The crooked path of capitalism
Thursday, 23 August 2007
Samuel Brittan
CAPITALISM has been subject to booms and busts for at least the past 300 years, notable early examples of which were the Dutch tulip mania and the British South Sea Bubble of the early 18th century. Any market system -- including market socialism, if that had ever got off the ground -- would probably have been subject to similar fluctuations, based as they are on human cycles of greed and fear, and alternations between unfounded optimism and unreasoning pessimism. Attempts to establish a cycle of regular duration and amplitude have failed. These fluctuations can, with a bit of luck and good policy, be tamed but not abolished.
The decade and a half of steady low inflation growth enjoyed by the UK since leaving the European exchange rate mechanism in 1992 has been quite exceptional, as have even the four years of similar behaviour enjoyed by the Group of Seven (G7) leading industrial nations as a whole. The confidence of mainstream forecasters in predicting yet another Goldilocks period for the world economy should have made one suspicious, not because of the faltering in the second quarter of this year, but because experts are never as likely to be wrong as when they speak with near unanimity.
Some economists of Austrian origin have claimed that recessions have their value in liquidating unwise investments and that attempts to keep the economy going full blast all the time only store up greater trouble for the future. It was their misfortune that their theory was promulgated during the Great Depression of the 1930s, when there really was a deficiency of purchasing power, which made them seem irrelevant. The Anglo-Austrian, Friedrich Hayek, tried to make amends by accepting the need to counter a secondary depression resulting from the multiplier effects of reduced investment spending, but he did so much too late, in the 1960s and 1970s. By then, Austrian economics had become a minority movement among US economists, who were beset by heresy hunting.
Today, the torch seems to have been taken up in Shanghai, where an economist, Andy Xie, has written that "it is time for central banks to stop bailing out markets", blaming current troubles on central banks, which after the attacks of September 11 2001 provided the cheap credit for the leverage bubble. Some central bankers are still suffering from a guilt complex arising from the failure of the US Federal Reserve to counteract a multiple contraction at the onset of the Great Depression.
When it comes to the present turbulence, a select band of analysts is entitled to say: "We told you so." They include Paul De Grauwe, the Belgian economist; Lord Lamont, the former British chancellor; and some brave economists at the Basle-based Bank for International Settlements who have been beavering away at the need to monitor asset prices, and not just for their possible effects on consumer price inflation.
The inflationary effects of easy credit have, until now, been offset by the threat of cheap imports from the developing world. But now that China and other developing countries are themselves experiencing high and rising inflation, loose money in the west, as Mr Xie points out, will feed straight into prices and the credibility of central banks could be fatally undermined.
The direct responsibility of central banks for controlling inflation is comparatively recent. They were traditionally bankers to the banks, in which capacity they became lenders of last resort. The art is to be ready to intervene without creating a moral hazard that unwise lenders will be painlessly rescued. The duty of such lenders was laid out in the mid-19th century by a famous early editor of The Economist, Walter Bagehot. This was not to bail out specific institutions, but to lend unlimited amounts to bona fide financial institutions at a penal rate. At first sight the European Central Bank, which has let it be known how many billions of euros it has made available, has been closely following Bagehot, but with one crucial difference. Instead of lending at a penalty rate, it has been chiefly concerned to keep the very short-term rate near the 4.0 per cent policy rate decided before the crisis broke.
The Bank of England was in some ways the best prepared. Under reforms introduced a year ago, 57 banks can borrow limitless cash but at a price 100 basis points above the target bank rate. But even this system will come under strain in a full-blown financial gale. There is little doubt that there would be rescues for large institutions whose failure would pose a "systemic risk", which the Barings crisis of 1890 apparently did but the one of 1995 did not. Life, as cynical Tories are fond of saying, is unfair.
Fed interventions have been more discretionary and less rule-bound. But unwise US fund managers have been berating Ben Bernanke, the US Federal Reserve chairman, for not bailing out the market. This is the voice of those who at the slightest sign of trouble call for cheap money and plenty of it. It is the mirror image of those lumpen Marxists who greet every financial shock by gloating that the long-predicted final crisis of capitalism has arrived. They deserve each other.
...........................................
— FT Syndication Service
CAPITALISM has been subject to booms and busts for at least the past 300 years, notable early examples of which were the Dutch tulip mania and the British South Sea Bubble of the early 18th century. Any market system -- including market socialism, if that had ever got off the ground -- would probably have been subject to similar fluctuations, based as they are on human cycles of greed and fear, and alternations between unfounded optimism and unreasoning pessimism. Attempts to establish a cycle of regular duration and amplitude have failed. These fluctuations can, with a bit of luck and good policy, be tamed but not abolished.
The decade and a half of steady low inflation growth enjoyed by the UK since leaving the European exchange rate mechanism in 1992 has been quite exceptional, as have even the four years of similar behaviour enjoyed by the Group of Seven (G7) leading industrial nations as a whole. The confidence of mainstream forecasters in predicting yet another Goldilocks period for the world economy should have made one suspicious, not because of the faltering in the second quarter of this year, but because experts are never as likely to be wrong as when they speak with near unanimity.
Some economists of Austrian origin have claimed that recessions have their value in liquidating unwise investments and that attempts to keep the economy going full blast all the time only store up greater trouble for the future. It was their misfortune that their theory was promulgated during the Great Depression of the 1930s, when there really was a deficiency of purchasing power, which made them seem irrelevant. The Anglo-Austrian, Friedrich Hayek, tried to make amends by accepting the need to counter a secondary depression resulting from the multiplier effects of reduced investment spending, but he did so much too late, in the 1960s and 1970s. By then, Austrian economics had become a minority movement among US economists, who were beset by heresy hunting.
Today, the torch seems to have been taken up in Shanghai, where an economist, Andy Xie, has written that "it is time for central banks to stop bailing out markets", blaming current troubles on central banks, which after the attacks of September 11 2001 provided the cheap credit for the leverage bubble. Some central bankers are still suffering from a guilt complex arising from the failure of the US Federal Reserve to counteract a multiple contraction at the onset of the Great Depression.
When it comes to the present turbulence, a select band of analysts is entitled to say: "We told you so." They include Paul De Grauwe, the Belgian economist; Lord Lamont, the former British chancellor; and some brave economists at the Basle-based Bank for International Settlements who have been beavering away at the need to monitor asset prices, and not just for their possible effects on consumer price inflation.
The inflationary effects of easy credit have, until now, been offset by the threat of cheap imports from the developing world. But now that China and other developing countries are themselves experiencing high and rising inflation, loose money in the west, as Mr Xie points out, will feed straight into prices and the credibility of central banks could be fatally undermined.
The direct responsibility of central banks for controlling inflation is comparatively recent. They were traditionally bankers to the banks, in which capacity they became lenders of last resort. The art is to be ready to intervene without creating a moral hazard that unwise lenders will be painlessly rescued. The duty of such lenders was laid out in the mid-19th century by a famous early editor of The Economist, Walter Bagehot. This was not to bail out specific institutions, but to lend unlimited amounts to bona fide financial institutions at a penal rate. At first sight the European Central Bank, which has let it be known how many billions of euros it has made available, has been closely following Bagehot, but with one crucial difference. Instead of lending at a penalty rate, it has been chiefly concerned to keep the very short-term rate near the 4.0 per cent policy rate decided before the crisis broke.
The Bank of England was in some ways the best prepared. Under reforms introduced a year ago, 57 banks can borrow limitless cash but at a price 100 basis points above the target bank rate. But even this system will come under strain in a full-blown financial gale. There is little doubt that there would be rescues for large institutions whose failure would pose a "systemic risk", which the Barings crisis of 1890 apparently did but the one of 1995 did not. Life, as cynical Tories are fond of saying, is unfair.
Fed interventions have been more discretionary and less rule-bound. But unwise US fund managers have been berating Ben Bernanke, the US Federal Reserve chairman, for not bailing out the market. This is the voice of those who at the slightest sign of trouble call for cheap money and plenty of it. It is the mirror image of those lumpen Marxists who greet every financial shock by gloating that the long-predicted final crisis of capitalism has arrived. They deserve each other.
...........................................
— FT Syndication Service