WHEN I was at school, many of the textbooks I read contained deeply inadequate accounts of the Great Depression. The biggest idiocy was the idea that the catastrophic collapse in output and explosion in unemployment was caused by the 1929 Wall Street stock market crash itself, rather than a range of other factors such as the subsequent collapse in the money supply and the imposition of crazed tariffs.
One of the reasons we are in such a mess today is that many policymakers still believed a version of this simplistic story in the 1980s, and remained terrified of what would happen in the aftermath of a stock market crash. They conflated a temporary collapse in the value of some financial assets with a collapse in the economy; while there are of course hugely important linkages between the two, you need much more than a stock market crash to trigger a real depression, as opposed to (at most) a correction.
When the Black Monday crash struck on 19 October 1987, many worried that it would trigger a nasty recession, or worse. So central banks pumped liquidity into markets in what proved to be the first in a long-line of interventions. Since that day, Alan Greenspan, who took over at the Fed in August 1987, stood ready with the metaphorical printing press, loosening policy at the first sign of trouble – at first, after every fall, and then eventually prior to any possible drop. Ben Bernanke intensified this further from 2006, when he took over.
Some of this pump-priming happened during the first Gulf War of 1990 (though at least there was the excuse of a rocketing oil price at the time). But the phenomenon really spiralled out of control in 1998, when the LTCM hedge fund was wrongly bailed out; in late 1999, ahead of the Y2K millennium bug scare story; and then following the ending of the dot.com bubble in 2000. The markets got used to what they first dubbed the Greenspan and then the Bernanke Put – the idea that the authorities had given everybody a free put option, a right to sell their shares at a particular price.
The view was that a 20 per cent fall in equity prices would automatically trigger a reaction from the Fed, pushing valuations back up again. The Fed had created a welfare state for investors and financiers; they could take risks, safe in the knowledge that the cavalry would rescue them.
It was the greatest injection of moral hazard anybody had ever seen, and it ruined previously free financial markets, distorting them horribly and leading to massive misallocations of resources and a cluster of ultimately devastating errors.
Needless to say, the likes of the IMF never realised any of this, and didn’t spot the bubble until it burst five years ago. It used to believe in the Washington consensus. This was good in parts – in favour of free trade, capital liberalisation, sound fiscal policy and privatisations – but instead of looking at markets as dynamic discovery processes, it was steeped in a flawed general equilibrium analysis, couldn’t cope with moral hazard, didn’t realise that activist monetary policies in both West and East were artificially lowering the price of credit and thought that independent central banks that targeted low consumer price inflation would lead to macroeconomic stability.
Unsurprisingly, the IMF has drawn the wrong lessons from the crisis, failing to hold the central bankers to account. Now it is seemingly calling for even more deficit-financed state spending in the UK. The government should ignore the IMF: its appalling record means that its advice comes with a very large health warning.
Follow me on Twitter: @allisterheath