Power politics in finance

I’m reading an excellent new book called “Red Capitalism: the fragile foundation of China’s extraordinary rise” by Carl Walter and Fraser Howie which provides some very detailed and fascinating background to the current state of the Chinese banking system. It’s not as sensationalist as the title suggests, though I think they overstate their case a little, but the data and historic analysis are very helpful.

One theme in the book is the recurring rivalry (sometimes outright hostility) between the Ministry of Finance (MOF) and the central bank (People’s Bank of China – PBOC). Originally the financial system was created out of the MOF (there was no central bank during the turbulent Maoist years) but since then they have vied for power and influence, especially over the recurring question of how to recapitalise the banks after their massive bad loans have to be dealt with.

This rivalry seems to be common to many countries. In the UK, Her Majesty’s Treasury (the MOF equivalent) and the Bank of England have for years been rivals. When I did my undergraduate degree in economics there were two other economics students at my college who were engaged to be married. One then went to the Treasury and the other to the Bank. This was apparently regarded by both institutions as something of a security risk. Later they split up, though I have no reason to think that was owing to MI5 sabotage.

In the US, the area of dispute is usually the exchange rate. The Treasury has formal responsibility for exchange rate policy but of course Federal Reserve policy inevitably influences the external value of the dollar. I understand that many Asian central banks really believed that the Fed’s quantitative easing (creating more liquidity by buying US government bonds as a way to cut long term interest rates when short term rates were, in effect, at a floor) was deliberately designed to push down the dollar and boost US export competitiveness.

While this might well have been a consequence of QE, it was almost certainly not the main goal, which was simply as stated by the Fed, to boost the domestic economy by cutting long term interest rates. The Treasury really would have been angry if the Fed had taken over responsibility for the dollar.

When I worked in the Central Bank of Lesotho, in southern Africa, I saw at first hand the institutional rivalries between the Treasury and Central Bank. There was a third rival in that case, the Central Planning and Development Office, something found in many developing economies reflecting the long standing and largely unfulfilled hopes for central planning. The annual plan involved all three organisations sitting uncomfortably together in a room glaring at each other. The Central Bank had the nicest offices and recruited the best people so naturally everyone else disliked us.

Rivalries are often worst when two parties are actually very similar. For example France and the UK are far more alike than either would admit – second rank former imperial powers having to adapt to a steady loss of influence in the world. I think the UK is adjusting slightly better but the competing for leadership of the recent intervention in Libya shows how similar the two countries’ position in the world really is.

Other examples would be the rivalries between virtually identical bankers at leading investment banks or the people working for leading strategy consultants.

In the same way, the clever, multiple-degree-holding and often insecure technocrats (nearly all economists) in MOF and Central Bank jobs are actually very similar and perhaps need to feel superior to the other. Political power is possibly reducible to either military (Mao’s view, still reflected in the very important role of the People’s Liberation Army in Chinese politics) or financial – the ability to grant or withhold funding. In stable democracies it’s financial power that wins (ie there is little risk of a military coup). The MOF/Treasury naturally thinks it should control everything to ensure the solvency of the nation and this creates a strong political power base. A central bank is a constant challenge to this monopoly because it can quite literally create money.

Years of experience suggested that independent central banks do a better job of controlling inflation (though not such a great job in managing the financial system). So they are a strange anomaly in a democratic system – they must be free of political influence to set interest rates free of the electoral cycle, but they must in some ultimate way be accountable to the people. The Fed is more accountable than other leading central banks and is therefore at risk of a congressional take over, which might jeopardise its credibility. The European Central Bank is all but bomb-proof because no German politician would ever dare tinker with its independenc and for the moment Germany dominates the European finance system.

All of this offends the well intentioned people at the MOF/Treasury and inflames the rivalry and battle for influence.

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