BY STEWART SLATER

We are in a crisis. We know this because it is being screamed from the front pages of every newspaper. The television news is full of panels of talking heads, gravely giving us their opinions. The IMF has issued a strongly worded statement. The Opposition wants Parliament recalled.

And yet, at the time of writing (massive hostage to fortune here) the pound is at roughly the same level against the dollar (having been higher) as it was before Kwasi Kwarteng delivered his non-Budget of Doom. Your correspondent is old enough that he has traded his way through the bursting of the Internet Bubble, 9/11, the Global Financial Crisis, the Eurozone Crisis, the “Taper Tantrum” and Covid, plus sundry other panics which seemed important at the time but which failed to make much impression on the memory, and in exactly none of those events did the assets in “crisis” actually go up.

Will those on the left, after decades of believing that financial markets are full of champagne-guzzling spivs who moisturise with the tears of the poor, follow through on their new-found opinion that they are the ultimate arbiters of all that is good and true now and hail the non-Budget as a work of economic genius? Probably not.

We should not, however, be complacent. All is not rosy in the garden. There are plenty of things which could go wrong, both here and abroad. But if we are not in the crisis the media think, that does not mean we are not in a crisis.

Since the Global Financial Crisis in 2008, Britain has grown about 1% more slowly per annum than its previous trend. Real wages have stagnated. So has productivity. We might be tempted to ascribe this to the British economy being over reliant on the financial sector, but this phenomenon applies across developed economies. Italy, for example, not a globally important centre of finance, is poorer today than it was before it joined the Eurozone.

We could ascribe this international problem to a series of governments each making different individual policy mistakes (which is possible if not particularly likely) or we can ask if there is a unifying thread which can explain what has happened. At which point, we need to talk about Japan.

Readers of a certain vintage might recall that there was a time when it appeared that the country was about to achieve global economic hegemony. That Die Hard was set in a Japanese-owned building in L.A. is emblematic of the feeling current back then that it was taking over America. But, as we all know, that did not happen. For Japan’s economic strength was, partly, a mirage. It had blown a massive property bubble which resulted in the Imperial Palace (a big building certainly, but not that big) being valued as worth more than the entire state of California.

As bubbles do, it popped. So what did the authorities do? They cut interest rates. But that did not work – growth remained sluggish. So they cut them again and (like the good Keynesians they were) started spending on public works. That didn’t work either. So they did more of both and started printing money as well. That still didn’t work, so they did even more. And it still didn’t work. Market wags nicknamed the policy “pushing on a string”. The 1990’s became known as the “Lost Decade” but with the minor wrinkle that the same phenomena lasted into the 2000’s and the 2010’s.

Given the lack of notable success in Japanese economic policy, one might have expected that when Western policy-makers faced a similar problem in 2008, they would have adopted a different approach – insanity being, according to the internet and possibly Albert Einstein, doing the same thing and expecting different results. But no. Interest rates were cut and money was printed. When cyclical economic difficulties arose, interest rates were cut again – the theoretically uncrossable Rubicon of 0% proved more a trickle than a raging torrent – and more money was printed. And, as we all know, that has not entirely worked out.

If the orthodoxy has been tried twice, and yielded the same uninspiring results both times, perhaps the problem is the orthodoxy.

So why, then, all the fuss about the government’s “unorthodox” ideas?

For some, in policy-making circles and those in the media who have cheer-led for them, admitting the policies have not been an unalloyed success would imply that they have got things wrong. And that would raise all sorts of nasty questions. As Upton Sinclair put it,

“It is difficult to get a man to understand something when his salary depends on his not understanding it.”.

The advantage of having one’s head in the sand is that it cannot be shot off.

For others, however, the reaction is less ignoble. Declining house prices, for example, will make people poorer – although since a mooted 10% decline would take them back to the level of January 2021, we might not see this as a reason for inordinate panic. But here too, we might point an accusatory finger at the policy-making classes. For UK house prices are firmly in bubble territory.

In October 1987, Alan Greenspan was new to his post as Chairman of the Federal Reserve (America’s Bank of England equivalent) when Black Monday hit. Seeing the declines as a challenge to his authority, he aggressively lowered interest rates to reassure investors. And this was successful. Markets ended the year higher than they had been before the crisis hit, making back a roughly 20% decline. Indeed, it worked so well that Greenspan rolled out the same policies every time a bout of turbulence hit, producing a decade of stable, low inflation growth. So high was his reputation that Bob Woodward (of Watergate fame) published a biography entitled simply, Maestro.

But if timing is everything, Woodward’s was off. For his book came out just after the bursting of the Internet Bubble as people started to realise that the stability of the nineties (“The Great Moderation”) owed more to the decline in defence spending after the Cold War and China’s integration into the global economy. All the “Maestro” had done was to enable a speculative asset boom.

Despite this, Greenspan’s thought lives on. Central Banks spend inordinate amounts of time thinking about the “wealth effect”. But this is a fundamental change in the way financial markets are seen. Greenspan’s predecessor as Fed Chair, Paul Volcker, famously said that his job was to “Take the punchbowl away just as the party gets going.” Central banks have spent the past 35 years spiking it with neat alcohol. Volcker and his predecessors saw their job as ensuring the stability of the financial system, and allowing markets to follow their course, Greenspan and his successors decided theirs was to stop anyone getting poorer.

But stockmarkets were invented to allow companies to raise capital and society, or the investing parts of it, to reach a consensus on the value of the business. They do not exist as perpetual money machines to allow people to make money by speculation. If your ability to appraise the worth of an enterprise is better than others’, then you will. If it is not, then you should not.

Interest rates exist to price the risk taken by a lender when giving money to a borrower. Declining rates, therefore, either imply that the world has become less risky (and if you believe that, I’ve got a lovely bridge you might be interested in, one careful owner) or that lenders are generously willing to accept less compensation than they have at any other point in history. How likely is that?

By printing money to protect wealth every time a problem has emerged, Central Banks have enabled a series of asset bubbles in everything from Emerging Market debt to Internet Stocks, UK houses to NFTs (remember them?). Each time one of these bubbles pops, the intervention has led to the blowing of the next one.

But there is a real world impact of this policy too. Low interest rates, reinforced by huge amounts of capital desperate to make a return, no matter how meagre, make it easier for unproductive businesses to stay in business, preventing the “creative destruction” which is necessary for the efficient allocation of capital. One of the reasons that Japan’s recovery was so slow was that, able to meet very low interest rates, zombie companies did not go bust, preventing the capital deployed in them from being reorientated to the more productive.

Closer to home, the large stock of money globally has served to fuel the recent rise in prices across the board. To put it simply, if the Banks had not spent a decade printing money, there would be less of it to chase goods. A world with a smaller money supply would not be able to afford elevated prices for, taking an example at random, gas, meaning that supply and demand would better regulate prices. If you chop down a tree and a spark hits your pile of wood, you will get a fire. The impact of the past decade is that we now have a whole forest in the lumber-yard.

We know from their book, Britannia Unchained, that Truss and Kwarteng are worried about Britain’s productivity, so anything which forces a change in the Central Banking orthodoxy is probably a good thing from their point of view. But it will be painful. House prices and stockmarkets may fall, spending will need to be cut. Some will have problems meeting their mortgage payments. Businesses may fail. What, though, is the alternative?

We can stick with the status quo, let Central Banks carry on protecting asset prices and see more of the same slow growth and declining productivity. Governments can continue taking an ever-increasing share of GDP in tax to pay for spending. We can then turn our minds to wondering how such an economy, awash with debt and prone to asset bubbles and inflation, can deal with a rapidly ageing population. Or we can take some pain now, long deferred, and let the system do what it was originally designed to do. If a patient develops gangrene in his toe, it is generally better just to take it off than let it spread to the whole leg. The best time to act was yesterday, the second best is today.

Stewart Slater works in Finance. He invites you to join him at his website.