It has a tiresome familiarity. When the financial markets stutter around the world the predictable doomsayers herald impending financial armageddon.
Recent market jitters were triggered by the continued incremental tightening of credit by the Federal Reserve and ongoing concerns about US President Donald Trump’s bellicose trade policies.
It is unlikely the world is facing imminent financial anarchy. The prophets of doom repeat their proclamations on a regular basis. This ensures media attention and possibly an anointment as a financial oracle.
The reality is more corrosion than implosion. The legacy of the Global Financial Crisis of 2008 is still playing out. The medicine that was administered a decade ago is still being used to treat the patient. The Fed is very slowly trying to wean the United States financial sector off its medicine. The medicine is easy money and ultra low interest rates.
During the GFC, central banks around the world gave a clear message to financiers. They will support them by flooding their economies with easy money rather than risk a complete financial meltdown. They will risk unleashing inflation in preference to a deflationary spiral that would be the likely outcome of an endemic financial meltdown. Central bankers have learned the pivotal policy lesson of the 1930s Great Depression. But this comes with a huge cost. They have created a Faustian pact.
The policy choice has narrowed to financial implosion and lengthy global depression versus the corrosive effects of easy money and credit. We are living with the consequences of the latter. The most corrosive consequences have been moral hazard and a huge growth in inequality, particularly in the distribution of wealth.
The moral hazard arises because the "get out of jail card" central banks have provided to financiers has allowed them to continue their shoddy practices that precipitated the GFC in 2008. There has been little meaningful legislative change to rein in dubious lending and leverage practices. The financial sector still regards itself as "too big to be allowed to fail". No other sector of the economy has such implicit backing from central bankers who control the money supply. The prices of raw material for farmers, manufacturers and all other producers are largely set in the marketplace.
The price of money for financiers is largely set by central banks. They are the privileged sector of modern economies ... and they know it. The huge increase in wealth inequality in New Zealand and abroad is the product of ultra-low interest rates facilitated by medicinal monetary policy. The inflation hawks who argued that this response to the GFC would cause hyperinflation were proved wrong. The huge increases in the output of developing economies such as China and India have kept consumer price inflation muted.
The real impact of ultra-low interest rates in recent years has been on asset markets, particularly property and shares. Those who hold such assets have become much wealthier because cheap money has pumped up asset prices. Asset prices are not measured in official inflation figures. This allows central banks to continue to keep interest rates low. The wealthy are getting wealthier at unprecedented rates, facilitated by central banks. But during this period most income-earners have seen little growth in their pay-packets.
It is unlikely we are facing imminent financial armageddon. Even if monetary policy loses its effectiveness, governments could still borrow and spend to keep their economies afloat. Politicians would probably embrace such policy if the alternative was another Great Depression. The sad reality is that the medicine of ultra-low interest rates has created larger divisions of wealth in many societies. It favours those already holding wealth. The other sad reality is that the financial sector still remains the Achilles heel of modern economies.
- Peter Lyons teaches at St Peter’s College, in Epsom, and has written several economics texts.
