LONDON (Reuters Breakingviews) - Just over 300 years ago, in early December 1718, a Parisian bank was nationalised by the French state. This marked the beginning of the Mississippi Bubble, which captivated France over the following couple of years. The aristocratic world of the “ancien regime” may seem impossibly distant to modern minds. Yet there are parallels between this saga and the modern age of quantitative easing, ultra-low interest rates and highly valued asset prices. As central bankers struggle to reverse their post-crisis monetary measures, the lessons imparted by the Mississippi Bubble are more relevant than ever.
LONDON (Reuters Breakingviews) - The Federal Reserve failed to anticipate the global financial crisis. Its hundreds of economists were too entranced by their abstruse mathematical models to see the storm clouds gathering. One central bank veteran, at least, was more alert. In April 2005, Paul Volcker publicly warned of “dangerous and intractable problems” besetting the U.S. economy. The lanky former Fed chairman remains famous for crushing the runaway inflation of the 1970s. His new memoir, “Keeping at It: The Quest for Sound Money and Good Government”, reveals the attributes that made him arguably America’s greatest central banker.
LONDON (Reuters Breakingviews) - Interest rates in China may never have turned negative, as they did in neighbouring Japan. Yet China’s economy has also become distorted by the decade of easy money since the 2008 financial crisis. As in the West, low interest rates in China are responsible for inflating asset prices, misallocating capital, aggravating inequality and undermining financial stability.
LONDON (Reuters Breakingviews) - The official position of the Federal Reserve is that the subprime crisis of 2008 was largely a consequence of poor financial regulation. There’s an alternative view: That the Fed’s easy-money policy after 2002 created a desperate search for higher-yielding securities. It also encouraged banks to partake in what are known as carry trades, borrowing cheaply in dollars and lending at higher rates both at home and abroad. From this perspective, the catastrophe following Lehman Brothers’ collapse was simply a giant trade gone wrong. Even lower interest rates in the past decade have revived this lending frenzy.
LONDON (Reuters Breakingviews) - The Greek philosopher Aristotle attacked the charging of interest on grounds that lenders demanded more money in return than they supplied. This ancient prejudice against interest lingers in the French economist Thomas Piketty’s claim that inequality increases when the return on capital, a quantum which includes the rate of interest, is higher than that of economic growth. Yet the overwhelming evidence from the easy money that followed Lehman Brothers’ demise shows that inequality really takes off when interest rates are maintained at artificially low levels.
LONDON (Reuters Breakingviews) - The economy is like a rubber ball. The harder it hits the ground, the faster it bounces back. That’s what normally happens. After the Lehman Brothers bankruptcy, Western economies experienced their deepest contraction since the 1930s. Yet their subsequent recovery was decidedly lacklustre. Soon after, the markets witnessed a startling rise in the number of zombie firms – marginal businesses that appear to feed and multiply on an unchanging diet of cheap capital.
LONDON (Reuters Breakingviews) - In 1776, English man of letters Horace Walpole observed a “rage of building everywhere”. At the time, the yield on English government bonds, known as Consols, had fallen sharply and mortgages could be had at 3.5 percent. In the “Wealth of Nations”, published that year, Adam Smith observed that the recent decline in interest had pushed up land prices: “When interest was at ten percent, land was commonly sold for ten or twelve years’ purchase. As the interest rate sunk to six, five and four percent, the purchase of land rose to twenty, five-and-twenty, and thirty years’ purchase.” [i.e. the yield on land fell from 10 percent to 3.3 percent].
LONDON (Reuters Breakingviews) - Back in November 2002, Ben Bernanke, then a governor of the Federal Reserve, attended Milton Friedman’s 90th birthday party. In his writings, the legendary monetarist had pinned the Great Depression on policy failures of the American central bank. Bernanke was a keen disciple and apologised to Friedman on behalf of his employer, vowing that the Fed wouldn’t make the same mistake again. Less than six years later, Bernanke found himself at the helm of the Fed on that fateful day, Sept. 15, 2008, when Lehman Brothers collapsed. Another Great Depression beckoned. But now the Fed chairman was ready to make good on his promise.
LONDON (Reuters Breakingviews) - There are some wonderful passages in “War and Peace” in which Leo Tolstoy ponders the reasons behind Napoleon’s disastrous invasion of Russia in 1812. Did this great historic event occur because of the French Emperor’s ambition or his Russian counterpart’s resistance, or because of British intrigue or any one of a myriad number of other factors?
LONDON (Reuters Breakingviews) - Inflows into exchange-traded funds (ETFs) approached $500 billion last year, according to ETF.com. Even with February's market ructions, another $64 billion arrived in just the first two months of the year. The rapid growth of these index-linked financial products is “worse than Marxism”. So argued the analysts at Bernstein back in the summer of 2016. Bernstein claimed that investors who adopt passive strategies are free-riders who abrogate their responsibility to allocate capital intelligently. The research firm may have a point. But a more pressing, and less widely aired, concern is the threat posed to financial stability by the newfound dominance of benchmark-tracking funds.