In his Cardiff speech last night, Sir Mervyn King admitted the Bank of England’s short term policies “appear diametrically opposed to those needed in the long term.”Sir Mervyn still believes that ulta-low interest rates have prevented the recession becoming a depression. However he confessed that such low interest rates prevent bad investments from the boom years unwinding and prop up failing firms surviving on cheap credit, thus postponing the recovery.
I could point out that I have been saying this for years. Although that would be true, I am not the only one. And it brings me no pleasure to have been right in foretelling these problems.
Followers of the Austrian school of economics like myself have long argued that economic boom/bust cycles are caused by an artificial expansion of credit by the banks. This expansion of cheap money causes businesses to make bad investment decisions and, in turn, cause major economic dislocation. Major dislocations are unsustainable over the long term and eventually the market corrects itself. This makes me a pro-capitalist critic of the existing world financial order.
The Governor has begun to elaborate how his own monetary policy contributes to the problem:
First, monetary policy supports demand and output by encouraging households and businesses to switch demand from tomorrow to today. But when tomorrow becomes today, an even larger stimulus is required to bring forward more spending from the future. Since the paradox of policy has been evident for almost four years, tomorrow has become not just today but yesterday. When the factors leading to a downturn are long-lasting, only continual injections of stimulus will suffice to sustain the level of real activity. Obviously, this cannot continue indefinitely. Policy can only smooth, not prevent, the ultimate adjustment. At some point the paradox of policy must be resolved.
A general market correction in not a petty sight. Firms that depend on excessively easy credit go bust, shareholders lose money and staff lose jobs. But the misery does not end there. Those firms’ suppliers – and the businesses where their staff and sharholders spend their pay and dividends – also suffer loss of business in turn. Even if they do not go bust, they too will have less money to buy from their suppliers and to pay staff and shareholders; and so on throughout the economy.
Tragically, this is inevitable. Further cheap credit can only put off the evil day for an even bigger crash later on. The Governor has gone part way towards admitting this. I hope in due course he and other proponents of monetary central planning will come to face their intellectual errors and the harm they have done.