Britannia Radio

SUNDAY TELEGRAPH    9.11.08
The day the Bank of England cut interest rates to 3pc is the day it 
lost its marbles
Ever since Thursday lunch-time, I've received a flurry of emails from 
friends asking what I'd write this weekend.

By LIam Halligan

As regular readers will know, for months - years! - I've banged on 
about the inflationary dangers of cutting interest rates too sharply.

In August 2005, the Bank of England's Monetary Policy Committee 
lowered rates to 4.5 per cent, when CPI inflation was on its 2.0 per 
cent target - but definitely on the way up. Back then, I accused the 
Bank of treading "a perilous path", while risking "a further 
acceleration in the growth of credit".

In December 2007, during the first wave of the sub-prime crisis, the 
Bank cut rates to 5.5 per cent, with the CPI already at 2.1 per cent. 
Even in those tranquil times, interbank rates still rose despite the 
MPC's rate cut - and I observed the Bank had "shot its bolt".

Only last week, after the US Federal Reserve lowered rates 0.5 per 
cent, I warned that if the Bank followed suit with such a "deep cut" 
it "could well makes matters worse".

Now the MPC has slashed rates by a staggering 1.5 percentage points 
in a single, mega-move. That's three times bigger than any shift 
since the Bank became independent - or "independent" - back in 1997.

UK base rates are now 3 per cent - the lowest since 1955 - even 
though CPI inflation is 5.2 per cent - a 16-year high. What do I say 
at a time like this? How angry should I get? That's why friends were 
in touch - to remind me to use language within the limits of decency.

So let me suggest - weighing every word - that future historians will 
look back on last week and shake their heads in disbelief. They will 
identify Thursday 6 November as the moment the Old Lady of 
Threadneedle Street went ga-ga.

Thanks to the wisdom of Gordon Brown, the UK has endured a decade of 
grossly irresponsible fiscal policy. This is the start of a period of 
zero-credibility in terms of monetary policy too.

We are kidding ourselves to say "inflation is dead". Fiscal policy 
and now monetary policy are wildly expansionary. Across the Western 
world, multi-billion dollar bail-outs are being funded by issuing 
debt and printing money - which will generate a new wave of 
inflation, making it even harder to escape the slump.

Suddenly, a consensus has sprung from nowhere that the Western world 
faces "deflation" - a situation where prices fall. Deflation is 
dangerous. Debts rise in real terms and price signals stop working.

I accept "le crunch" is very serious - and there is evidence, as the 
Bank said last week, of a "severe contraction". But inflationary 
expectations remain sky-high. We're a million miles from absolute 
price falls.

Yet still, the Bank must slash rates, we're told, because of "the 
spectre of deflation". I say Boo! to that ghost. Our political elite 
are talking about deflation not because it's a real danger, or 
because they know much about it, but because "deflation" is a good 
excuse for yanking monetary policy back from the Bank of England and 
nailing interest rates to the floor in the desperate hope such 
drastic moves will solve our problems.

We must simply face the truth. Our top commercial bankers must report 
to a secure room - under threat of legal redress - and disclose to 
each other the full extent of their sub-prime liabilities.

This is not straightforward. It will involve massive international co-
operation. The endless chains of CDOs, MBSs and other complex 
derivatives means reconciling who owes what, and where the toxic 
liabilities lie, will take time. But it must be done.

Because the balance sheets of the world's big banks simply aren't 
credible. That's right - banks think other banks are lying when it 
comes to the losses they could incur as more and more sub-prime loans 
go wrong.

So the interbank market is gummed up - blocking the credit lines so 
crucial to firms and households. The banks are literally driving us 
the Western world into recession by refusing to lend to each other. 
But they won't until they are to disclose their loans.

Last week, the Depository Trust and Clearing Corporation issued a 
report showing the $33,600bn worth of transactions outstanding in the 
credit default swaps market. This unregulated market, used by banks 
and asset managers to insure against loans losses, is just as complex 
as the netherworld of sub-prime.

The DTCC report was compiled on the insistence of the US authorities. 
And you know what, once overlapping trades were cancelled out, the 
numbers weren't nearly as bad as expected. Sunlight is the best 
disinfectant.

Similarly with sub-prime derivatives, estimates of the outstanding 
losses are spiralling as fears escalate - because the truth is that 
no-one really knows.
But we simply must know - if this crisis is to end. "Full disclosure" 
must happen between the banks and our regulatory authorities. It must 
happen behind closed doors, so failed banks can be merged with 
survivors and so the public isn't spooked.

This day of reckoning approach will involve the humiliation of some 
of the biggest names in global banking.

But carrying on as we are is humiliating the entire Western world - 
while provoking the worst slump for the best part of a century.

Slashing interest rates isn't hard, or even courageous. What's really 
tough is facing up to the truth. Oh - and by the way. I hope I wasn't 
too rude.