Anarchy in the UK? Or just ‘how we do things around here’?

 Order is restored! But perhaps not for long. The mini-rebellion by bond owners on day one of the Bank of England’s (BoE) latest effort to destroy British savers was crushed on Wednesday.Meanwhile, some British government bond yields have already gone negative. That prompted a call for a national inquiry into the effect of negative rates on pensions. More on that shortly. But first…What’s that idiom about closing the stable door after the horse has bolted? Insert it here.Let me back up and explain what happened, in case you missed it. On Tuesday, the first day of open market operations to implement its new £70bn bond-buying programme, the BoE hit a “glitch”. It had its handy digital chequebook out and was prepared to buy £1.17 billion worth of gilts with a maturity between seven and 15 years.Slight problem! Sellers were only prepared to part with £1.11 worth of gilts. If you’re scoring at home, that’s a £52m shortfall. It immediately raised doubts about whether the BoE could get long-term bond owners to part with some of the only higher-yielding and safe (ahem) assets in the market.The bank issued this statement at 9am yesterday:“The Bank will incorporate the £52mn shortfall from yesterday’s uncovered  operation within the second half of the current six-month purchase programme. As set out in the Market Notice of 4 August 2016, details of these purchases will be announced on 3 November 2016.”Blah blah blah. Nothing to see here move along. And yesterday?Well, either arms were twisted behind the scenes or bondholders changed their mind. The bank again set out to buy £1.17bn in 7-15 year gilts. This time sellers offered up £5.1bn. The offer-to-cover ratio was 4.71. Thus, after an initial hiccup, the bank’s scorched earth campaign against saving and prudence can resume.Forward, march!Not everyone is happy. David Cameron’s former pensions minister, Ros Atlmann, is calling for national inquiry into the effects of negative rates on the pension system. What do you think? Should MoneyWeek organise another petition to Parliament and demand an end to quantitative easing (QE) and the war on savers? Express your support or opposition to [email protected] .Meanwhile in the bond market, ten-year gilt yields traded as low as 0.51% yesterday. And here is the problem: the Bank’s new QE policy forces pension funds and savers to take more risk at exactly the point they want to be taking less in order to get a safe, predictable income.There’s already a £1trn deficit in the UK’s private-sector defined benefit pension scheme sector. You might not weep for corporate pension funds or the fact that their deficit climbed by £24bn last month, according to the Pension Protection Fund. But there are three reasons everyone in Britain should be worried.

Pension triple threat

First – and I know some people will see this as a radical view – but the harder it is for defined benefit pension schemes to fund future payouts with income from government bonds (because government bond yields have been driven into the ground by the BoE), the more likely you’ll see the end of defined benefit pension schemes full stop. And I’m not talking about just the private sector. Defined benefit pensions for public sector employees will come under scrutiny too, as they should.This isn’t me having a go at public servants and their pensions. But it is me asking a genuine question: if the middle class and the working class have been thrown to the mercies of globalisation and its impact on wages, why are public sector workers – whose wages and pensions are paid for by the British taxpayer – on a defined benefit pension scheme?It’s a genuine question. Answers welcome to [email protected] second reason to be worried about the deficit in private sector pensions is that makes it far more likely you’ll see a disastrous bubble in the stock market. If you own stocks, or your retirement depends on a portfolio of stocks, the last thing you want is a dangerous melt-up in stock prices. Why would it happen?If scrapping defined benefit pensions altogether proves either too unpopular or simply not legal and fair to people who already have them, the logical move is to allow pension funds to meet future liabilities by buying higher-yielding assets… such as stocks. Make sense?This is probably wants the BoE wants anyway. Burn interest rates to the ground. Buy up the government bonds held by pension funds and insurance companies. Force regular bond-buyers to buy something else. Watch the FTSE 100 climb to 10,000. Cross your fingers and hope everything turns out OK. And, if you have a conscience or believe in God, say a prayer for the collateral damage you create by destroying the income stream British pensioners and savers rely on.Do you think I’m being too harsh? Well, then, think about the third reason to be worried. The deficit in private sector pensions is a signal. It’s a signal that British interest rates are headed lower and even negative, even if Mark Carney says he’s “not a fan” of them. Newsflash, Mr Carney: the market doesn’t care what you say. It cares what you do.While rates on 30-year gilts fell to a record low of 1.26% yesterday, something even more ominous happened. Rates on short-dated gilts maturing in 2019 and 2020 went briefly negative. That’s right: negative-rate anarchy right here in the UK government bond market. Cry havoc, and let rates slip lower still!If what I’ve described to you above sounds unthinkable, make sure you read what Tim Price has written below. We live in an “age of the unthinkable”. Tim’s been thinking about that harder than anyone. You can see his latest thinking here.Also, maybe you think I’m being unfair to the bank? Putting words in its mouth? Attributing it to motives that aren’t genuine? Well, read the following from last week’s Inflation Report by the Bank and then my comment below. Then tell me if I’m being unfair. Here’s the comment (emphasis added is mine):An easing in monetary policy in part acts through changing the interest rates facing households and companies. By lowering the cost of borrowing and the return on saving it encourages people to bring forward spending – the real interest rate channel. Lower rates also reduce the cost of debt servicing for existing borrowers with floating-rate debt – the cash-flow channel. Lower funding costs for banks also increase the availability of credit – the credit channel. Monetary policy also acts through financial markets more generally. Lower rates and portfolio balance effects, for example as people who sell assets to the Bank reinvest the money received in other assets, support asset prices  –  the wealth channel. A monetary policy expansion at home, relative to policy abroad, can also lower the value of sterling, supporting net trade and raising the cost of imports – the exchange rate channel.Finally, monetary policy can directly influence people’s expectations and behaviour. An easing in policy in the face of a prospective reduction in demand can bolster sentiment and prevent a drift down in inflation expectations – the confidence and expectations channel.Did you see the six channels through which the Bank hopes QE and lower rates will transmit positive effects to the UK economy? You have the real interest rate channel, the cash-flow channel, the credit channel, the wealth channel, the exchange rate channel, and the confidence and expectations channel.A full exploration of all of them is beyond the scope of today’s Money Morning. But the Bank clearly has the last one exactly wrong. It hasn’t bolstered sentiment and increased spending. It’s frightened the British public that there’s something profoundly broken with the financial system as we know.The public has reacted in a sensible way, by hoarding cash and decreasing spending – precisely the opposite of what the Bank wanted. Either the Bank will change the channel, and admit it’s policy is wrong. Or it will double down and create a new channel: the come-for-your-cash-by-creating-money-that-depreciates-in-value channel.