Sean O'Grady: No wonder the Bank of England Governor is feeling grumpy

Economic Life: The opportunity to forge a new deal in the eurozone and a 'New Bretton Woods' came and went during what we thought was the recovery

In his Inflation Report press conference the Governor of the Bank of England, Sir Mervyn King was, to us seasoned King-watchers, a bit grumpy. That is not his habitualdemeanour, at least in public. Then again, he has a lot to grump about.

Click HERE to upload graphic (131k jpg)

The Bank had to downgrade its growth forecasts, again, and had to admit that inflation would indeed hit 5 per cent, on the CPI measure,later in the year. The risks to the British economy, he rightly pointed out, came principally from abroad, about which he and his colleagues can do very little except pile up the sandbags around our own banking system and economy.

Indeed, the obvious risks to growth from the incessant sovereign debt crises in the eurozone are so substantial that the Bank doesn't even count them in its "fan chart" of possible outcomes. Again, it's correct in "abstracting" those, in the sense that there isn't a meaningful figure that can be attached to them. Yet we all know that they could render the Bank's calculations irrelevant. Sir Mervyn might also be forgiven for being out of sorts because, as his deputy for monetary policy, Charlie Bean said, the recessionary hit to the economy's capacity to produce may be more substantial and long lasting than might have been hoped. That means that growth will be slower and inflation higher for any given level of interest rates than would have been the case if the factories hadn't shut, the offices closed and the pubs and shops gone bust in the great recession. Or interest rates have to be higher than they would otherwise be – another way of saying we will have to be poorer. Or that the non-inflationary rate of unemployment has gone up. They did that at the previous inflation report too.

To see that jargon in tangible form, you only have to wander around any town and see the number of redundant, empty and abandoned pubs, shops, offices, industrial units and former banks, premises that have been idle for years now, and with little sign of them being put back to productive use – ever. They may as well be demolished, as some sites have already been, the productive potential gone forever. It is as if some alien air force had come and rained bombs down upon us.

Much of our physical and even human capital has been scrapped, and more than the Bank presumed before. Meanwhile, British business sits on £60bn of spare funds, too nervous to invest it because of the manifest economic and political risks, so rebuilding economic capacity will take longer than it might.

All this is not so very unusual in a "recovery" that follows a financial crisis, and has happened before, although you have to go back a long way to find precedents. In any case, it is a phenomenon that should make us all nervous.

The good news, as Sir Mervyn pointed out, is that so far private sector job creation has been healthy, and in the spring was geared towards full-time permanent positions rather than the part-time and temporary work that characterised the earlier stages of our slow recovery.

Inflation too is set to come down very sharply – the Bank even claims inflation could be negative right now if it were not for the VAT hike and imported (especially fuel, energy and food) inflation. That ought to ease the squeeze on living standards.

Still, all the Bank's projections explicitly discount much of the risk from abroad. It is time now to consider what that risk precisely involves, and how this island fortress can be best defended against it.

How will it hit us? Via the British banks, intimately linked to the stresses on European ones; through trade, as 50 per cent of our exports go to the eurozone; and through a generalised knock to confidence and "animal spirits" – people's will to invest and start businesses.

The first transmission mechanism will be – probably already is – coming through the money markets. A second credit crunch has been a real possibility for many months, on the cards because of the poisonous interplay between sovereign debt crises and the still-weak banks.

The welding of the two was a product of the "too big to fail"mentality, where governments offered banks implicit guarantees – especially after the Lehman Brothers collapse in 2008. It was also a result of open-ended guarantees to depositors and creditors offered by governments.

These two are now producing what economists like to term "negative feedback loops" – vicious circles. So, if France loses its AAA credit rating then the French government bonds held by its banks are devalued. Then their balance sheets automatically shrunk, their capital adequacy is dented and their ability to lend to the real economy and other banks, and to borrow from savers and other banks, is curtailed.

Without transparency – and even with it – that can easily turn into a contagion, and there are some signs of stress in the inter-bank markets. If the banks refuse to lend to each other at virtually any interest rate, as happened in 2007, a second recession is almost guaranteed, and UK growth falls off the Bank's fan chart.

The Bank, we can be sure, has new weapons at its disposal to protect the UK's financial system, via its various repo and discount window arrangements (much neglected by commentators but crucial in a crisis), and has done its best to cajole the UK institutions to improve capital adequacy. We also have living wills and, soon, probably, ring-fenced retail banks that will ensure that "too big to fail" doesn't hit the UK taxpayer once again. What we, and Europe, do not yet have is adequate arrangements for cross-border failures and, even more crucially, the funds to rescue the banks again.

To take the French case again, it would not be easy for the French government to nationalise distressed banks if the French treasury found it impossible to issue the bonds to do so. That is the terrifying debt end-game that is spooking the markets. And, perhaps, upsetting the Governor's usual equilibrium. He must have spent a good deal of his time constructing contingency plans.

So what should the world do with all its excess debts – and excess savings in places such as China and the oil-rich Gulf states?

Sir Mervyn's answer is: "One way or another, the losses that were built up in recent years will have to be shared between creditors and debtors; in the world economy between creditors in the East and debtors in the West, and within the euro area between creditors in the North and debtors in the South.

"The key question is whether that burden-sharing will take place in the context of a downturn in the world economy, or whether it will take place in the context of a rebalancing of overall demand."

He has probably sat through far too many futile international conferences to be optimistic about matters being resolved in an orderly way, and events are forcing a violent resolution of global imbalances. The window of opportunity to forge a new deal in the eurozone and a "New Bretton Woods" came and went during what we thought was a recovery. It was, in retrospect, something of a fool's recovery. The Bank perceives this international political failing better than most. Grouchy as he is, Sir Mervyn King is no fool.

PROMOTED VIDEO
Extras
indybest
Arts and Entertainment
Judi Dench appeared at the Hay Festival to perform excerpts from Shakespearean plays
tvJudi Dench and Hugh Bonneville join Benedict Cumberbatch in BBC Shakespeare adaptations
Arts and Entertainment
Exhibition at the Centre Pompidou in Metz - 23 May 2012
art
Sport
Is this how Mario Balotelli will cruise into Liverpool?
football
News
Ronahi Serhat, a PKK fighter, in the Qandil Mountains in Iraqi Kurdistan
i100
Arts and Entertainment
Alfred Molina, left, and John Lithgow in a scene from 'Love Is Strange'
film
News
ebooksAn evocation of the conflict through the eyes of those who lived through it
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Soft Developer (4.0, C#, Windows Services, Sockets, LINQ, WCF)

£65000 - £75000 per annum: Harrington Starr: .NET Developer (4.0, C#, Windows ...

C# Developer -Winforms, VB6 - Trading Systems - Woking

£1 per annum: Harrington Starr: A leading financial software house with its He...

C #Programmer (.Net 4.0/4.5/ C#) -Hertfordshire-Finance

£45000 - £50000 per annum: Harrington Starr: C #Developer (.Net 4.0/4.5/ C#, A...

JQuery Developer JQuery, UI, Tomcat, Java - Woking

£1 per annum: Harrington Starr: JQuery Developer JQuery, UI, Tomcat, Java - Tr...

Day In a Page

Middle East crisis: We know all too much about the cruelty of Isis – but all too little about who they are

We know all too much about the cruelty of Isis – but all too little about who they are

Now Obama has seen the next US reporter to be threatened with beheading, will he blink, asks Robert Fisk
Neanderthals lived alongside humans for centuries, latest study shows

Final resting place of our Neanderthal neighbours revealed

Bones dated to 40,000 years ago show species may have died out in Belgium species co-existed
Scottish independence: The new Scots who hold fate of the UK in their hands

The new Scots who hold fate of the UK in their hands

Scotland’s immigrants are as passionate about the future of their adopted nation as anyone else
Britain's ugliest buildings: Which monstrosities should be nominated for the Dead Prize?

Blight club: Britain's ugliest buildings

Following the architect Cameron Sinclair's introduction of the Dead Prize, an award for ugly buildings, John Rentoul reflects on some of the biggest blots on the UK landscape
eBay's enduring appeal: Online auction site is still the UK's most popular e-commerce retailer

eBay's enduring appeal

The online auction site is still the UK's most popular e-commerce site
Culture Minister Ed Vaizey: ‘lack of ethnic minority and black faces on TV is weird’

'Lack of ethnic minority and black faces on TV is weird'

Culture Minister Ed Vaizey calls for immediate action to address the problem
Artist Olafur Eliasson's latest large-scale works are inspired by the paintings of JMW Turner

Magic circles: Artist Olafur Eliasson

Eliasson's works will go alongside a new exhibition of JMW Turner at Tate Britain. He tells Jay Merrick why the paintings of his hero are ripe for reinvention
Josephine Dickinson: 'A cochlear implant helped me to discover a new world of sound'

Josephine Dickinson: 'How I discovered a new world of sound'

After going deaf as a child, musician and poet Josephine Dickinson made do with a hearing aid for five decades. Then she had a cochlear implant - and everything changed
Greggs Google fail: Was the bakery's response to its logo mishap a stroke of marketing genius?

Greggs gives lesson in crisis management

After a mishap with their logo, high street staple Greggs went viral this week. But, as Simon Usborne discovers, their social media response was anything but half baked
Matthew McConaughey has been singing the praises of bumbags (shame he doesn't know how to wear one)

Matthew McConaughey sings the praises of bumbags

Shame he doesn't know how to wear one. Harriet Walker explains the dos and don'ts of fanny packs
7 best quadcopters and drones

Flying fun: 7 best quadcopters and drones

From state of the art devices with stabilised cameras to mini gadgets that can soar around the home, we take some flying objects for a spin
Joey Barton: ‘I’ve been guilty of getting a bit irate’

Joey Barton: ‘I’ve been guilty of getting a bit irate’

The midfielder returned to the Premier League after two years last weekend. The controversial character had much to discuss after his first game back
Andy Murray: I quit while I’m ahead too often

Andy Murray: I quit while I’m ahead too often

British No 1 knows his consistency as well as his fitness needs working on as he prepares for the US Open after a ‘very, very up and down’ year
Ferguson: In the heartlands of America, a descent into madness

A descent into madness in America's heartlands

David Usborne arrived in Ferguson, Missouri to be greeted by a scene more redolent of Gaza and Afghanistan
BBC’s filming of raid at Sir Cliff’s home ‘may be result of corruption’

BBC faces corruption allegation over its Sir Cliff police raid coverage

Reporter’s relationship with police under scrutiny as DG is summoned by MPs to explain extensive live broadcast of swoop on singer’s home