How Central Banks Could Benefit From A "Protectionist-Driven" Global Downturn

Authored by Steven Guiness,

From observing the behaviour of ‘leavers‘ and ‘remainers‘ since the EU referendum in 2016, I have seen first hand how partisanship works as an effective tool to cloud judgement. Once a position of bias becomes ingrained, it has proved next to impossible to see beyond it or for the individual concerned to be convinced of an alternative perspective.

The psychological operation of ‘fake news‘ is now entrenched within society, with both sides of the divide claiming one another to be peddlers of false truths. By my reckoning this is all the more reason why positioning yourself as neither one thing or the other is the only logical way in which facts can be objectively scrutinised.

The role of the Bank of England in the Brexit process is an example of how bias is serving to insulate central banks from impartial and informed criticism. On one side are those who depict governor Mark Carney as an ‘enemy‘ of Brexit, whilst on the other are people who consider Carney as a safe pair of hands amidst a whirlwind of political turmoil. Non-partisan analysis of communications and policy decisions emanating from the BOE is rarely given space to evolve.


For instance, last week the bank published its latest Financial Stability Report in conjunction with a press conference delivered by Mark Carney. Whilst much of his interaction with the press on Brexit was of a similar theme to previous events, one aspect in particular stood out.

Asked by Joel Hills of ITV News about the level of preparation in the event of a no deal Brexit, Carney affirmed that the financial system in which the BOE presides over was ‘ready for whatever form Brexit takes.’ Carney’s conviction stems from a series of bank stress tests that the BOE conducted in 2018 in an attempt to gauge how the financial system would stand up to a crisis greater than 2008. The results as published by the BOE showed that the UK’s banking system was fully prepared.

Indeed, Carney’s confidence was such that he went on to say how the system would continue serving both households and businesses, ‘even if a worst case disorderly Brexit occurred at the same time as a global slowdown triggered by a trade war.’

Where it started to get more interesting is when Carney made an unequivocal distinction between financial stability and that of market and economic stability. The area where the BOE possess overarching control – the financial system – is, according to the bank, prepared for any adverse scenario. But this preparation does not extended to currency or equity markets, nor economic fundamentals such as inflation which would likely become volatile should supply chains into and out of the UK be compromised.

To quote Carney exactly, ‘market stability will adjust potentially quite substantially if there is a no deal Brexit. Even with a smooth adjustment this would still be a major economic adjustment and major economic shock – in not just a short period of time but virtually instantaneously.’

The expectation from the BOE is for immediate volatility if and when a no deal exit is confirmed. Not from within the financial system itself, but within the surrounding economic environment. The areas which the bank purport not to have direct jurisdiction over. Those who keep abreast of Brexit led developments will know that the pound would be most susceptible to a dysfunctional exit from the EU.

According to Carney, the preparedness of the UK system, which encompasses the country’s trade infrastructure, had seen ‘some progress‘, but ultimately it was for ‘the government to speak directly to that‘ and not the Bank of England.

Gradually over the last three years, the BOE have been carefully positioning themselves so as not to be held culpable for the economic ramifications of a ‘disorderly‘ Brexit. One mechanism for achieving this has been to re-elevate the importance of their 2% mandate for inflation, when in the years post 2008 it had no direct relevance for how the bank conducted monetary policy.

What we learn from Carney is that a no deal eventuality is a more pressing concern for markets and the economy than it is for the financial sector. Is this true? To a point perhaps, but not entirely as the Financial Stability Report alludes to.

An area of concern that has gestated since the referendum result is with uncleared OTC (Over the Counter) derivative contracts. Derivatives are essentially a contract between two or more parties that derive their value from the performance of an underlying asset, such as a commodity, currency or interest rate. Banks use a high degree of leverage to attain these positions in the market. Derivatives can also be used to speculate (bet) on the future value of assets, without the need to own the asset outright.

When it comes to uncleared contracts between the UK and EU, the Financial Policy Committee specifies these as a medium risk should Britain depart with no withdrawal agreement. As for the scale of contracts affected, the report is forthright. Note that the term ‘lifecycle events‘ includes actions such as settlement, modification and termination of derivative contracts.

Certain ‘lifecycle’ events will not be able to be performed on cross-border derivative contracts after Brexit. This could affect £23 trillion of uncleared derivatives contracts between the EU and UK, of which £16 trillion matures after October 2019. This could compromise the ability of derivatives users to manage risks, and could therefore amplify any stress around the UK’s exit from the EU.

This concern is what Mark Carney refers to as a potential ‘spillover‘. In their communications the Bank of England have routinely called for EU regulators to implement measures to mitigate the risks of a no deal exit. This is something that The European Banking Federation  and The European Banking Authority have also been encouraging.

As well as this, the report states that for derivatives, the government has ‘legislated to ensure that EU banks can continue to perform lifecycle events on contracts they have with UK businesses.’

A possible spillover, however, stems from how The European Commission ‘does not intend to reciprocate for UK-based banks’ contracts with EU businesses.’ In particular, ‘uncertainty remains about the scope of current or proposed legislation in jurisdictions which account for approximately half of the notional value of outstanding contracts.’

A safe assumption is that potential economic fallout from derivatives would impact on financial stability. On the home front the Bank of England’s position is that markets and the economy would suffer from a volatile form of Brexit, but the financial system would remain fully functional and be able to withstand unprecedented stress. The validity of this claim could only be tested if a no deal exit comes to pass.

The caveat here is spillovers originating outside of the UK, which three months before the intended exit date of October 31st remain unresolved. Because the global economic system is interconnected, a banking crisis in one part of the world has the capacity to infect the system as a whole. This was evident over a decade ago when Lehman Brothers was sacrificed.

Derivatives, along with other financial instruments, are an inherent weakness built into the system. But instead of automatically interpreting such weaknesses as a threat to central bank autonomy, it is feasible that they present an opportunity for further far-reaching ‘reforms‘ to the financial system.

To globalists, crises open the gateway for establishing broad consensus for major economic change. Because out of chaos invariably comes consolidation of resources.

The question is, how could substantial financial instability be of benefit to the Bank of England? After the initial phase of the 2008 crisis had played out, the Bank for International Settlements put into motion new regulatory standards called ‘Basel III‘. Conceived on the global stage, the new regulations were designed to be implemented by national jurisdictions over a gradual period of time. Many of the standards are now in place, but the full roll out is not due to be completed until around 2021.

One of the aims of the FPC, as expressed in the Financial Stability Report, is to ‘ensure that systemically important payment systems support financial stability.’ This resonated with me because as I have touched on in previous articles, the Bank of England is targeting the year 2025 for the wholesale reform of the RTGS payments system in the UK. A reformed RTGS would have the capability of connecting to distributed ledger technology (DLT). As explained elsewhere, blockchain is a form of DLT, and works in conjunction with cryprocurrencies such as Bitcoin.

Changes on this scale would represent a major overhaul of the UK’s financial system, and would conveniently coincide with the BIS 2025 initiative. This initiative, as outlined by the BIS, will ‘foster international collaboration on innovative financial technology within the central banking community‘.

Based on the documentation I have read from the BIS, the IMF and the BOE, the introduction of central bank digital currencies (CBDC’s) is very much part of the drive for ‘innovative financial technology.’

The prospect of central banks issuing their own form of digital currencies in the future is, according to BIS general manager Agustin Carstens, something that might come sooner than people realise:

Many central banks are working on it; we are working on it, supporting them. And it might be that it is sooner than we think that there is a market and we need to be able to provide central bank digital currencies.

Whereas attention is directed to the short term actions of central banks, longer term plans provide a clearer perspective on the direction that global institutions want to take the financial system in the medium to longer term. It appears that globalists are targeting the period between 2025 and 2030 as the time when digital currencies would start to be implemented, resulting in the eventual abolition of physical money.

The concerted attention placed on CBDC’s comes as sterling remains highly sensitive to the Brexit process. I continue to think it is probable that a no deal exit will trigger a currency crisis. And given that currency markets have no borders, the danger is that a global trade conflict stemming from Brexit and the trade policies of the Trump administration would jeopardise the fiat currency system. This is a topic I discussed earlier this year when looking at the possibility of sterling no longer being considered a reserve currency post Brexit.

A crisis of this magnitude could quite easily be used by central banks as a rationale for a new approach to how currencies are disseminated and controlled.

Back in the present, the conventional theory pushed throughout alternative media is that protectionism is something that central banks and international institutions like the BIS and the IMF fear. On examination, I am doubtful of this claim. The FPC’s report makes it clear that even in the event of a ‘protectionist-driven slowdown‘ running in parallel to a no deal Brexit, the financial system would ‘absorb, rather than amplify, the resulting economic shocks.’ It remains to be seen whether this rhetoric bares any semblance to reality.

My concern is that rather than fear the breakdown of what globalists call the ‘rules based global order‘, it is in actuality an essential variable for orchestrating reforms of the system.