Leading Article: Low inflation, cheap money and endless growth never added up


Stock markets indices are falling across the world. Hedge funds have collapsed. No one wants to lend to the buccaneers of the private equity industry any more. The central banks have been forced to pump liquidity into the system to stop commercial banks from going under as investors clamour to get their money back. But was ever a financial crisis so widely foreseen?

A huge amount of cheap money has been sloshing about in the financial markets in recent years thanks to historically low interest rates. Borrowers and lenders alike found their judgements impaired by the scale of the rewards on offer in a world where asset prices seemed to be for ever rising. Risk was mispriced. Too much debt was taken on. In short, people got greedy. This was a feature across the economy, from humble British borrowers taking on vast mortgages, to mighty private equity houses leveraging up to the hilt to take over blue-chip companies. Experts began to speak of a "new paradigm" of low inflation, cheap money and never-ending growth. When one hears such hubris it is usually the time to worry. And now the chickens are coming home to roost with a vengeance.

It began in the US where the "sub-prime" mortgage market - hefty housing loans to people with little or no regular income - began to flounder as the Federal Reserve raised interest rates and borrowers began to default on their repayments. Without this revenue coming in, the holders of this dodgy debt - the hedge funds, the banks - began to struggle to meet their other financial commitments. With the Bank of England and the European Central Bank following the Federal Reserve and raising interest rates, investors are now beginning to panic. They want to switch their holdings out of the thousands of complicated debt investment packages that have sprung up in recent years and put their cash into something safer, such as government bonds. The result is that credit is now all of a sudden much harder to come by. That means the takeover and buyout projects that have underpinned much of the stock markets' recent gains are in jeopardy. People are selling shares.

In truth, the crunch would have come a lot sooner were it not for China's growth as a manufacturing giant. That nation's ability to provide the world with electronics and clothing at cheap prices has kept global inflation down. The investment of Asian banks of their huge cash surpluses in Western currencies has also helped in that respect. Without these factors, interest rates would have risen in the West some time ago and exposed most of the dubious borrowing.

Looking back over the past seven years it is increasingly clear that the central banks of America and Europe pumped too much liquidity into the system - and bailed out previous bouts of market jitters too generously. Interest rates should have been higher. The question now is whether the economic correction will be sharp and short, or whether it will take on a momentum of its own as investor and consumer confidence collapses. Will, for instance, our own housing market go the same way as that of the US?

There is strong case to be made for calm. Despite the proliferation of poor lending, the fundamentals of the global economy remain good. The integration of China, India, Brazil, Russia and parts of Africa into the world trade system is powering growth.

But of course there will have to be changes too. Now interest rates are finally rising, a period of financial belt-tightening by companies, governments and consumers is inevitable. There will also be a purging of some of the cavalier capitalists of the City and Wall Street who did so much to encourage us to binge thoughtlessly on cheap credit. For that at least, we can be grateful for the return of those chickens.

React Now

Latest stories from i100
iJobs Job Widget
iJobs General

Senior Risk Manager - Banking - London - £650

£600 - £650 per day: Orgtel: Conduct Risk Liaison Manager - Banking - London -...

Commercial Litigation Associate

Highly Attractive Package: Austen Lloyd: CITY - COMMERCIAL LITIGATION - GLOBAL...

Systems Manager - Dynamics AX

£65000 - £75000 per annum + Benefits: Progressive Recruitment: The client is a...

Service Delivery Manager (Software Development, Testing)

£40000 - £45000 per annum: Ashdown Group: A well-established software house ba...

Day In a Page

Read Next
The economy expanded by 0.8 per cent in the second quarter of 2014  

British economy: Government hails the latest GDP figures, but there is still room for skepticism over this 'glorious recovery'

Ben Chu
Comedy queen: Miranda Hart has said that she is excited about working on the new film  

There is no such thing as a middle-class laugh

David Lister
Finding the names for America’s shame: What happens to the immigrants crossing the US-Mexico border without documents who never make it past the Arizona desert?

Finding the names for America’s shame

The immigrants crossing the US-Mexico border without documents who never make it past the Arizona desert
Backhanders, bribery and abuses of power have soared in China as economy surges

Bribery and abuses of power soar in China

The bribery is fuelled by the surge in China's economy but the rules of corruption are subtle and unspoken, finds Evan Osnos, as he learns the dark arts from a master
Commonwealth Games 2014: Highland terriers stole the show at the opening ceremony

Highland terriers steal the show at opening ceremony

Gillian Orr explores why a dog loved by film stars and presidents is finally having its day
German art world rocked as artists use renowned fat sculpture to distil schnapps

Brewing the fat from artwork angers widow of sculptor

Part of Joseph Beuys' 1982 sculpture 'Fettecke' used to distil schnapps
BBC's The Secret History of Our Streets reveals a fascinating window into Britain's past

BBC takes viewers back down memory lane

The Secret History of Our Streets, which returns with three films looking at Scottish streets, is the inverse of Benefits Street - delivering warmth instead of cynicism
Joe, film review: Nicolas Cage delivers an astonishing performance in low budget drama

Nicolas Cage shines in low-budget drama Joe

Cage plays an ex-con in David Gordon Green's independent drama, which has been adapted from a novel by Larry Brown
How to make your own gourmet ice lollies, granitas, slushy cocktails and frozen yoghurt

Make your own ice lollies and frozen yoghurt

Think outside the cool box for this summer's tempting frozen treats
Ford Fiesta is UK's most popular car of all-time, with sales topping 4.1 million since 1976

Fiesta is UK's most popular car of all-time

Sales have topped 4.1 million since 1976. To celebrate this milestone, four Independent writers recall their Fiestas with pride
10 best reed diffusers

Heaven scent: 10 best reed diffusers

Keep your rooms smelling summery and fresh with one of these subtle but distinctive home fragrances that’ll last you months
Commonwealth Games 2014: Female boxers set to compete for first time

Female boxers set to compete at Commonwealth Games for first time

There’s no favourites and with no headguards anything could happen
Five things we’ve learned so far about Manchester United under Louis van Gaal

Five things we’ve learned so far about United under Van Gaal

It’s impossible to avoid the impression that the Dutch manager is playing to the gallery a little
Screwing your way to the top? Good for Lana Del Rey for helping kill that myth

Screwing your way to the top?

Good for Lana Del Rey for helping kill that myth, says Grace Dent
Will the young Britons fighting in Syria be allowed to return home and resume their lives?

Will Britons fighting in Syria be able to resume their lives?

Tony Blair's Terrorism Act 2006 has made it an offence to take part in military action abroad with a "political, ideological, religious or racial motive"
Beyoncé poses as Rosie the Riveter, the wartime poster girl who became a feminist pin-up

Beyoncé poses as Rosie the Riveter

The wartime poster girl became the ultimate American symbol of female empowerment
The quest to find the perfect pair of earphones: Are custom, 3D printed earbuds the solution?

The quest to find the perfect pair of earphones

Earphones don't fit properly, offer mediocre audio quality and can even be painful. So the quest to design the perfect pair is music to Seth Stevenson's ears