The following, by Max Rangeley and Steve Baker MP, was published by Moneyweek’s Fleet Street Newsletter http://www.fleetstreetletter.co.uk/.
Over the previous half century, economic central planning and price fixing have been intellectually discredited in almost every sector of the economy. In the 1970s many developed countries, including Britain and the United States, had governments which used widespread price fixing, extending to petrol and other goods used every day by the public. Both academic institutions and pragmatic government officials realised over time that such interventionism by government agencies does not work. At best it prolongs the malaise, but more often than not it seriously distorts the structure of the economy both in conspicuous ways, such as product shortages, but also in ways that are more insidious.
Having deracinated almost all theoretical support for price fixing from economic theory, we in the developed world now only have one domain of our economy wherein this ghost has still not been exorcised – central banking. Economists understand that prices coordinate economic activity, that when there is too much of a good prices must fall in order to accommodate this, and that when a good falls into shortage prices must rise, which both reduces demand and entices people to enter the market to supply more of the good. These mechanisms of free market capitalism are the reason why in developed countries we can go to the supermarket and buy exotic food from all over the world rather than seeing the bare shelves that are all too familiar in Venezuela and other countries that engage in economic central planning.
Interest rates perform a similarly crucial role in the economy. They must be allowed to move with the demand and supply of credit rather than being set by bureaucrats. In a free market for credit, when too many people want to borrow money the cost of borrowing goes up, just like the price of butter or coffee when demand exceeds supply; this increase in interest rates is itself the mechanism by which bubbles should be prevented from forming, just as is the case with free markets for food and other products. Our current monetary system means that this coordination of the supply and demand for credit can no longer take place in the natural market way, and we therefore have the wild fluctuations in the credit markets that in bureaucratically controlled economies are frequently seen for everyday goods in the shops.
Friedrich von Hayek won the Nobel Prize in Economics in 1974 for his exposition of how central banks’ manipulation of interest rates causes distortions in a manner that is at least as pernicious as other forms of government intervention in the market. This theory, hardly taught in economics schools in the twenty-first century, should be resurrected and brought back into the spotlight as a conceptual framework that clearly explains the problems we are facing right now. Central banks have set interest rates at close to zero. Just as fixing the cost of food at artificially low levels causes terrible distortions in Venezuela, we should not be surprised if central bank dirigisme similarly results in distortions throughout financial markets.
The world now faces an eighty trillion dollar global bond bubble caused by the manipulation of interest rates by central banks. Whereas the fixing of prices in certain sectors of an economy can remain relatively constrained in its effects, the fixing of interest rates causes widespread malinvestment. The tremors in the markets earlier this year are the initial stages of a more widespread disintegration that will occur – and must occur – as a consequence of the artificially low interest rates of the previous years. Regrettably, central banks will be pressured to return to more artificially cheap credit as the markets begin to recognise the level of distortions caused and the ruptures required to rebalance the economy, but the consequences of trillions of dollars of cheap credit must be faced down at some point. Bureaucratic fixing of prices has a 100% failure rate in economics, this has been proven in all other sectors of the economy and will now be proven to be the case for central banks in the financial sector.
Steve Baker is MP for Wycombe and Co-Founder of The Cobden Centre, Max Rangeley is Editor of The Cobden Centre