It was Friedrich von Hayek, the great Austrian economist, who explained just how central the price system is to capitalism and our civilisation’s astonishing prosperity. The fact that goods, services, assets, money, time, ideas and risk all come with a price attached allows resources to be allocated remarkably effectively.An increase in the price of oil means that demand has gone up, which encourages producers to invent new ways of extracting more of it. A reduction in the price of corn means that there is too much of it, and the fact that it becomes less profitable to sell it encourages producers to exit the market. Adam Smith described this as an invisible hand that aligned the self-interest of individuals, coordinating their actions for the greater good.
The free market makes mistakes, of course, but it fails far less frequently than any alternative way of allocating resources. The only other way is to direct activity centrally - an extreme version of central planning - but that is a recipe for catastrophe. Tragically, while policymakers supposedly understand this, they have spent years undermining the price system, making it less useful and efficient, planting the seeds for one crisis after another. The current market turmoil - which has pushed the FTSE 100 down 22pc from its recent peak, sent yields into a spin and turbocharged gold - is one consequence of all of this. Far from being a manifestation of what the left describes as “neo-liberalism”, it is primarily a failure of statism.
The triggers for the recent turmoil were the slowdown in China and emerging markets - reducing the demand for oil, energy and commodities - a group of economies that were propped up directly and indirectly thanks to domestic and global monetary easing and other interventions following the Great Recession of 2007-09. As a result, many of the problems besetting those countries were not tackled and just grew worse; it was always a certainty that reality would eventually catch up with them, and that bad debts would have to be written off and resources reallocated to more productive uses. Another name for that process is a recession, or - at least in the case of China - a slowdown.
Not everything that is going wrong can be blamed on politicians or central bankers, of course: the private sector can also make spontaneous errors. But the US, UK, European and Japanese economies would not be in the position they are in today had the price system been allowed to clear freely and had policymakers allowed more of the malinvestments of the past to be liquidated more quickly. Kicking the can down the road can help ease an adjustment, but it can also allow denial to set in. Tragically, the latter is what appears to have happened in many economies and markets around the world.
Ever since the Wall Street crash of 1987, central banks have relentlessly disrupted the price system to smooth economic activity and placate financial systems. The former goal came from a belief in the power of monetary activism; the latter from the view that higher asset prices can only be good for growth.
The tragedy is that, even though both of those theories are tragically misplaced, the global economic establishment continues to cling to them, despite the devastation that they keep causing. An ultra-activist monetary policy triggers immense moral hazard: it means that the markets begin to assume that they will always be bailed out by lower interest rates or quantitative easing whenever asset prices begin to fall. It creates an artificial floor below prices; traders have called this the Greenspan, Bernanke and now Yellen put (after a put option, which gives the holder the right to sell an asset at a certain minimum price).
The result of all of this is that monetary policy and other regulatory interventions have badly disrupted the price system. They are not the only forces at play but they are the most powerful ones. The price of risk in particular has been pushed down too low, just as it was for a different set of assets in 2005-2006; the value of equities, including many financial stocks, has gone up too much; the price of prime real estate has soared to dangerous levels; the value of some currencies has been distorted; and government bond yields are often irrationally low.
Instead of working freely, as it should, the market has become distorted and corrupted, sending out misleading price signals and guaranteeing clusters of errors from investors. A failed intervention begets another failed intervention, and another, and another: this cycle has been ongoing for 25 years at least, triggering ever more extreme action. None of this is novel: Ludwig von Mises, another Austrian economist, described earlier versions of this phenomenon in the early 20th century. The next step in some countries will be negative interest rates, followed by helicopter money. Central banks need to ensure that there is enough money in the economy. But they should follow simple rules to ensure that this happens, not seek to micro-manage sentiment.
The price of equities should be determined by investors interacting freely; instead, the primary driver is now hints from the Federal Reserve. This isn’t right; it is bad for our long-run economic prosperity and very dangerous politically. Other markets are equally mispriced. A 10-year Bund yield at 0.168pc implies zero growth and zero inflation for the next decade, which is nonsense. Investors who feel let down by central banks are fleeing equities and piling into safe havens beyond anything that can be justified through fundamental analysis. This storm may yet blow over, but the economy will only be truly cured when the root causes of its ailment are finally addressed.
Original Article
Source: telegraph.co.uk/
Author: Allister Heath
No comments:
Post a Comment