If you want to cut inflation you need strong central banks that can stand up to governments that try to borrow too much.
As William McChesney Martin, the chairman of the US Federal Reserve, famously said in 1955, it was the Fed’s job to ‘take away the punch bowl just as the party gets going’.
That means central banks have to be independent, able to set interest rates at a level that does indeed curb inflation.
The Fed has had that authority since 1951. Here in the UK the Bank of England has only been able to do so since 1997, when Gordon Brown as chancellor passed that decision from the Treasury to the Bank’s newly constituted Monetary Policy Committee. Unsurprisingly the UK has had a rather worse inflation record that the US.
Well, the party is going strong in America, with the S&P500 and Dow Jones indexes hitting new highs. I have just returned from a week talking to business people in the US and there is already deep concern about inflation, currently 2.7 per cent and surging up again.
Donald Trump’s relentless attacks on the Fed have upped those fears. If you haven’t been following this, he has repeatedly called for the chairman, Jerome Powell, to cut rates.
Concern: Chancellor Rachel Reeves is known to be fearful of a run on gilts, sterling or both
Then, last week, he tried to sack one of the governors, Lisa Cook. In the termination letter, he said she ‘may have made false statements on one or more mortgage applications’.
Apparently, she gave two addresses as her primary residence, something a senior central banker should never do.
That is going through the courts and if Trump succeeds in ousting her, he may be able to appoint someone who will press for lower interest rates.
In any case Powell leaves office in the spring, and whoever follows him is unlikely to be a hardliner on inflation.
At the moment this is all being seen through the lens of the country’s fractured politics. Liberals argue this is dire attack on central bank independence. Conservatives say central banks are not above the law and that the Fed has not been well run.
There are echoes here. Former prime minister Liz Truss has backed Trump’s efforts to take control of the Fed, talking of ‘a reckoning coming’ for central banks.
She clearly feels that had the Bank of England handled the gilt market better after that controversial Budget, the financial pressures that brought her down could have been contained. That must be wrong.
Global confidence in the financial competence of the UK Governments is fragile, just about held together by the role of the Office for Budget Responsibility.
That is why we pay more to fund our national debt than any other major economy. It’s like that awful situation in 1976, when the Labour government had to get a bailout from the International Monetary Fund.
Actually, it didn’t need the loan. It needed the stamp of approval from the IMF because, once it got that, others were happy to stump up the cash. So when Truss pushed aside the OBR, a run on gilts – British Government IOUs – became inevitable.
At the moment, governments just about everywhere are borrowing at an unsustainable rate.
The US is. We are. France is in dreadful trouble. Japan has huge debt and a shrinking population to service it – the litany goes on. The great question is whether it will be the central banks that force governments to cut their deficits or whether it will be up to the bond markets to do so.
We cannot know the answer to that but we do know that central bank discipline will be more orderly and less capricious than that of the markets.
Last week’s story is the American one. Next week’s may be a French affair. Eric Lombard, France’s finance minister, has warned that it may have to seek a bailout from the IMF.
But it is the UK that is most exposed. We don’t have the global role of the dollar or the clout of the US economy.
We don’t have the European Central Bank to support our currency, as do the French, or the mass of savers in Japan prepared to buy their government’s debt. Chancellor Rachel Reeves is known to be fearful of a run on gilts, sterling or both.
She’s wrong on a lot of things, but right on that.
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