Stephen King: Things can only get better? There's always another crisis ahead
Faced with a low cost of capital, investors chased easy wins. Discipline went out of the window
Monday 23 January 2012
This is my penultimate column for the Independent. After more than a decade of writing for this wonderful newspaper, it is time to move on. However, before I disappear into the sunset – or, at least, head off to pastures new – I thought I could offer some thoughts on how we've ended up – as Oliver Hardy might have said – in "another fine mess".
I wrote my first column in August 2001. The headline was "How it all went wrong for bullish global economy". Sometimes it seems that time stands still. Back then, the big story was the collapse in the tech bubble. Financial Armageddon threatened.
Yet, as the months went by, the global economy was able to rebound. The US economy recovered, helped by a strong dose of monetary stimulus and a liberal application of tax cuts. The UK economy avoided recession. Eurozone nations began to flourish, spurred by a dramatic convergence of long-term interest rates. Emerging nations, which had lurched from one crisis to another in the late 1990s, loomed.
Policymakers indulged in mutual backslapping. There may have been no return to the productivity-driven "new economy" of the late-1990s but the 2000 stock-market crash didn't lead to the economic stagnation that had blighted Japan following its own market meltdown at the beginning of the 1990s. A diet of low interest rates and relatively accommodating fiscal policy was apparently just the ticket. New buzz-phrases began to circulate: the Nice (non-inflationary, consistently expansionary) decade, the Great Moderation, the Longer, Smoother Cycle.
It seemed as though policymakers had discovered the elixir of economic and financial success. Sadly, it didn't last. Precious policy metal turned to fool's gold. Rather than preventing a Japanese-style stagnation, the stage had been set for a far bigger crisis. Within a few years, Western economies went from modest recovery to the edge of a financial abyss. If growth was so smooth, inflation so low and policymakers so clever, how could this possibly have happened?
The answer lies both with the type of growth and the level of interest rates required to achieve it. Let's take interest rates first. Following the collapse of technology stocks, the Federal Reserve slashed official interest rates to just 1 per cent. Rates eventually went back up again, but not before the US economy had succumbed to a housing boom. Long-term US government interest rates – Treasury yields – also dropped, helped not only by the Fed's monetary stance but also by an insatiable demand from the Chinese and other emerging investors as they intervened to prevent their currencies from appreciating excessively.
At the same time, private investors were engaged in a hunt for yield. Following the bursting of the equity bubble, fixed-income assets were the only investment game in town. Yet yields on Treasuries were simply too low. Investors turned elsewhere, looking for anything that appeared to offer an attractive mix of high yield and low risk. So they bought up mortgage-backed securities, collateralised debt obligations, Greek government debt and other temptations.
The money raised was invested in the wrong areas: too much in housing, too little in education, too much in financial services, not enough in infrastructure. Faced with a remarkably low cost of capital, investors chased easy wins. Discipline went out of the window. The quality of growth dwindled.
It is easy enough to blame our current woes on the collapse of Lehman Brothers and all that followed. But in truth the rot set in long before and was associated with a collective hubris, an arrogance that claimed we had become masters of our economic and financial destiny. Warning signs – rapid house-price gains, huge credit growth, an alarming pace of financial innovation – were casually brushed aside. The Bank of England, for example, argued that there was nothing at all sinister about the UK's property boom. Instead, we promised ourselves – or our leaders promised us – no more boom and bust, low inflation, good growth and ever-rising prosperity.
Chancellor of the Exchequer, Gordon Brown summed up this collective hubris nicely, saying "I can report not only the longest period of sustained growth in our history, but of all the major economies... Britain has enjoyed the longest postwar period of economic growth. In no other decade has Britain's personal wealth grown so fast". That was at the end of 2006, just months before the demise of Northern Rock. In economic policy, pride often comes before a spectacular fall.
Ultimately, we use capital markets to make economic choices which involve time: jam today or, if we're lucky, more jam tomorrow. None of us, however, has a crystal ball. Capital markets mustreflect both risk (which can be measured) and uncertainty (which can't). What goes up can go down. Too often, however, complacency sets in.
Economists and policymakers – including former and present Fed chairmen Alan Greenspan and Ben Bernanke, pictured – are constantly looking for the secret of strong, stable and sustainable economic growth. It's an honourable ambition but it may be one which is also, ultimately, self-defeating.
We too often suffer from collective delusions. It's almost as if we're programmed to believe that things can only get better. By acting on these sentiments, however, we help make the system as a whole a lot less stable.
Policymakers need a dose of humility. But policymakers, in general, are not a humble bunch. They'd rather encourage the rest of us to believe they have managed to tame capitalism's excesses.
If, however, the rest of us believe them, we'll end up taking precisely those risks that will lead us to the next crisis. In managing capitalism, we still have a lot to learn.
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