by Neil Irwin
The day of the Mansion House speech, Britain could borrow money on global markets for a decade for less than 4 percent. But to King, the nation’s finances were more precarious than the bond market made it appear. The market for U.S. Treasury bonds is the largest and most liquid in the world; a pension fund or sovereign wealth fund from the developing world can always buy or sell Treasury bills, even on a massive scale. That has allowed the U.S. government to borrow more money for longer periods than might seem justifiable based on its finances. (In the summer of 2009, U.S. government debt was 90 percent of GDP.) Japanese bonds, meanwhile, are bought primarily by the nation’s own citizens as a savings vehicle, almost as a patriotic duty. That allows Japan, too, to borrow on much larger scale than its fiscal situation would seem to justify. (That same summer, Japanese government debt was 210 percent of GDP.)
But the pound isn’t the world’s reserve currency the way the dollar is, and Britons don’t invest in their own government’s bonds the same way the Japanese do. Investors would readily dump UK government bonds—or “gilts,” for the gilt edges the securities once had—if they concluded that the nation’s finances were at the breaking point. The low interest rates that Britain was paying to borrow money were little solace. Market sentiment, as the financial crisis had shown, can shift quickly and unpredictably. The British government would need to borrow £175 billion that year to fund itself, and nearly as much for years to come. If global investors were to suddenly cut off the taps, the result could be disastrous. Parliament, King argued, should act now to prevent Britain from being threatened with a debt crisis down the road.
The governor had come a long way since the earliest days of the crisis, in the second half of 2007, when he led a restrained, even timid response and didn’t want to get involved with bank regulation. Like the Federal Reserve and the European Central Bank, the Bank of England had by this time thrown out the rulebook. King had viewed bank supervision as a messy, legalistic job, and his apparent contempt for bankers had only deepened after the industry’s failures became more apparent. But it was clear that the Bank of England would need to play a greater role in overseeing the banks. The Financial Services Authority, created in 1997 under then chancellor of the exchequer Gordon Brown, had fallen down on the job in the run-up to the crisis, focused more on dealing with narrow problems like stock market scams than the bigger picture of whether the British financial sector was sound.
In the tumultuous eighteen months that followed the Northern Rock failure, the Bank of England was the only institution with the power and resources to step in as lender of last resort. Yet its institutional knowledge of the inner workings of the banking system had atrophied in the years of King’s reign, when the bank focused instead on theoretical macroeconomics. Parliament had passed a law earlier in 2009 stating for the first time that one of the objectives of the Bank of England would be to “contribute to protecting and enhancing the stability of the financial systems of the United Kingdom,” though that law included little in the way of new powers.
It had been famously said that the governor of the Bank of England could direct the activities of British banks simply by raising an eyebrow, but King wanted something a little more concrete. If the Bank of England were going to stand behind the banks, it needed some real control over what they might get up to.
A week after the Mansion House event, King went before Parliament’s Treasury Select Committee for his regular report on the state of monetary policy—but it was the simmering hostility between him and the government that was on the minds of his audience. King didn’t back down from his statements at the lord mayor’s dinner. On fiscal policy, he said, “I do not think we can afford to wait until the Parliament after next before taking action to demonstrate credibly that the United Kingdom is going to reduce its deficit and that fiscal policy will be credible.”
The Conservative opposition immediately seized on his statements to bash the government. It was “demolition day for Gordon Brown’s tax and spending policies,” said George Osborne, the shadow chancellor of the exchequer. King’s comments, he continued, “demolished for good any claim that this discredited government ever had a credible plan for the recovery.”
Darling was in the process of working up the government’s plan for financial reform—a white paper outlining the strategy was due out the following week—and signs were pointing to a divided set of regulatory responsibilities, with the Financial Services Authority sharing power with the Bank of England as well as the Treasury. Relations between King and Darling were sufficiently toxic at this point that, asked if he had consulted on the white paper, King replied, “It all depends on your definition of consultation. I have not seen a draft of it, no. . . . I do not know what will be in the white paper. Whether anybody else does, I don’t know.” (By contrast, during this same period Tim Geithner’s staff was making plans for its own financial reform, and Bernanke and the Federal Reserve were heavily involved; some Fed staffers were even detailed to Treasury to help with technical issues.)
“I have a good working relationship with Alistair Darling,” King assured the members of Parliament that morning. “There is no problem with that working relationship whatsoever.”
Hardly a person present believed him.
When he wasn’t trying to use the bully pulpit to guide Parliament, King had his usual job to attend to—even if his working relationship with his own Monetary Policy Committee was also becoming problematic. In March 2009, he and his colleagues had agreed to push their main benchmark of the price of money, known simply as Bank Rate (no “the” please, we’re British), down to 0.5 percent, the lowest it had been in the 315-year history of the Bank of England.
They might have gone lower still, except they worried that because many building societies made loans tied to Bank Rate, they would stop lending at all if rates fell too low. Instead, they joined the Fed and the Bank of Japan among those central banks experimenting with quantitative easing, or using newly created funds to buy longer-term government bonds in hopes of pushing more money out into the economy. They started with £75 billion; two months later, they increased that to £125 billion.
This early phase of the crisis had been a time of peace on the Monetary Policy Committee, a result of both a clear-cut sense of what needed to be done and a desire to project unity in the face of panic. Even the pre–Lehman Brothers feud between King and Danny Blanchflower died down, in part because the latter was getting his way on cheaper money.
Blanchflower’s term on the MPC ended in May 2009. Yet by August, conflict between King and his committee members flared again—with a nearly unprecedented result. The British economy had pulled out of its nosedive over the summer, but it didn’t seem to be climbing with any vigor, and the risk of deflation hadn’t fully receded. Everyone on the nine-member MPC thought it was time to ease policy more. The question was, by how much?
The committee, following the procedure King had helped create as chief economist more than a decade earlier, first assembled on the Friday morning before the meeting itself, in this case on July 31. This session, which includes dozens of economists and other staffers from across the bank, as well as “bank agents” with business contacts around the United Kingdom, is an opportunity to get a broad interpretation of what is happening with the British and world economies.
The following Wednesday, the afternoon before a decision is to be made, the nine members gather for a much smaller meeting in a Pemberley-worthy room with a huge crystal chandelier and a grand Palladian window overlooking a courtyard. They talk for three hours or so, then reconvene on Thursday to discuss what policy action the bank should take. The final meeting starts at 9 a.m., with a decision due to be announced to the world promptly at noon.
The Bank of England’s monthly meetings to set monetary policy are intimate affairs, at least compared to the Fed’s, in which seventy or so people are in the room and nineteen people make up the committee itsel
f, or the ECB’s, in which there are twenty-three members of the committee. The sheer size of the Fed and ECB policy meetings means they must rely on protocol, with clear dictates of who speaks when and for how long.
The grandeur of the interior aside, MPC meetings aren’t dissimilar from the get-togethers of any corporate board in the world, in the sense that they involve a very small group of people debating in a rather informal fashion in order to reach a consensus. For all of Mervyn King’s dominance of the Bank of England, this less structured format left him with less power to control the actual decision than his counterparts at the other major central banks. He couldn’t, for example, use Trichet’s technique of limiting potential dissenters to only five minutes’ say. British political culture is one in which people feel free to state views vigorously and disagree openly. Never was that more evident among the members the MPC than on the morning of August 6, 2009.
The session the afternoon before was, as is often the case, relatively freewheeling, with jokes and interjections. On Thursday, the meeting always began with the governor speaking for five or ten minutes, summing up the discussion of the economy from the previous day and setting a framework for the decision. Then Charles Bean, the deputy governor for monetary policy, would speak for another ten minutes to propose policy options—although a careful listener might have already discerned which one King favored.
The Bank of England’s models, Bean explained that day in August, suggested that it would have to make about £50 billion in further bond purchases to keep inflation near its 2 percent target. King then invited the other seven members of the committee to share their views, one at a time. Next, he made explicit his own view: that the risk of deflation taking hold was high enough to warrant even more aggressive easing than the bank’s models suggested. He had in mind £75 billion.
This is the kind of thing that committees exist to hash out. According to the bank staff’s analysis, the British economy wouldn’t have been radically different a year later either way. Whether to authorize £50 or £75 billion was a close call—equivalent to choosing to cut Bank Rate by either 0.5 percentage points or 0.75. The meeting should have been routine.
But for reasons that still mystify some of the participants, it wasn’t. Everyone was in a tetchy mood, perhaps burnt out from the long year of crisis fighting and eager to get on with an August vacation. The committee members’ irritability might also have been in part a passive-aggressive response to King’s high-handed, top-down mode of leadership. King seemed to expect the kind of deference to his views that he received during the worst days of the crisis, when MPC disunity could have rattled markets, even as many of the other committee members wanted to reassert their role as independent shapers of policy.
When King finally went around the table to count the votes, only two committee members, Tim Besley and David Miles, sided with the governor on buying £75 billion in bonds. The other six—among them King’s seniormost deputies, Bean and Paul Tucker, who was in charge of financial stability, as well as the bank’s chief economist, Spencer Dale, and its markets chief, Paul Fisher—all voted for £50 billion. It was only the third time King had been outvoted in more than seventy meetings of the committee.
Two weeks later, when the minutes of the meeting were released publicly, they contained only the subtlest of references to the verbal warfare at Threadneedle: “There was a range of views amongst the Committee over the precise balance of risks to the outlook for inflation and how much significance to ascribe to the various arguments about the appropriate policy response to that outlook.”
But the document clearly disclosed the outcome of the vote, and the world knew that King had faced a small act of rebellion by his committee.
• • •
In the final months of 2009 and the first few of 2010, the evidence that Britain needed to reckon with its fiscal deficit sooner rather than later was, at least to King, mounting. Debt crises in Greece in October and the Arab city-state of Dubai in November meant that global investors were no longer cavalier about the risks of government bonds. At the G7 meeting in Iqaluit, Canada, in February, King, when he wasn’t dogsledding, was joining with other high officials in calling for a move away from high government deficits. If you squinted, you could even see signs that the bond markets were becoming less fond of UK debt: The ten-year gilt yielded 4.02 percent at the end of 2009, up from 3.4 percent in early October. (Never mind that a six-tenths of a percent increase doesn’t necessarily signal an imminent debt crisis, or that those rates were quite a bit lower than they had been during the Lehman crisis in late 2008.)
King never made the argument that Trichet did with regard to Greece, that cutting deficits would increase business confidence enough to fully counteract the negative impacts of lower government spending and higher taxes. But the Bank of England chief did suggest that fiscal austerity would result in at least some boost to confidence, easing the UK’s pain more than conventional economic models might suggest. Asked in a February 2010 press conference whether he agreed with Trichet’s view that cutting budget deficits is stimulative, King said it “depends on the circumstances.” “I just think it’s more complicated than just saying, you know, you must always close the deficit immediately. But what is very important, and why I totally agree with Jean-Claude Trichet, is that at all times governments need to have a clear and credible plan for reducing a structural deficit.”
King was essentially splitting the difference between Trichet and Bernanke, the latter taking a more traditional Keynesian view that slashing budgets causes economic suffering with few offsetting benefits in the immediate future. Fundamentally, King wasn’t an adherent to Trichet’s theory of “expansionary austerity,” as some of his critics argued. Rather, he was making an argument for risk management: If a fiscal crisis arose, it would both damage the nation’s economy and limit the Bank of England’s options for dealing with it. Helping his case was the fact that the bank could ease monetary policy and reduce the value of the pound, helping to some degree to counteract near-term budget cutting.
But no matter how nuanced or substantive King’s calls for government debt reduction were, they didn’t exactly endear him to the ruling party. “If there were any mobile phones, staplers or printers still intact in 10 Downing Street on Tuesday, it’s a good bet they found themselves being hurled towards the nearest cowering staffer that afternoon,” wrote Daily Telegraph economics editor Edmund Conway in January 2010, “for it was then that Gordon Brown learned of the contents of a speech that the Governor of the Bank of England was about to read out that evening. Despite private remonstrations with the Bank, despite Mr. Brown having thought he had secured Mervyn King’s agreement to refrain from barbed economic comments until the election was over, the turbulent Governor had gone and done it again.”
Conservatives, meanwhile, took King’s comments as independent verification that the Labour government had been feckless in its stewardship of the nation’s finances. “This is a decisive moment in the economic debate in Britain,” Shadow Chancellor of the Exchequer George Osborne said in February, “a moment when Gordon Brown’s argument on the deficit has collapsed and a new consensus for more decisive action emerges.”
His relationship with Darling and the Labour government increasingly strained, King sidled ever closer to the men who would soon rule Britain. Five times in the winter and spring of 2010 King met at his office on Threadneedle Street with Osborne and future Conservative prime minister David Cameron. Despite efforts to keep the existence of the meetings secret, they only increased the sense that King was advising the Tories. Said Kate Barker, who served on the Monetary Policy Committee from 2001 to 2010, “The cynical view would be that this was Mervyn’s effort to get the Bank into a good working relationship with the next regime. The uncynical view is that he was worried markets could lose confidence, which is certainly plausible, so you can argue Mervyn was right to say, ‘This can’t go on.’ But the way he expr
essed his views on fiscal policy meant they could be interpreted in a political way.”
Whatever King’s true motivations for becoming so vocal an advocate of fiscal austerity, he seems to have been unimpressed with Osborne and Cameron themselves. On February 16, 2010, King met with Louis Susman, who had recently been installed as U.S. ambassador to the Court of St. James’s, assigned with nurturing the “special relationship” between the United States and its former colonial master from the fortress of the U.S. embassy building overlooking Grosvenor Square. Susman reported back to Washington what he had heard from the Bank of England governor. “King expressed great concern about Conservative leaders’ lack of experience and opined that Party leader David Cameron and Shadow Chancellor George Osborne have not fully grasped the pressures they will face from different groups when attempting to cut spending.”
King indicated that in his meetings with Cameron and Osborne he “received only generalities” when he asked how they would reduce the debt. And he seems to have viewed the two relative youngsters—Cameron was forty-three at the time and Osborne thirty-eight—as lightweights. “King also expressed concern about the Tory party’s lack of depth. Cameron and Osborne have only a few advisers, and seemed resistant to reaching out beyond their small inner circle. The Cameron/Osborne partnership was not unlike the Tony Blair/Gordon Brown team of New Labour’s early years, when both worked well together when part of the opposition party, but fissures developed . . . once Labour was in power.”