The Bank of England's volte-face on financial bail-outs seemed to be complete yesterday with news that it is preparing to inject £10bn of term money into the money markets in a bid to bring three-month rates down to more normal levels.
Merv seems finally to have proved himself a more or less total swerve, so much so that the City has been left wondering whether he is any longer in charge of the show at all. Instead, policy looks as if it is being dictated by the Treasury and the Financial Services Authority. Is the Governor's credibility so shot to bits that he should resign? The wolves are certainly at his door, but though I have been critical of the Bank's handling of the credit crisis, I'm not convinced by those baying for blood.
Much depends on his performance before MPs today. This public grilling is surely the most important of his career. He'll need to summon up every ounce of his intellect to see off his critics. The answer to the question of whether he should resign also depends on how the crisis pans out. If there is now a gradual return to calm, then everyone will be much more tolerant. The Governor might even be able to claim he played it right. But if it gets worse, then all bets are off.
Mr King is an honourable man, and I therefore suspect he will already have considered locking himself in the study with the loaded revolver and the bottle of whisky. Yet if you wanted to make a serious situation a great deal worse, there would be no better way than to have the Governor fall on his sword in the midst of it.
Neither Gordon Brown, the Prime Minister, nor the Chancellor, Alistair Darling, have yet notably come riding to the Governor's rescue by issuing statements of confidence in the Bank's handling of the crisis. Unless they truly believe Mr King to be a busted flush, perhaps they should.
The case for the prosecution is certainly a damning one. Mr King admittedly didn't rule out the course of action he took yesterday in his statement to the Commons Treasury Committee, but he came pretty close by taking such a strong stance against it. The provision of large liquidity facilities penalises those financial institutions that sat out the dance, he said, encourages herd-like behaviour and increases the intensity of future crises.
I doubt he meant it as a deliberate slight to either the European Central Bank or the US Federal Reserve, both of which had already indulged extensively in this form of support, but that's certainly the way they took it. It wouldn't be thought polite for central bankers to respond directly to such criticism, but there are no such constraints on a former chairman of the Fed. Alan Greenspan has dismissed Mr King's strictures out of hand.
The problem with now applying the liquidity that Mr King has to date been so reluctant to use is that it further adds to the sense of crisis. The implication is that things must be really serious to have prompted such a U-turn. OK, so the Northern Rock debacle considerably changed the dynamics of the crisis, but it seemed to be abating. The message from yesterday's actions is that the situation may still be worse than assumed.
It is this sort of confusion that has coloured the Bank's entire approach to the crisis. At every stage, the Bank seems to have been forced into doing something it had previously thought inappropriate, thus compounding the sense of crisis rather than defusing it.
You can't help thinking that it wouldn't have happened if Eddie George, a Bank of England Governor out of the old school with a sureness of touch which commanded real authority in the City, had still been around. Gordon Brown wanted a professional economist in the job, which is why he chose Mr King as Sir Eddie's successor. But as we are now seeing, at times like these, the position also requires an experienced banker. Mr King didn't seem to want to listen to the City, adopting instead an academic and high-minded approach to the problem in hand.
We'll never know what would have happened had the Bank provided the liquidity it now promises at an earlier stage, but it possibly would have saved the authorities from the extreme embarrassment of having to underwrite the deposits of the entire UK banking system. Mr King's considerable achievement in the management of interest rate policy gives him the right to a second chance. But he is going to have to give a better account of himself before today's Treasury Committee than he's managed so far.
Parallels with 1998 will make Bank cautious on rates
History never repeats itself exactly, but even so there are unmistakable similarities between the way in which the authorities responded to the credit crunch of 1998 and what's happening with the present crisis in debt markets. Then as now, the US Federal Reserve reacted to the disruption by sharply cutting interest rates and flooding the system with liquidity. There were also rescues and bail-outs.
Then as presumably now, recession was as a consequence narrowly avoided. And then as now, share prices staged a dramatic recovery once it was realised that the immediate danger had passed. The parallels are far from exact. The immediate cause of the 1998 credit crunch was the Russian debt default. Today's seizing up of the money markets was prompted by the meltdown in US sub-prime lending.
Yet the similarities are close enough, and, by providing support to rescue the system from paralysis, there is again a danger that the authorities will go too far. Back in 1998, the Fed's actions stemmed the immediate crisis, but they also helped stoke the latter stages of the dotcom bubble.
The really serious excesses in markets took place after 1998, and were arguably a direct consequence of the cheap money policy put in place earlier. By cutting rates sharply, the Fed may have prolonged the cycle a bit, but the effect was like a morphine drip which alleviates the pain but fails to treat the underlying disease.
By delaying the inevitable comedown after a long boom, the Fed may have made the eventual outcome much worse. This is the moral hazard problem which has so exercised Mervyn King. If investors believe they are always underwritten, it will encourage ever more reckless behaviour.
So if not now, when will the present expansion blow up in our faces? The fashionable though wholly unscientific view is that we are little more than a year away from the final reckoning, which will be marked by the Beijing Olympics and the US presidential elections, the former as a climatic moment in China's development story, after which it will collapse in exhaustion, the latter as the point at which new political blood grips the problem of public and private debt to undertake a painful rebooting of the US economy.
If these two events pan out in the way just described, they certainly have the potential to tip the world into recession. There was a similar combination of events which preceded the last downturn – the end of millennium and a change of administration in the US. Bizarrely, they postdated the actions of central bankers in dealing with the 1998 credit crunch by almost exactly the same time frame. Spooky, or what?
Still, at this stage, it's only a theory. Or is it? Personally I'm not convinced by the consensus view that a cut in UK interest rates later this year is now wholly inevitable. Following the volte-face on market intervention, there seems to be a collective belief in the City that Mervyn King is now on the run and will do almost anything the markets demand. This I very much doubt. With underlying inflationary pressures still to the fore and the warning of 1998 to look back on, I'd expect the Bank of England to hold the line on interest rates.
Back in 1998, the Bank was again more cautious in acting than the Fed. The Bank didn't cut interest rates until later, and, even then, not by as much and only in response to clear evidence of a fast-slowing economy. Arguably, this served Britain's long-term interests better. The subsequent boom was not quite as heady as it was in the US nor the following downturn nearly as bad.