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Sir Mervyn King, who is to end 10 years as governor of the Bank of England at the end of the month, has organised this lunch himself. Uli in Notting Hill, he has explained in advance, is a favourite local restaurant, specialising in east Asian food. It is normally closed on Saturday lunchtime but Sir Mervyn has arranged for it to be opened especially for us. He has also asked the owner, Michael, to choose the food. The result is as excellent as it is excessive: soft-shelled crab; spicy scallops; Mongolian lamb, Singaporean laksa (a soup); steamed turbot; lamb curry; special fried rice; aubergine in sweet chilli; and seafood udon (noodles). The meal is devastatingly large.
When I arrive at the restaurant just before 1pm, Sir Mervyn is, predictably, already there. Wearing a suit and tie, he tells me he has picked this date for lunch because he intends to avoid anything that might appear to be a commentary on the policies of his successor, Mark Carney.
“You just cannot appear to do anything which potentially makes life difficult for your successor,” he says. “Even to talk about what’s going on at a lunch or dinner in London, you don’t want to do it. And from that follows a wish not to think about it.”
Does he feel a sense of relief over his departure? “It’s a mixed set of feelings. I know I’m going to miss enormously not being at the centre of things. That’s going to be very hard to adjust to. You just can’t step away from it and pretend you’re happy no longer to be at the centre of events. So that is a big change. The things I won’t miss will be the treadmill aspect of it, sitting in rooms, stuck in meetings for hours on end where nothing terribly interesting happens.”
The first courses arrive, with the crab dish exceptional, and I ask if he thinks the BoE, as it is now, will be able to fulfil the range of tasks it has: both monetary policy and prudential regulation?
“I think what went wrong with regulation in the period running up to the crisis was that there weren’t any obvious problems with the banks in the sense that no one was coming to the central bank for money and none was failing. So it was very hard for anyone to argue that prudential supervision was at the heart of regulation.
“It’s a lot easier now to get people to say to banks, ‘Look, your leverage is much too high, or this strategy is very risky.’ Because people [now] are very conscious of what can go wrong.”
I say that almost nobody thought that a failure of the British banking system on the scale we have experienced was possible.
Sir Mervyn agrees. “No. We didn’t have a banking crisis in the 1930s, as the Americans did. I remember very clearly that after the failure of the Bank of Credit and Commerce International in 1991, we had a debate about depositor protection. And, in a rather naive way, I argued, ‘Well, shouldn’t we have 100 per cent protection up to a certain limit, because otherwise you wouldn’t prevent a bank run?’ And no one thought this was a sensible argument because everyone was focusing on the idea that it was very important for depositors to know that they would take some share of the loss on their bank account.
“This is why I don’t think we’ve reached a final position yet in terms of deposit insurance. There will often be one day in their lives when individuals have a much larger sum of money in their accounts than usual – because of a house purchase, a divorce settlement, a court settlement or an insurance payout. What that means is that, on any given day, if a biggish bank got into trouble, then thousands of people would be in this position. And I don’t believe any government would let them lose their money.”
. . .
Michael checks whether we want some wine. We both agree on a glass of white. I then ask, what did Sir Mervyn wish he had known a decade ago that he knows now?
“I don’t think I appreciated the scale of the shocks that could occur. We drew great comfort from the fact that we had a framework that meant interest rates would not have to rise to 15 per cent, or 20 per cent, again. But we never imagined we would get to zero and be stuck there.
“I suppose the thing I hadn’t really appreciated was a key part of the work of Keynes. It was the idea that the future is unknowable. Cash is fundamental to the day-to-day running of the economy. At the same time, it’s the asset that you move into when you have no idea what to do. That is why our monetary economy is so unstable.”
I turn to the alternative view that the calamity was due not to defective banks but to irresponsible central bankers. By targeting inflation at a time of deflationary shocks, particularly the entry of Chinese labour into the world economy, critics argue that central banks encouraged credit booms and asset-price bubbles.
Sir Mervyn’s answer is firm: “The central bank would then have been arguing that the right monetary policy was to accept lower growth than we could achieve, with rising unemployment and inflation below its own definition of price stability. And it would be arguing it should do that because, in the long run, ‘Something might happen’. This would have generated a major political issue.”
As Michael clears the plates and serves the laksa, I compliment him on the wonderful food. Sir Mervyn adds: “This is one of the gems of London.”
I return to present dilemmas: even if one accepts that inflation targeting did not cause the crisis, didn’t complacency about a so-called “great moderation” encourage people to believe that everything was more stable, more predictable than it actually was? “I think we probably did. [But] I don’t think it’s an argument against inflation targeting. We demonstrated it was possible to avoid high and variable inflation. I think what happened was that people interpreted that to say, ‘Oh well, all the problems have been solved.’ ”
What about how the crisis was handled? Was something like the Lehman failure, in September 2008, necessary if there was to be any effective action?
“I’ve used the phrase ‘the audacity of pessimism’, ” he replies. “Only when things look bleak will people get round to doing anything.” The international meetings in Washington, in October 2008, were the only ones where “we tore up the communiqué. I’ve never been in a meeting when anyone was remotely prepared to do that, before or since.”
The discussion then turns to how one restores confidence, post-crisis. Sir Mervyn defends current UK policy. “We had a fiscal policy that said, whatever happens, the automatic stabilisers would be allowed to work. And the issue was: do you announce some medium-term path for demonstrating that the government actually is in control of this situation? There has to be a policy framework that people believe is credible. And I think, in some circumstances, that means saying you have to think about what the path of debt is in the future.
“Look what’s happened in Japan. I think they’ve reached the limits of what fiscal policy can do.” I disagree, saying that if people are happy to lend to the government, at negative real interest rates, the government should borrow and build something.
Sir Mervyn resists: “I’m always struck when I speak to not just ministers but people who work in the Treasury that it is actually quite difficult to produce the investment projects. It’s very easy to spend money but in a way that maybe doesn’t add to the real gross domestic product.”
. . .
As more food arrives, in the form of some fish courses, I quiz the owner if he was aware how many people he was supposed to be serving. “I had rational expectations about what you would eat,” says Sir Mervyn. As it turns out, he does not – I am unable to finish the fish.
Getting back to the economy, I tell Sir Mervyn that I continue to regard UK fiscal tightening as premature. He continues to think it appropriate. But what about quantitative easing – has that worked as he hoped?
“I’ve always seen this as a way of increasing the broader money supply. And the thing that’s so extraordinary is that, for the past few years, the banking system, which is normally responsible for creating 95 per cent of broad money has been contracting its part of the money supply. And since we at the bank only supply about 5 per cent of it, the proportional increase in our bit has to be massive to offset the contraction of the rest.”
What about more adventurous approaches? Should the BoE not have purchased riskier assets, or bypassed the credit system, to lend directly?
“No, right from the beginning I said that if other assets should be purchased, and I took no view as to whether they should or should not, then the government should decide on which assets are purchased, and we would finance it. I think that’s the right division of labour between central bank and the finance ministry.”
If we go back to the crisis itself, I ask, would it have made much difference if the British government and the central bank had acted differently before the Lehman crisis?
“Other than effectively nationalising and recapitalising a wider range of banks sooner, I’m not sure we could have done much. That would have made some difference but it would have cost more.”
But, it turns out, what really bothers Sir Mervyn is not the cost of bailing out the banks, but that “we’re five years on, and still we’re debating about how we’re going to restructure the banks, which have been receiving so much support. This should have been done a whole lot earlier.”
So what else worries him now?
“For a US attorney-general to go to Congress and basically say this bank was ‘too big to jail’ – those are his words, not mine – is an extraordinary statement.”
. . .
I ask whether reform has been so modest because the crisis has been handled quite successfully. “Well, we’ve dealt with the short-term problem, the immediate short-term problem, except in the euro area,” he says.
Knowing Sir Mervyn’s longstanding “euro” scepticism, I ask what his solutions for the eurozone’s woes are.
“I think there are four. One is to continue with mass unemployment in the south, in order to depress wages and prices until they’ve become competitive again. The second is to say, ‘Well, we have to get rid of this imbalance in competitiveness, so we need inflation in Germany.’ That seems unattractive, certainly to the Germans.
“The third is to give up on this question of restoring competitiveness quickly and accept that this is an indefinite transfer union. That requires two things: one is for people in the north to give money to people in the south; the other is for people in the south to accept the conditions imposed on them, which will limit the size of the transfer.
“The fourth is to change the membership. Now, I don’t know what the right answer is, and it will depend on their political objectives, but economics tells you that you have to have one or some combination of these.”
I turn to the British economy and ask whether it has lost the ability to grow. “No. I don’t find it easy to understand, not at all, but my big judgment would be that if we could find a way to encourage people to spend more in a way that was sustainable, and, in particular, if the rest of the world would buy more from us, then we would certainly be able to meet that without leading to a massive pick-up in inflationary pressures.”
For Sir Mervyn, the villain of the post-crisis story is the contraction in lending from UK banks. So I ask whether banking is shrinking because it’s turning its back on perfectly good investment opportunities? Or is it shrinking because there are few such opportunities?
“Of course, there’s a chicken and egg problem here. If all the banks together don’t extend lending and the business economy is flat, then that justifies the decision not to lend. But I do sense that the banking system has just said, ‘We have to contract our balance sheets. We have to deleverage.’ ”
I concede defeat when offered pudding but order a double espresso and Sir Mervyn chooses a green tea.
One of the big questions, I argue, is whether the globalisation of finance is sustainable. How can you have the economy blown up by the foreign adventures of entrepreneurial thrill-seekers? How can you explain this to the public?
“That is just the international equivalent of the proposition that you should not want to run your financial system with such a high degree of deposit finance, or leveraged investments. So I think one of the consequences of the crisis should be quite radical thinking about the structure of finance, both domestically and internationally.
“But I don’t think it will happen until we get through the immediate problems. And then the people who will still worry about these longer-term questions will be you and me over a nice meal. And the audacity of pessimism will turn into the complacency of growth.
“One of the things people are reluctant to do in finance is to ask what they can learn from other industries. And one of the big lessons I think about regulation is: keep it simple. The big thing that we should be thinking about is leverage. But, of course, it’s for that reason that banks will resist regulation of leverage most strongly. And politicians will compromise on precisely that.”
What is puzzling, I say, is that people still take seriously the idea that the bankers’ economic interest is also our economic interest.
“There’s always been a willingness to be overly impressed by people who appear to be extraordinarily financially successful,” he says.
The time has come to depart. Soon, Sir Mervyn will be just another outsider and one who has taken a vow of silence on the state of the economy. It will be a painful adjustment.
Martin Wolf is the FT’s chief economics commentator
Uli Oriental Restaurant
16 All Saints Rd, London W11
Soft-shelled crab; spicy scallops; Mongolian lamb; Singaporean laksa; steamed turbot; Malay lamb curry; special fried rice; aubergine in sweet chilli; seafood udon
Glass of white wine x 2
Total (incl service) £131.96
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