FYI | Sep 21 2007
By Greg Peel
Since Britain abandoned its attempts to become part of the EU monetary system in 1997, under overwhelming pressure from a populace unwilling to compromise pounds sterling, the Bank of England has been a model of monetary discipline to the world. That reputation now lies in tatters.
Right up until last week stoic BoE governor, Mervyn King, had refused to pander to a profligate financial sector. While the European Central Bank, the Fed, and half the central banks in the world poured desperate funds into failing banking systems, and agreed to accept tenuous mortgage-backed securities as collateral, King stood firm – upper lip as stiff as a board. Then came the run on Northern Rock.
The governing Labour party is furious. How could this have been allowed to happen? Treasury officials and brokers suggest that if King had only followed suit with his global counterparts and expanded the collateral rules then the Northern Rock fiasco may never have transpired. King has been dragged into parliament for a grilling. A stake has been erected and kindling collected. But before the match is lit, the UK Treasury has taken over the reigns. The Bank of England has now agreed to flood capital markets with 10 billion pounds of three-month liquidity and accept a wider range of securities as collateral. The BoE’s independence has been slaughtered in one fell swoop.
The pressure came directly from Chancellor of the Exchequer Alistair Darling. Darling has been in the role for about five minutes, having been appointed when the previous Chancellor – Gordon Brown – took over as Prime Minister. Welcome to the big league.
BoE officials maintain that liquidity injections and collateral changes would never had saved the Rock. The lender relied on capital markets to fund its mortgages and they were frozen across the globe. US counterpart Countrywide has had to be bailed out by the banking fraternity despite the actions of the Fed. But even the BoE got a shock when there were near riots in the streets, and when queues started forming outside other UK lenders. It was forced to turn to the Treasury to make guarantees and restore calm.
It is now highly anticipated the BoE will cut the cash rate at its next meeting. It will certainly have to if the new measures do little to alleviate a critical situation. But the LIBOR rate has already fallen back following the Fed rate cut, and commercial paper is again being issued and rolled over across the globe. The US dollar has been sold down heavily against the pound. If the BoE does cut, the market is not expecting anything as drastic as 50 basis points.
Ironically, the BoE has another problem. Someone thought it best just to do a rough stock take on gold reserves in case…well…just in case. It doesn’t take nearly as long these days as then chancellor Gordon Brown sold half of Britain’s supply back in 1998 at the bottom of the market, in order to assist its major ally in preventing the collapse of the US dollar following the LTCM crisis. But what the stock take found is that some of Britain’s gold actually isn’t.
Some of the older bars (possibly plundered from Spanish galleons?), have cracks in them. This means they are not made of pure gold. It was further revealed that some of the gold coins held are actually part base metal. Damn those Catholic swine!
Britain was holding, it believed, about 300t of gold (down from 700t before 1998). Other European central banks hold much more. Just how pure is that gold?
It’s not likely that the variation is going to be enormous, and it’s fairly easy to fix in a smelter. But at a time when gold threatens to rush to new highs as the US dollar crumbles, it’s rather embarrassing, and certainly won’t help.
