central bank can achieve is another boom based on malinvestment – the bubble Mark Carney's deputy Mr. Bean cannot see is going to be set into motion. This will weaken the economy's ability to generate real wealth further, and the accounting profits that will be made early on in the process are bound to be revealed as illusions later on (consider how the accounting profits of all those involved in the U.S. real estate boom disappeared in a flash as soon as the Fed's monetary pumping merely slowed down).
Regardless of how well-meaning the central planners are, their decisions will lead to a sub-optimal outcome relative to a market-derived outcome. Lastly, the attempt to influence interest rates cannot be continued indefinitely, as it will require more and more fiduciary media (uncovered money substitutes literally created from thin air) to be thrown on the loan market. Eventually this will affect not only relative prices and falsify economic calculation, but will lead to a noticeable devaluation of the money so generously issued. At that point, so the BoE has already promised, it will voluntarily stop the 'stimulation'. That will however end the illusory boom, so what is the point? Ending it later will only result in a far more painful bust than would have occurred otherwise.
Mark Carney: the man responsible for leaving Canada's households mired in debt and the country sporting one of the most egregious property bubbles in the world, is set to repeat the same feat in the UK.
(Photo via telegraph.co.uk)
Today's Rate Levels in the Historical Context
We have come across a very interesting chart that puts today's situation in perspective. Bank of America has recently published a chart book containing very long term charts. Since the Bank of England is the oldest central bank in the world (it was established in 1694), UK base interest rates are among the longest running economic data series available. So where are today's base rates relative to over 300 years of history? It turns out that they have never been lower – not even during the Great Depression era, or at any time before that, when the UK was still on a metallic standard. Clearly the current situation is highly unusual. It should also be pointed out how bizarre it is to hear the head of the central bank talk of 'more stimulation' in the middle of an explosive rise in money supply growth.
The UK base lending rate administered by the Bank of England between 1705 and today. It has never been lower in over 300 years – via BofA / Merrill – click to enlarge.
We think it is a very good bet that current administered UK interest rates do not reflect the time preferences of consumers. Boom conditions will very likely make an appearance as a result of the recent sharp acceleration in UK true money supply growth. Mr. Carney, following his thinking presented above, will then presumably conclude that a 'sustainable recovery' is underway. In reality, his policies will have inflicted even more structural damage on the economy and another bust will inevitably follow in the boom's wake.