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

Pharmaceutical Computer System Validation Specialist

£300 - £350 Per Day: Clearwater People Solutions Ltd: Pharmaceutical Computer ...

High Level Teaching Assistant (HTLA)

£70 - £90 per day: Randstad Education Birmingham: Higher Level Teaching Assist...

Teaching Assistant

£50 - £80 per day: Randstad Education Birmingham: Randstad Education is the UK...

Senior Java Developer - API's / Webservices - XML, XSLT

£400 - £450 Per Day: Clearwater People Solutions Ltd: Our client is currently ...

Day In a Page

Read Next

i Editor's Letter: Take a moment to imagine you're Ed Miliband...

Oliver Duff Oliver Duff

Letters: No vote poses difficult questions – so why rush?

Independent Voices
Secret politics of the weekly shop

The politics of the weekly shop

New app reveals political leanings of food companies
Beam me up, Scottie!

Beam me up, Scottie!

Celebrity Trekkies from Alex Salmond to Barack Obama
Beware Wet Paint: The ICA's latest ambitious exhibition

Beware Wet Paint

The ICA's latest ambitious exhibition
Pink Floyd have produced some of rock's greatest ever album covers

Pink Floyd have produced some of rock's greatest ever album covers

Can 'The Endless River' carry on the tradition?
Sanctuary for the suicidal

Sanctuary for the suicidal

One mother's story of how London charity Maytree helped her son with his depression
A roller-coaster tale from the 'voice of a generation'

Not That Kind of Girl:

A roller-coaster tale from 'voice of a generation' Lena Dunham
London is not bedlam or a cradle of vice. In fact it, as much as anywhere, deserves independence

London is not bedlam or a cradle of vice

In fact it, as much as anywhere, deserves independence
Vivienne Westwood 'didn’t want' relationship with Malcolm McLaren

Vivienne Westwood 'didn’t want' relationship with McLaren

Designer 'felt pressured' into going out with Sex Pistols manager
Jourdan Dunn: Model mother

Model mother

Jordan Dunn became one of the best-paid models in the world
Apple still coolest brand – despite U2 PR disaster

Apple still the coolest brand

Despite PR disaster of free U2 album
Scottish referendum: The Yes vote was the love that dared speak its name, but it was not to be

Despite the result, this is the end of the status quo

Boyd Tonkin on the fall-out from the Scottish referendum
Manolo Blahnik: The high priest of heels talks flats, Englishness, and why he loves Mary Beard

Manolo Blahnik: Flats, Englishness, and Mary Beard

The shoe designer who has been dubbed 'the patron saint of the stiletto'
The Beatles biographer reveals exclusive original manuscripts of some of the best pop songs ever written

Scrambled eggs and LSD

Behind The Beatles' lyrics - thanks to Hunter Davis's original manuscript copies
'Normcore' fashion: Blending in is the new standing out in latest catwalk non-trend

'Normcore': Blending in is the new standing out

Just when fashion was in grave danger of running out of trends, it only went and invented the non-trend. Rebecca Gonsalves investigates
Dance’s new leading ladies fight back: How female vocalists are now writing their own hits

New leading ladies of dance fight back

How female vocalists are now writing their own hits