From Nick O’Connor – Capital & Conflict (Great Britain) –
Will the UK monetary system have a new master by the end of the week?
It just might. It seems autumn 2016 could be shaping up to be the “crowded hour” of UK monetary policy in the 21st century. At the weekend, reports surfaced that Mark Carney, governor of the Bank of England, may be close to stepping down. Several sources reported that he could even use this Thursday’s inflation report to make the announcement.
It’s all speculation for now – though Thursday will roll around quick enough and confirm things one way or another. But it’s certainly clear that Carney is under pressure. Relations between the bank and the government have deteriorated since the EU referendum, with several politicians speaking out against what they perceive as Carney’s over-willingness to talk the post-Brexit UK economy down.
According to the governor, that kind of talk threatens the bank’s independence. Last week in a Commons select committee hearing, Carney said markets had “taken note” when politicians had previously spoken out against monetary policy.
Well, yes. They will. If you give one organisation the power to set the price of money then – for better or worse – the internal politics of that organisation become a kind of price signal. That’s part of the deal when you centralise and control the most important price in the entire economy – the price to rule all prices, the price of money.
Let’s just analyse that thought for a second. How can criticism of the bank by the government threaten the bank’s independence? Surely it’s a sign that it still is independent. If the bank and the government were acting entirely in unison there would be no cause for criticism. Carney has the freedom to do things the government doesn’t agree with. Sounds like independence from where I’m sitting.
Of course independence can mean different things to different people. Former chancellor George Osborne pushed hard to have Carney appointed governor. Chances are that was because he believed their policies would be complimentary – ie, Carney would keep interest rates ultra-low and indulge in the odd bout of quantitative easing (QE), taking the strain as Osborne cut public spending.
In that context, independence for the bank essentially meant a free pass from the Treasury to do as you please. Now things are different. Osborne is gone. There’s a new government, a new PM and a new chancellor. These aren’t the people who pushed to hire Carney. Independence now means: do as you please, but don’t expect us to be happy about it, privately or publically.
To me, it sounds like Carney wants the independence to set policy free from criticism from Westminster. Power without accountability: ah, to be a public servant!
We should take all this against the backdrop of the pound’s continuing weakness. It’ll be interesting to see how the markets respond to the rumours. Keep reading Capital & Conflict all week to stay in touch (by the way, your daily issue will be with you every morning around 11am from now on).
If we’re talking about the pound we should remember what Charlie Morris had to say last week. If you missed it, Charlie’s view is that the pound’s move is consistent with the fall seen in other countries doing QE (Japan and the eurozone). Or to put it another way, the pound’s fall is a monetary policy story, not a political (Brexit) one.
And keep in mind that Charlie made a prediction: QE will end early and the pound will move higher. Maybe Carney will switch his printing presses off on the way to Heathrow, go long the pound on the plane and arrive back in Canada better off. Everyone wins!
That’s probably enough speculation for now. Oh go on then, let’s indulge ourselves a little more. If the bank were to find itself in need of a new governor, who might it be? Would the bank perhaps lurch towards a more hawkish position or would we get more of the same? You can bet that would have an effect on the pound. The race to become the next governor would itself become a price signal. A price signal within a price signal, like some strange and hard-to-grasp derivative.
I doubt there’ll be a candidate we’d support here at Capital & Conflict. But let’s not be hasty. Perhaps they’ll come ask what we think. I’m sure publisher Dan Denning could be persuaded to have a crack. Imagine that – a central bank acting in the interests of sound money, free markets and personal liberty.
What would that look like? I can’t imagine. Maybe you can. If so I’d love to hear what that world would look like. I’m on email@example.com.
Politics of the pound
In other news, we got another reminder of just how tangled and warped the dual worlds of central banking and politics are becoming on Friday.
A judge in Northern Ireland ruled in the government’s favour on two separate challenges to the Brexit process. The pound promptly dropped 50 pips in short order.
Though take note: the court also said it’d defer to the English courts on the issue of whether Teresa May’s government can invoke Article 50 without first holding a vote in Parliament. So don’t expect the story to go away overnight. Chances are we’ll see it play out again in the near future, as politicians wrangle with the technical processes involved in exiting the European Union.
Again, the decision of a judge on a political issue shouldn’t really act as a price signal for the national currency. But we don’t live in a perfect world. We should understand that fact and, while we’re at it, figure out a way of using that understanding to profit from the sharp moves we’re seeing in the currency markets. You don’t have to like it to make money from it. More on that in a future issue.
More news on the future of the world’s most important commodity again over the weekend. Oil prices slumped after another Opec meeting in which divisions within the cartel were obvious.
There’s a strange symmetry developing between central bank policy and the way Opec is acting. Central banks talk of “forward guidance” to set expectations in the market. In simple terms this means if the Bank of England wants the pound to go up it’ll start talking about an interest rate rise, hoping that talk alone will do the trick. If it works, the markets do what the bank wants without it ever having to raise interest rates.
Now look at what’s happening with Opec. What Opec wants is stability for the oil price. It may even want prices to tick higher (more on that in a second). To do this it knows a cut in production is probably required. But failing that, talk of a future cut – forward guidance – will suffice.
Going into the latest Opec meeting over the weekend, that seemed to be the most likely outcome. Not a cut. But more talk of one. Some guidance for the market to digest.
It didn’t work like that. A cartel only works if the whole is greater than the sum of the parts. There has to be unity. The individual goals and ambitions of each individual nation have to mirror the goals of the whole group, otherwise you get chaos.
We’re not quite at chaos yet, but we’re getting there. Opec is only as strong as it is united, and right now it’s divided. Before the weekend, the plan Opec had been indicating to the market was for a production cut in November. This meeting was a precursor to that and a chance to talk the plan up.
The problem is, it became clear over the weekend that more and more nations are now seeking an exemption from the cut. The more nations do that the more pointless the cut itself is. And there’s always the underlying threat that if Opec as a whole cuts production, an individual nation could go rogue and increase it to gain market share.
In short, national interests are trumping the interests of the wider organisation. Why is that?
Keep in mind that Opec is not a central bank – it can’t just “set” the price of oil the way a central bank can just decide what the price of money (the interest rate) should be. It can’t know exactly what will happen if it cuts production.
That introduces an element of risk. Imagine you’re an oil producing nation and 40% of your national revenue comes from oil. You’ve just suffered a major bear market and your national finances are in a mess. What happens if you cut production… only for the price to stay the same? You lose money. You’re selling less oil at the same price as before. The price climb has to make up for the loss of volume. If it doesn’t, you’re in trouble.
That introduces risk to the equation. It makes you think twice before agreeing to cut along with other Opec nations. And that fundamentally weakens Opec’s position.
And remember this: Opec is looking for the “perfect” oil price for itself and its members. Not too high and not too low. The Goldilocks price. If prices fall too far, its own members will suffer again. If prices spike, that helps its rivals – mostly shale and other tight oil producers in the US.
Narrow margin for error and discord within the group. What could go wrong?
Who knows. But going into the weekend, US Commodity Futures Trading Commission data showed that short positions against oil futures are at their highest level since 2007.
We’ll come back to this as the week goes on.