Washing Dirty Central Bank Linen

It appears that one of the tactics of the Northern Rock litigants in their ongoing claim for compensation from the Bank of England will be to expose in gory detail exactly how much money the Bank of England has actually been making out of its Northern Rock loans.

While it has been assumed that the Rock's eventual return to the private sector will net a profit for the public purse, the profitability of the loan itself has been shrouded in secrecy. A source close to shareholders said: 'We want to get that out in open court.'

Lawyers will also be keen to publicise the fact that the Treasury has received fees from the Rock in return for its guarantee of customers' deposits. It also had about £31m of advisers' fees refunded by the bank.

Now, I am not proud to admit in public my unhealthy addiction to the Financial Pornography of Central Banking, but I did have a couple of Northern Rock based Diaries on the subject, such as

Bank of England - Unplugged

and

Not Northern Rocket Science

Rhetoric and Reality
As I explained, the actual mechanics of Central Bank money creation constitute Financial Pornography which no decent newspaper will print. The FT - uniquely, in my experience - allowed the economist Tim Congdon to expose the truth in fairly clear - if technical - terms.

The Rhetoric of Northern Rock - as being an immense "Drain" on the poor bloody taxpayer - is totally at odds with the Reality, which is that the Bank of England has been "coining it" (pun intended) at the rate of £ tens of millions per week.

The BoE achieves this profit because they have been "over-funding". That is to say, they have been receiving the base rate of >5% (plus penalties) from Northern Rock on loans of up to £30 billion, and have been paying zero percent on the cash balances of Clearing Bank reserves they hold. (as opposed to funding through issuance of Treasury Debt).

An extremely astute commentator has pointed out that one key reason for this course of conduct is that the Debt Management Office ("DMO") - which used to be part of the Bank of England - is now part of the Treasury.

Interbank lending should be used to balance the books of a bank which has lent more than its deposits with the excess deposits (of equal amount) which some other bank must have. (Rules of Double-Entry Bookkeeping state that total debit balances in the banking system will be matched exactly by total credit balances.)

In Britain the balancing used to be achieved, not through the central bank, but through 'Discount Houses', for they alone had access to funds from the Bank of England. The EU rules have changed this. All banks will have excess deposits at the Central Bank if the government is unable to fund its borrowings by replacing loans from the central bank with loans direct from investors. If the government borrows too much direct from investors, it will strip the banks of liquidity. Same if it raises more tax than it spends.

Such a shortage of liquidity is resolved by the Central Bank lending to the commercial banks who deposit the money back with the Central Bank. Mad of course but it happens.

Thus the key to the level of true liquidity is what the government's Debt Management Office (DMO) is doing. The DMO should be under the control of the head of the Central Bank.

In Britain at the moment it is not, the fault of Gordon Brown who stripped the Bank of England of the powers it has used for 300 years.

The profit made from the power to issue Money is known as "seignorage", and is normally only received by Central Banks in respect of notes and coin.

The (political) Treasury simply could not resist the "free" money from seignorage and have now brought the subject blinking in the light out from (neutral) Central Banking darkness.

There are probably fewer than 100 people who actually understand the Reality of Central Banking, and from the tenor and quality of the political debate re Northern Rock, no leading politician is among them.

Lost Knowledge?
There was a time when there was a widespread knowledge and understanding of the methods, rights and wrongs of Central Banking as it has been since John Law's Banque Royale in 1718.

Over the years - the battle having been won by the banking interests (in the US in 1913) - this knowledge died with the protagonists, and the debate has been air-brushed from History, so that all that is now left is the assumption that this is the way it is, and some technical understanding by the people who run the system, who never question its right to exist.

The knowledge has therefore been lost, which was precisely the intention of those in power, and any discussion confined to the tin foil hat brigade.

The Private Life of Central Banking
So the Private Life of Central Banking has long been placed "off limits" in the decent Press and was right up there with the Private Life of the Royal Family, so that anything touching on it has been automatically "spiked", in the way that (say) Prince Philip's peccadilloes always were.

Times Change: and while I do not expect to see banking matters splashed interminably over "Hallo" magazine, it may just be the case that the financial press may be about to open up the Private Life of Central Banks.

A Lady Chatterley Moment?
The literary "Pornography" floodgates opened in 1960 in the famous UK obscenity case re D H Lawrence's

Lady Chatterley's Lover

- the killer moment being the prosecution barrister's classic...

"Is it a book that you would even wish your wife or your servants to read?"

It's possible that the litigants are hoping the government will stump up to avoid having this Financial Pornography aired, but I doubt whether this motivates the litigants. Even if that were the case, I doubt whether the government will be embarrassed about it, because no one has thought twice about the rights and wrongs of the system for generations.

So perhaps we might see a similar Lady Chatterley Moment in relation to the Financial Pornography of "deficit-based" Central Banking.

If so, this may actually open up the possibility of public discussion of alternatives to a fundamentally unsustainable system.