As the reverberations from the Northern Rock debacle continue to echo, and as the evidence grows for a major fallout from the growing US Dollar crisis- one major casualty emerges: the credibility of the independence of the British Central Bank.
The first act of Brown as Chancellor was to grant the Bank of England independence. one of the first acts of Brown as Prime Minister is to demonstrate that the Bank is in fact not independent at all.
The political fallout of Northern Rock placed the Governor, Mervyn King under some pressure to resign, but even more pressure to change his policy of limiting support to lenders who get into trouble. The Governor's long held view is that to provide generous credit terms to banks that get into trouble would eliminate moral hazard and therefore encourage banks to take even greater risks.
More importantly still, the wash of extra money would add to inflationary pressures in the economy.
None of this seems to have counted with the UK Treasury- they have insisted on an all encompassing state guarantee for the Northern Rock depositors- such that remain- and have railroaded the Bank of England into giving their consent.
The next crisis will doubtless leave the independence of the Central Bank looking even more threadbare. In the meantime, despite the economic success claimed by Gordon Brown, the fact is that British interest rates have continued to be consistently higher than our European counterparts in the Eurozone. In the past few years the Sterling premium has allowed British financial system to take advantage of the "carry trade", and borrow in cheaper currencies now, however, even the premium has not been enough, and liquidity in Sterling has vanished.
In such a crisis, it is critical that the Central Bank has credibility. Unfortunately, by undermining this credibility, Gordon Brown has created a moral hazard for his own government: it is now expected that he would underwrite large parts of the banking system, and if he does not, then even greater volatility could result. Meanwhile, there are substantial inflationary pressures in the economy that imply a necessary brake on lending.
As the growing fallout of the Dollar crisis shows: there is now a real risk that the UK could join the US on the road to 1970's style "stag-flation". As in the early 1970s, the US is headed by a discredited administration, deeply embroiled in a disastrous land war in Asia. The difference now is that the US is not the world's creditor, but its debtor. The UK, as one of the largest investors in US business, has already lost billions as the value of those investments, measured in Sterling, diminishes. Yet our competitiveness versus the rest of the EU is also falling, as the supply of cheap and high quality labour from Central Europe now dries up.
These inflationary risks remain, yet the risk of a slowdown, based on falling house prices, has now risen dramatically. Brown may have already laid the seeds of his own downfall, by reversing the one single policy that Liberal Democrats could support whole-heartedly: an independent Central Bank.