Bank to the Rescue
On 22nd June, Andrew Bailey, Governor of the Bank of England gave an interview to Sky News.
The headline from the above story ran as follows.
The link contains the full interview, but I include the following quotes to give the reader a flavour.
“I think we would have a situation where in the worst element, the government would have struggled to fund itself in the short run.”
Asked what would have happened if the Bank had not intervened, he replied: “I think the prospects would have been very bad. It would have been very serious.”
“We basically had a pretty near meltdown of some of the core financial markets,”
Rishi Sunak is a everyone’s favourite politician; he’s got a lovely smile and he’s writing a lot of cheques. Rishi has got us! However, when we are sticking our Rishi posters to the fridge, perhaps we should instead think like that consummate investigative journalist, Lois Lane. Lois, who when falling from a helicopter only to be swept up in Superman’s arms, responded to his cheesy yet comforting refrain, “Easy Miss, I’ve got you” with what, given the circumstances, was a surprisingly clinical response, “You’ve got me….Who’s got you? If you’ve got us Rishi; who’s got you? The guy with the cape and fancy tights in our story, is the aforementioned Andrew Bailey at The Bank of England.
To understand the dynamic at work, consider the following. For the UK Government to be able to stand behind the UK economy, pay furloughed workers wages etc. it must be able to borrow the money to do so. What is more, given the already substantial debt pile, they need to be able to do so very cheaply indeed.
UK 30 Year Gilt Yield
This chart shows the yield on the UK 30-year Gilt. As we entered March and the coronavirus panic gathered momentum, gilts initially benefitted, and yields fell from around 0.9% to 0.4% on 9th March. However, in the next 8 sessions we entered the “pretty near meltdown of some of the core financial markets” part of the story as the gilt market started to crash along with equities and the yield went above 1.5%. On 19th March, this crash was averted by the Bank of England’s announcement of £200bn in QE.
Absent this intervention, it is not obvious what would have come to the rescue of the UK gilt market and where we would be as a country as a result. As such we agree wholeheartedly with Mr Bailey’s sentiment that “The Bank of England saved the UK from effective insolvency in the early stages of the coronavirus pandemic”.
On the same day, 22nd June, the same Andrew Bailey appeared to be talking out of the other side of his mouth in an opinion piece for Bloomberg.
“The current scale of central bank reserves mustn’t become a permanent feature,”
“As economies recover, it’s likely that some of the exceptional monetary stimulus will need to be withdrawn, including by reducing reserves.”
Given the outlook for the UK, our view is that unless the UK Government is prepared to run substantial and persistent deficits for a very long time to come, then the prognosis for the UK economy is bleak. Also, given the mood of the nation, any Government that refuses to run those deficits will be kicked out of office at the earliest opportunity. Given this reality, unless the Bank of England is prepared to see “a pretty near meltdown of some of the core financial markets,” again in the future, it is our strong view that in fact, the current scale of central bank reserves will become a permanent feature.
The reality of the situation is that a Government that can print its own currency is highly unlikely to have its solvency compromised by failing to use that ability as and when required. What is more, now the genie is out of the bottle in terms of broader public awareness, politicians are unlikely to sacrifice their electoral prospects by assuming the policies that would allow “the current scale of bank reserves not to become a permanent feature”. True central bank independence has always been and always will be a canard, that was to be revealed as such when push came to shove. We have reached the pushing and shoving stage.
Today, UK 30-year gilts currently yield a little over 0.6%. Given the Bank of England’s explicit inflation target of around 2%, to find that an attractive investment one must believe at least one of the following to be true. The Bank is going to massively undershoot its inflation target for three decades; that regulations will force certain market participants to be buyers in sufficient size; that everything else is going to be worse; or that central banks will be there to support the market to keep yields at politically expedient levels and avoid the aforementioned solvency crisis from occurring. From our perspective, a 30-year gilt purchased today and held to maturity is virtually certain to be both “money good” and simultaneously provide a catastrophic destruction of future purchasing power.