GROWING up in the West in the 1980s, new Bank of England governor Mark Carney was almost certainly inundated with stories about how the Soviet Union was not only an odious regime, but how even the possibly well-intentioned aspects of Soviet central planning inevitably resulted in sub-optimal economic outcomes.
A classic example was shoes. Absent a pricing mechanism to match supply and demand, there was invariably either a glut or shortage. And even when there was a glut, there were plenty of summer shoes, but a shortage of winter boots. Central planners just couldn’t get it right. By contrast, the largely capitalist West, responding to real price signals in real markets, did a pretty good job at producing, in sufficient quantities, a range of shoes that customers wanted, that fit, that they could afford.
But you can’t produce shoes without machines and materials. Machines and other productive assets comprise the capital stock producing all things that we consume. To provide a higher standard of living in future, the capital stock must grow and adapt. And as it ages and depreciates, maintenance is required just to keep it working efficiently. But if central planners can’t even get the day-to-day shoe situation straight, how are they going to maintain, grow and adapt an economy’s entire capital stock to provide for the future needs of consumers?
They can’t. Only real price signals in real markets can do that, although in the case of the capital stock, the prices that matter are asset prices. Stocks, bonds, interest rates, and all associated derivatives thereof that trade in our capital markets are the critical signals that determine, today, what the capital stock is becoming next week, next year, or next decade. If these signals are distorted, how can we be confident that the capital stock we are growing for the future can produce what is even remotely desired?
We can’t. Yes, the world isn’t perfect, and there can be no such thing as a perfect capital stock. But we want the best we can get, and that requires proper asset price discovery in markets, free of distortions. Unfortunately, everywhere you look today, officials are intervening in the money, debt and asset markets.
Front and centre is the Bank of England, which has been growing the monetary base via quantitative easing at a rapid clip since 2008. Some have denied that central bank bond buying distorts bond markets, but the severe reaction to the US Fed’s mere hint that it may scale back bond purchases at some point demonstrates the degree to which central banks have taken control of their respective bond markets.
As with shoes, even well-intentioned central planning of the money supply and interest rates can lead to sub-optimal economic results: if not immediately, then in the future. The present policy of suppressing interest rates effectively subsidises borrowing at the expense of saving, thereby increasing the volatility of the business cycle. This was the ultimate cause of the 2008 crisis. Among other central banks, the Fed slashed rates during prior recessions, preventing a more thorough liquidation of malinvestments and rebuilding of savings. By 2008, the accumulated imbalances had grown to systemically dangerous proportions. Unwilling to end their ways, officials responded by expanding on their previous market interventions.
Market manipulation has become the new normal in what some still call “capitalism”. It wasn’t capitalism then and it isn’t now. Many Western economies are now comprised of over 50 per cent government spending, with over half the capital stock controlled by central planners. Yet the central banks’ suppression of interest rates – the price of money itself – is the greatest distortion of all.
Central banks may claim they are suppressing rates because inflation is low. But doing so discourages saving. As Carney must be aware, the UK has long had a low national savings rate and is dangerously reliant on foreign borrowing. Suppressing rates exacerbates this imbalance. And recent decades have been characterised by inflation not deflation: in the money stock, asset and consumer prices. Yet the crisis came. Economists of the Austrian School predicted it. Why? Because they understand how central banks can create imbalances by manipulating interest rates.
Focused on chimerical efforts to proactively manage economies by targeting an arbitrary definition of “price-stability”, central banks fail to see the deleterious impact of their policies on the capital stock. They assume, wrongly, that stability in consumer prices implies economic stability and healthy, sustainable growth, when only proper asset price discovery can accomplish that.
It is time for Carney and other central bankers to acknowledge that the policy regime of consumer price inflation targeting is misguided: it is asset prices, not consumer prices, that are of central importance in maintaining economic stability. This is the most important lesson of the financial crisis, but it is one that the central planners don’t want to learn. If they do, they will put themselves out of a job, just like the Soviet shoe industry planners.
John Butler is author of The Golden Revolution (Wiley) and the Amphora Report investment newsletter (www.amphora-alpha.com). He is managing partner of Amphora Capital and a former managing director at Deutsche Bank and Lehman Brothers.