Adair Turner’s analysis of the crisis is worryingly incomplete

Allister Heath
IF, like me, you believe that the bubble that blew up the global economy in 2007-08 was caused primarily by years of excessively loose monetary policy which pumped too much liquidity into the system, global imbalances that pushed down long-term interest rates, the promotion of sub-prime lending by the US authorities and massive moral hazard caused by government guarantees that encouraged private risk-taking – well, you would have been disappointed by last night’s speech by Lord (Adair) Turner, the FSA’s chairman.

His very public application for the job of governor of the Bank of England gave an incomplete analysis of the causes of the crisis, focusing on the stupid behaviour of institutions (such as excessive leverage) rather than on the underlying causes for these mistakes. Some of his explanations were spot on, of course. He has belatedly seen sense on the euro, after spending years trying to convince Britain to join. He is right about the intellectual errors that caused so many in the private and public sectors to wrongly assume the world was safer than it was. And of course regulations were deeply flawed, with one of my worst bugbears the fact that accounting rules allowed so many off-balance sheet vehicles, even though they turned out to be at anything but at arms-length when the music stopped. Turner is also obviously right that banks held preposterously little capital of the right quality.

But he didn’t emphasise that this was caused at least in part by the fact that governments had implicitly nationalised losses while keeping gains privatised and had thus created a distorted market. Capitalism only works if greed is balanced out by fear; and misguided government policies, including the Federal Reserve’s constant interventions at the first hint of trouble, meant that the two emotions got out of sync. Shame Turner didn’t mention any of this last night.

THERE is a growing view among some in the economic and financial establishment that increased inflation may be a solution to our problems. The argument is that debt mountains are so vast that the only way out is to allow consumer prices to increase at a faster rate, thus reducing the actual value of the debt relative to wages and economic output.

I disagree with this argument, for several reasons. If debt needs to be written off, it should be done openly, not via the backdoor. Monetary stability is a key asset for any economy; governments shouldn’t be encouraged to debase currencies. Inflation leads to the redistribution of wealth but this happens secretly, not through the democratic process. There is also lots of evidence that shows that there is no such thing as controlled bursts of inflation – once prices start to shoot up above a certain rate, and workers and investors realise they have been duped and that what caused the higher inflation was deliberate action, rather than a one-off accident, they soon try and protect themselves. Workers ask for higher wages; and creditors ask for substantially higher interest rates, to protect their returns and their capital. The blow to the economy can easily outweigh the gains from falling real debt.

Inflation wipes out the value of your debt, of course, but it does so at the expense of wiping out somebody else’s assets, as the economist Gabriel Stein reminds us. The aggrieved parties are likely to include domestic pension funds – hitting the elderly – and other holders of fixed-value assets, such as insurance companies. It’s the oldest lesson of economics: there is no such thing as a free lunch.