Thursday, 10 July 2008

Bank of England Fails

The Bank of England is charged with ensuring that those pretty scraps of paper we use as money retain their value. It's important that someone does this as scraps of paper have an innate tendency to devalue to their actual paper value. This task of making sure money keeps its value is called, “controlling inflation”, and when New Labour came to power in 1997 they formed the Monetary Policy Committee of the Bank of England and gave it the power to set interest rates. The general rule is: the higher they set the interest rates the higher the value of those scraps of paper. (The reason scraps of paper can lose their value is because it’s too easy to make new ones; if we used something rare as money, a precious metal maybe, then there would be no need to worry about inflation, simple scarcity would keep the money valuable.)

So the MPC was tasked to ensure sterling retained its value by keeping inflation, measured by the Consumer Prices Index, low. Specifically they were told to make sure the Great British public didn’t lose more than two percent of its wealth every year by keeping CPI at 2% more-or-less; they were allowed a leeway of 1% either way.

You might think a 3% loss of wealth is still rather fearsome. And it has to be said that CPI is anyway not a good measure of inflation. It’s calculated from a basket of goods which does not include house prices - which are a significant expense to most people (be they owner-occupiers or renters they still have to “buy” housing one way or another.)

Last month’s CPI number was 3.3%. Today the MPC should have leapt into action to get than number below the 3% absolute cap they are tasked to enforce. They should have done that by raising the base rate from its current 5.0% level.

You may be wondering how raising interest rates would actually help reduce CPI. It’s like this: when interest rates are raised people with debts have to pay more to service them and so have less money to buy goods and services so suppliers have to hold their prices down; and, more people want to keep their savings in sterling so the value of the money goes up compared to foreign currencies and imported goods, eg oil, food, manufactured goods from China and the like, all become cheaper in Britain. This gives our scraps of paper more value.

How did the MPC acquit themselves in this solemn duty of keeping our money valuable today? Well, sad to say, they failed. Despite CPI being 65% over target they did not use the one and only weapon in their arsenal and raise interest rates. No, they held interest rates at 5.0%. They decided to let the theft of 3.3% of your wealth annually carry on unabated.

So everything you own is losing value; your house, your car, everything you’ve got in the UK has a value denominated in sterling - and sterling is losing its buying power. Even intangibles such as your pension rights are losing value. You will be poorer in your old age due to the MPC’s inaction today.

Frankly, flogging would be too good for the bastards!

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