2013 is the year that the myth of the independent central bank is finally, and brutally, put to rest.
In the US, it’s never really been an issue. Both the central bank and the government have always pandered to Wall Street, so there’s never been a conflict as such.
In Japan, any pretence of independence is gone. New prime minister Shinzo Abe has effectively told the Bank of Japan to weaken the currency and kickstart inflation, whether it likes it or not.
And here in Britain, chancellor George Osborne can barely conceal his desire to get Bank of England governor-to-be Mark Carney in the hot seat. He’s desperate for the UK economy to show signs of growth before the next election.
Unfortunately, desperate men have a tendency to make mistakes. Which is why you should take steps to protect your wealth now…
The myth of independent central banks
The theory behind having an independent central bank is that it provides a bulwark against the electoral cycle.
Naturally, when election time rolls on to the horizon, the party in power wants the economy to be doing well. In Britain specifically, you ideally want house prices to be rising, so that the average voter feels richer than they did last year.
The easiest way to do all this (at least, it was the easy way at one point) is to cut interest rates. Sure, it might ignite inflation somewhere down the line, but as far as politicians are concerned, as long as that happens after the polls are closed, who cares?
So having independent central bankers with the power to say “no” to politicians seeking short-term gain is a seductive idea.
It’s also complete nonsense, of course. As Richard Woolnough at M&G points out, “politicians in the UK have played loose with fiscal and monetary policy over the years”.
Even the creation of the Bank of England’s inflation target in 1997 “aligned the economy to the electoral cycle in Tony Blair’s first term”. And then “the amendment of the consumer price index target by Gordon Brown in 2003 brought a handy monetary stimulus ahead of the 2005 election”.
In other words, a central bank is only independent for as long as the government of the day wants it to be – that is, for as long as it does what it’s told. If it isn’t doing what it’s told, then the gloves come off.
George Osborne has already explicitly called for looser monetary policy. As Chris Giles notes in the FT, yesterday he argued that the government’s action to tackle the deficit “means that… monetary policy action by the Bank of England can and should continue to support the economy”.
The problem is very simple.
As one of our Roundtable experts notes in the latest issue of MoneyWeek magazine (out tomorrow – if you’re not already a subscriber, subscribe to MoneyWeek magazine), the coalition has realised that under its current plans, growth isn’t going to come back in time to get re-elected in 2015.
So if they want to stay in power, they have to change tack. But they can’t look as if they’re doing a U-turn from their ‘austerity’ plans. So the burden will fall on the Bank of England.
The coalition’s desperate bid for growth is bad for the pound
Trouble is, the government is running out of time. Changes in monetary policy don’t take effect right away. Depending on who you ask, the time lag can be anything from nine months to two years. So in theory, anything the Bank of England does now, won’t show any results until at least 2014.
With Carney taking over in summer, he won’t have much time to get cracking. So as far as Osborne is concerned, now’s the time to go for broke. If the government can at least talk up the prospect of looser monetary policy, then the markets might start to price it in that bit earlier – perhaps by sending the value of the pound even lower.
After all, it worked for Japan. The mere prospect of Abe’s election and the idea that inflation might return, sent the yen tumbling, and it hasn’t stopped since.
Of course, you could argue that the weak pound is the last thing we need. After all, it hasn’t made that much difference to our export picture. Meanwhile, persistently high inflation has meant that the average wage is falling in real terms, which is hardly good news for consumer spending.
But if slack monetary policy is the only tool you’ve got, then it’s the one you’re going to use. So expect sterling to suffer this year – the government wants it to.
As we noted last week in MoneyWeek magazine, this is why you need to have a diversified portfolio with exposure to currencies other than the pound. And as I’m sure we’ve mentioned before, we’d hang on to gold as portfolio insurance – it’s the one currency no one can print.
• This article is taken from the free investment email Money Morning. Sign up to Money Morning here .
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