Posted 10 months ago Comments
It’s been a while since I’ve pontificated (read “ranted”) about the global economic malaise…
On the back of the LIBOR scandal, Alan Kohler wrote a sensible piece on the world of interest rate manipulation this week. The bottom line:
As for the other interest rate manipulation, the one that central banks solemnly do once a month, nobody is questioning whether that is a good idea.
Let me give it a try.
Since central banks started running the monetary system in the 20th century there has been a succession of financial disasters – depressions, inflation, hyper-inflation, and lately the biggest credit bubble and bust in the history of the world. It hasn’t gone well, you’d have to admit.
Why is this? Because central banks come under intense pressure from their owners to keep interest rates low. We see it in Australia, where government politicians constantly play to the mortgage belt by hoping that rates are not raised.
Imagine if it was another basic price that was being manipulated by a government agency to raise and lower aggregate demand – say, rent. There would be constant baying for rents to be lowered; the “rent policy agency” would be in fear of their jobs every time they raised them.
The capitalist system works through investment creating production and productivity. Investment is created by deferred consumption, otherwise known as saving. The financial system exists to collect the savings and direct them to the most productive purpose.
Interest is what borrowers pay to persuade other people to defer their consumption, in the belief that they will be able to consume more later on. The natural interest rate changes all the time according to society’s propensity to save or consume – it’s the rate, taking account of risk, which balances the desire to consume with the desire to save.
If interest rates are artificially manipulated, as they have been by central banks for a hundred years, imbalances inevitably occur because the market clearing mechanism is not allowed to work. The recessions will be deeper and longer and the booms will become bubbles.
While another round of global interest rate reductions might spur sharemarkets for a month or two, the reality is that the developed world’s dependence on keeping rates at such artifically low levels (negative real interest rates, anyone?) means that we’ve got nowhere to hide over the longer-term. Austerity is shrinking economies faster than they can respond; even if it can be engineered, slowly digesting debt is going to be painful (read “politically unpopular”); if the recovery somehow manifests then it will be quashed as soon as rates rise; andthen we’ve got the spectre of inflation, which will surely pop up on the horizon eventually…
It’s hard to know what to do now, but with the benefit of hindsight it’s easy to see what should have been done years ago, to prevent us from ever reaching this point. As a recent piece in The Economist explained:
During the boom, policymakers ignored rising asset prices—and indeed welcomed them as evidence that all was well—and disregarded accompanying private-sector credit growth. But when asset prices collapsed, and the banks got into trouble, some of that private-sector debt ended up on the public balance-sheet, leading to the current phase of the crisis.
The myth of perpetual growth (and asset price rises, ad infinitum, supported by ever-expanding debt) is only just being realised.
I fear that its debunking will prove much more painful to economies (and, more importantly, people) across the world than anything the GFC has thrown at us thus far.
Post Script: One day later and Nouriel Roubini is warning that next year could be a global perfect storm bringing greater economic challenges than 2008 and at a time when policymakers have already fired most of their policy bullets… *gulp*