by Edward Chancellor*
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.
What followed has been the boldest monetary experiment in history, not just in the United States but around the world. Interest rates were held close to zero in the world’s largest economy for years, while negative rates prevailed elsewhere; trillions of dollars of debt securities, in some cases even including corporate bonds and shares, have been acquired by central banks with money conjured from thin air. The Fed’s balance sheet quadrupled to more than $4 trillion. Bernanke instituted other new practices, such as directing the markets as to the expected course of future rate changes known as forward guidance. During and after the crisis, the Fed made huge loans to foreign central banks so they could bail out domestic lenders with large dollar liabilities.
Ten years on, it’s possible to look back on some of what the Fed has accomplished. A severe market panic was quickly arrested. The Great Recession turned out to be mercifully brief. By acting as global lender of last resort, the Fed stopped the subprime mess from metastasizing around the world. True, a sovereign debt crisis in the eurozone cropped up a couple of years later. But the European Central Bank under Mario Draghi promising “to do whatever it takes” quickly put an end to that. When Bernanke’s successor, Janet Yellen, left her post earlier this year, the Fed had achieved its twin mandates of stable prices and low unemployment. The American economy is currently enjoying its longest recorded period of uninterrupted expansion.
Yet under the surface, something appeared to be going in the wrong direction. While the U.S. economy continued to hire new workers, productivity growth collapsed. Companies have been reluctant to invest. Savings have been abnormally low. Workers’ incomes have struggled to keep up with inflation. High asset prices are all very well, but the ownership of financial securities is heavily skewed towards the rich. There is a widespread political consensus on both the left and right that the post-crisis policies benefited the “haves” at the expense of the “have-nots”. Despite a swathe of new financial regulations, there are concerns that many of the unsound financial practices from before the crisis have resurfaced.
Productivity growth, inequality, financial risk-taking, and asset price bubbles are mind-bogglingly complicated matters. Still, a single influence appears to have dominated in recent years. The low-interest rate policy of the Fed and other central banks has inflated a handful of speculative bubbles, thereby contributing to an increase in inequality. Easy money has created an indiscriminate search for yield that threatens financial stability at home and abroad. Low interest rates have dampened the forces of creative destruction, fostering “zombie companies”, which act as a drag on economic growth.
To understand what has happened in the post-Lehman era, it is crucial to grasp the multiple functions of interest. It governs the discount rate, which puts a value on future income streams (the so-called capitalization rate). In a capitalist economy, interest influences the allocation of resources. Interest determines the distribution of unearned income or rents between the “haves” and the “have-nots”. As the price of leverage, interest determines both the extent and quality of lending. Interest also regulates the flow of capital around the global financial system. Interest is not the price of money, as sometimes described, but the price of time. All financial and economic activities take place over time. This makes the rate of interest the single most important price in the economic system. Get that price wrong and unpleasant things are bound to happen.
This series of essays marking the 10 years since Lehman’s demise will show how the post-Lehman era of ultralow interest rates has: Unleashed speculative manias, including the great crypto bubble; and misallocated capital on a grand scale, creating the zombie company phenomenon (2); Benefited Wall Street at the expense of Main Street, thereby contributing to the rise of populism (3); Produced an epic credit and real estate bubble in China, the country responsible for nearly half of global economic growth since Lehman’s demise (4).
*He is a financial historian, investment strategist and journalist. His book “Devil take the hindmost: A history of financial speculation” was a New York Times Notable Book of the Year.