Houses have become speculative financial assets rather than places for people to live in A thin-skinned, self-absorbed, belligerent man at the helm of the world’s most powerful democracy. Extreme right wing political power re-emerging in Germany. Obvious signs of devastating climate change around the world. We are living in very strange times.
But one of the strangest aspects of our current reality is seldom commented upon. It is an elephant in the room. Our economy, like many around the world , is still hooked up to a life support system. Our Reserve Bank is still keeping interest rates at record low levels to keep the economy in apparent rude good health. We have become so used to this medicine it is seldom commented upon. What is also never mentioned is the irony that, in a market economy, the price of money is largely determined by a government-appointed authority rather than the market. A strange peculiarity of modern capitalism.
I find the role of money and credit in an economy fascinating. It is the lubricant for the economic engine. If this lubricant dries up then the entire economic engine will seize up. We came very close to this a decade ago. Yet this lubricant is so poorly understood. I am a monetarist bore. I spend much solitary time in the kitchen at parties.
Yet a little understanding in this area goes a long way to understanding our current strange economy. In 2008 the world economy narrowly dodged Armageddon. There were strong parallels with the onset of the Great Depression of the 1930s. There was potential for a complete collapse of the financial system around the world. Central banks saved the day. They flooded their economies with easy money. They slashed interest rates. Some gave computer-generated money to shaky banks and governments in return for IOUs. Central banks entered a Faustian pact which favoured the threat of hyperinflation over a descent into the prolonged misery of the 1930s.
The world economy encountered major turbulence but managed to largely sail on. The fears about hyperinflation proved unfounded. Or did they?
The huge amount of easy money sloshing around the world has not caused hyperinflation in the prices of goods and services. The Consumer Price Index in New Zealand has been little affected. Headline inflation has been at record lows. There are several reasons for this. The huge increases in the supply of consumer goods from emerging countries such as China and India has depressed prices. Lower world oil prices have also muted consumer price increases. A lack of growth in most people’s incomes has also kept inflation low. Global competition for jobs restricts pay increases for the average worker.
But the central bank medicine has come at a huge cost. It has provided the fuel for asset price inflation, particularly in housing and shares. This type of inflation is not measured by conventional inflation statistics. For this reason central banks are able to keep interest rates at record lows further fuelling asset price inflation. So we enjoy watching our houses go up in value but wonder why we are struggling to pay the bills. This is because houses have become speculative financial assets rather than places for people to live in. The medicine saved the patient but there have been some very ugly side effects.
• Peter Lyons teaches economics at St Peter’s College in Epsom and has written several economic texts.
