Much ink has been spilled about the “enormous challenges” facing Mark Carney in his new role as Bank of England Governor – but I’m afraid to say that most of it has missed the point.
The challenges everyone’s tended to focus on so far have been the country’s financial problems – the broken banking system – and its broken economy. And while it’s right that these will be considerable issues facing the new man at Threadneedle Street, for me the biggest challenge he faces is something far more important.
The Bank of England is sitting on a bed of financial nitroglycerine. And the smallest misstep from the Canadian could cause a crisis that would dwarf anything we’ve seen over the past few years.
The explosive stuff I’m talking about is the record amount of Government debt – gilts – sitting in the Bank’s own bank account.
The Bank of England has the biggest proportionate stock of Government debt in the world – bigger than Japan, bigger than the US. You can see the situation from the pie chart above from a recent working paper by Jochen Andritzky of the IMF [pdf]. If you want to compare Britain internationally, see the whole load of pie charts below.
In short, the Bank of England owns more than twice the amount of government debt (19.7% of the total debt stock and rising – in case you have trouble with the colour scheme above) of its nearest counterpart, the Bank of Japan.
This debt is, of course, the consequence of the Bank’s quantitative easing programme, under which it’s been creating money and buying up Government debt, in order to attempt to stimulate the economy.
Why does that matter? Because in many ways this is precisely what happened in Weimar Germany in the 1920s and Zimbabwe in the 2000s: when the central bank buys up government debt, it often leads in turn to hyperinflation and an international capital crisis (investors refusing to buy your debt).
The difference (and it is an absolutely fundamental one) is that in Britain’s case, the central bank is not buying up Government debt specifically in order to help finance the state. It is doing it in order to carry out its own job of getting the economy going. In this, the Bank is broadly regarded as independent from the Government – something Sir Mervyn King has generally reinforced with the occasional public sideswipe at one or other politician.
But the moment anyone starts to question the Bank’s impartiality in holding this Government debt – if the Bank of England Governor blinks, if there is any hint of collaboration with the Treasury to help it with the deficit – that independence, the key thing separating Britain from Weimar Germany is threatened.
That is the real problem Mark Carney will have to wrestle with when he takes up office. Given how much more government debt the Bank owns than any other central bank around the world, it is far more incumbent on him than any of his counterparts to maintain his independence.
Because if investors convince themselves he and the Treasury are in cahoots to monetise the deficit, then Britain is in serious, serious trouble.