Coffee House

A credit boom before each bust

14 January 2014

14 January 2014

Here is a graph that shows the four economic downturns Britain has been through (red lines) over the past forty years.

What I find strking is that each downturn was preceded by the same thing: a surge in the growth of money (blue line). In other words, the bust followed an unsustainable credit-induced boom.

The motives and justification behind monetary policy leading up to each boom/bust might have been different. In the early 1970s, monetary policy was shaped by Competition and Credit Control (CCC) reforms. In the late 1980s, those who decided monetary policy wanted to shadow the Deutschemark, then join the Exchange Rate Mechanism (ERM). After that unhappy experience, monetary policy was made in order to target inflation.

No matter what those in charge thought they were doing – CCC, ERM or inflation targeting – as the blue lines show, they nonetheless presided over an unsustainable growth in the money supply. Which was followed by a sharp downturn.

In a paper on monetary policy published in the House of Commons tomorrow, I argue that we are in danger of repeating the same mistakes again. Yet another growth in money and credit – which will be followed by yet another falling red line on the graph.

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Many of the warning signs of yet another credit-induced boom are already there; increasing reliance on consumer spending, surging house prices, falling savings ratio and a deteriorating current account balance.

What ought we to do about it?

First, we need a tighter monetary policy, with higher interest rates. But we also need some more far reaching change in the way we run the economy, too.

One of the reasons, I suggest in my paper, why successive administrations have failed to prevent these credit bubbles is not merely down to misjudgement. Part of the problem is that banks are able to conjure credit out of thin air.

Preventing endless boom/busts requires real banking reform. In my paper I suggest how we might prevent runaway credit bubbles forming – but using the free market, rather than the flawed judgement of central bankers or regulators.

Although the Bank of England might not have met its inflation target for many months, it has delivered lower, and more stable, inflation. In the twenty years since inflation targeting began, inflation has average 2.1 per cent – compared to 12 per cent in the 1970s and 6 per cent in the 1980s.

But low and stable inflation on one side of the equation has seen bank busts and credit crunches on the other. As long as banks lending is simply a function of their appetite to lend, combined with the appetite of borrowers to borrow – and restrained only by regulators – this fundamental instability will remain. A banks ability to lend must also be a function of its deposits. My paper proposes a simply way of achieving this.

If we are to avoid boom/bust 5, we need to change the way we manage the money. I hope my paper and its suggestions help. I suspect at some point in the future we might need new ideas on monetary reform.

Douglas Carswell’s paper After Osbrown is published by Politeia tomorrow.


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Show comments
  • flower78

    To my point of view credit booms are often
    triggered by financial reform, capital inflow surges associated with capital
    account liberalizations, and periods of strong economic growth. They tend to be
    more frequent in fixed exchange rate regimes, when banking supervision is weak,
    and when macroeconomic policies are loose. There appears to be widespread agreement that periods of rapid credit
    growth tend to be accompanied by loosening lending standards. Most major
    banking crises have occurred in the wake of periods of extremely fast credit
    growth.

  • Ariel Adam

    What would inflation have been if land prices were included ?

  • ohforheavensake

    Douglas- you need more than one graph . Credit is likely to play a smaller part in the first two crashes (and in 1988 as well) because, simply, it was a smaller factor in economic activity in the 1970s, Credit only becomes widely available toward the end of the 70s and into the 80s; house price inflation takes off in the 1980s: and complex financial mechanisms ensure the free flow of credit in the 90s-00s. What makes the 2008 crash different is that, like 1929, it’s a crash caused by overleveraging rather than by external factors (the oil price hike in 1973, for example).

    What you have here is a graph that shows correlation, but which doesn’t prove causation.

    • Makroon

      Correct, but why bother ?
      Carswell likes his truths black ‘n white, and nice and simple.

      • HJ777

        Correlation doesn’t prove causation, but then few things in economics are provable.

        However, repeated correlation is consistent with causation and can suggest it and there are plausible causation mechanisms suggested by economists.

    • Tony_E

      I suspect that the large growth in money supply in the 69-75 area of the graph is largely caused by the devaluation of the late 60’s and then the spiralling inflation that followed both this and the closure of the US Gold window.

      So maybe it’s not entirely credit expansion that we should focus on, but also loose monetary policy, in which case then we should look further back to the 1920’s, and possibly observe that both were a factor there, just as they were in the the post 2000 era.

      • MrVeryAngry

        not quite. The expansion of money and credit is inflation. The rise in prices is because of that.

        Para 2. Yes, but it is the very policies of bad money that enable loose policy – fiscal/monetary – by politicians and their bureaucratic satraps. That’s why they love fiat currencies. Not Carswell, obviously.

        • Tony_E

          Yes, that’s absolutely correct in terms of the definition of inflation (I should have used more correct language). I was purely thinking of price inflation and that governments seemed to chase price inflation with more money creation to satisfy high public sector pay demands and that the situation spiralled out of control.

    • MrVeryAngry

      It reflects the expansion of money and credit. I recall a secondary banking crisis in the 70’s (about 1973 from memory) which was fuelled by these twin failures. So you are only partially correct.

      Oh, and arguably the 1973 oil crisis was sparked not only by the Arab Israeli spat but also by Nixon’s abandonment of the gold standard in 1971.

  • HJ777

    One interesting aspect of these graphs is that they suggest that if credit booms are the cause of subsequent busts, then the downturn immediately after Margaret Thatcher came to power in 1979 was a due to legacy that she inherited rather than one caused by her government.

    I am inclined to this view, although it is also arguable that her (and Howe’s) policies in the two years immediately after she came to power may have exacerbated the inevitable downturn (a view I also hold). The question is what was the relative importance of these two factors?

  • Chris

    Boom bust 5 is well underway. The bust will be along soon. Maybe just after the election.

  • HookesLaw

    Does Mr Carswell also believe then that there is a correlation between for instance the rise of CO2 in the atmosphere and the rise in atmospheric temperatures?
    If he does not then he needs to do a deeper analysis than this cursory juxtaposition.

    • Makroon

      In a recent radio interview, our “chief scientist” made exactly that correlation between CO2 and temperature to prove AGW ….. before launching into a blistering attack on “deniers” for not understanding the difference between correlation and causation.
      You have to laugh.

  • HookesLaw

    Its interesting reading this how everybody from the author down don’t know what they are talking about.

    • MrVeryAngry

      Especially you?

  • sfin

    Good God! A politician who researches and learns from the lessons of history! Sir, were I to live in Clacton, you would have my vote.

    Now, having read your political biography, I think it’s high time that you defected to your spiritual home. You are clearly a real Conservative and your party is now called UKIP.

    • Makroon

      Ha-ha, that would double the IQ of both UKIP and the Conservatives.
      Carswell, like Brown and Fraser Nelson – historians with a morbid fascination (but little understanding), of things economic (or statistics).

      • MrVeryAngry

        More like ‘MakLoon’…

  • Q46

    Bribing the electorate.

    The problem will only ever be resolved when Government no longer has control over anything which affects economic activity.

    So remove fiat currency, the fiction whereby an ‘independent’ BoE fixes interest rates… let the free market do that… prohibit State funded ‘infrastructure’, prohibit State ownership of anything, forbid subsidy and regulation.

    Leave it in the hands of the dispassionate free market.

    • Daniel Maris

      The private sector has shown itself just as prone to delusion and fantasy as central banks. Imagine if the people (incredibly overpaid bankers) who bought all that toxic debt which was supposedly triple A had been in charge…

      • HJ777

        You are clearly not familiar with the work of Hayek on this issue.

        What he proposed was competitive currencies in which any issuer of currency who did not maintain its value would be severely punished by the market.

        • Makroon

          It’s pretty obvious what you got for Christmas.

          • HJ777

            How did you discern that I got some very nice Dartington wine glasses, a visit to Vinopolis and a special pair of cycling trousers for Christmas from my comments?

            You must be psychic. Or mistaken.

            • Daniel Maris

              I suggest you stick to all those pursuits signified by the presents rather than stray into economics.

              • HJ777

                At least I have taken the trouble to educate myself on the subject.

                You prefer ignorance (which, unfortunately doesn’t restrain you from shooting your mouth off).

              • MrVeryAngry

                Wot, you mean you’ve actually looked at some economics books? Well, who’d uv thunk it?

        • Daniel Maris

          “Severely punished by the market”. Carp.

          The people who make the decisions can make enough in five years to retire on in lavish comfort for the rest of their lives. They are long gone by the time the bubble bursts.

          Why on earth would they be worried about being “punished” by your mythical markets.

          Money is not just about economics – it’s about social policy as well. You might not care what happens to X workers in Y industry but it is the government’s job to care.

          Since you’ve taken a rather high tone with me, may I suggest you learn more about how markets work in practice. There isn’t a perfect market in operation anywhere in the world. Even your whacky scheme would require licensing – or are you really suggesting just anyone can set up on the high street as a bank claiming to issue money? Our friends from abroad would love it if you did.

          After you’ve had your first few bank riots with dead people on the streets, you’ll rethink your naive support for such a bonkers proposal.

          I haven’t even got started on money laundering…perhaps another day…

          • HJ777

            I see that not having the intellectual curiosity or capacity to educate yourself in the slightest on his proposals has not prevented you from making breathtakingly ignorant assertions about them.

            Instead you indulge in constructing straw men, banker bashing and all sorts of other popularist crap.

            Idiot.

          • MrVeryAngry

            Total, ill informed prejudiced nonsense.

      • MrVeryAngry

        The bankers were overpaid because of government failure. That’s the whole problem. The bad money so distorts everything. In any event Blair Brown Balls needed the bankers to push their dodgy money. BBB were the drug cartel. Fiat money and credit was their product. Bankers were their pushers. We were the users.

        • Baron

          The bankers, well, some of the bankers, were overpaid for the same reasons some top footballers in the Premiership were and still are overpaid.

          From the beginning of the 90s, the global flow of money got boosted massively by the colapse of the Red Menace Empire, the Chinese makeover, the BRICS awakening and stuff like that, but the number of banks that could handle it didn’t change much. As the big banks competed for the juicy fees in IPOs, takeovers and whatever, they paid their best millions because their best generated billions.

          That has less than FA to do with government failure, any government, anywhere, for no government in the world could have either stopped the boost in the money flows, or set up new banks the buy side would trust.

          Or, you reckon the Bank of Essex could have done it?

          • MrVeryAngry

            Indeed. That all adds to the problem, but it is still essentially the banking model that is essentially flawed. That same model was adopted by all the emerging ex commie nations and the rest. Their bureaucrats realised that controlling the money was almost as good a way of controlling the population as was totalitarianism.

  • Mynydd

    I note from the graphs that the blue line peak, when Mr Brown was C of E, is a lot lower than blue line peak for the boom when Mr Cameron was special advisor to the then C of E. Why no graph for the period 2010 to 2014, which would indicate the present Cameron/Osborne trend?

    • Tony_E

      I think that you have to look at the trends in inflation at the time – during the Brown boom inflation was hidden by China pricing and immigration both increasing demand and reducing costs. There should have been less at that point driving the rate of monetary expansion.

      Also, another thing to look at is the difference between the beginning and end of each blue trend line, i.e. the rate of change in money supply. It really shows how fast devaluation hit the UK in the late 60’s as the government struggled against the outflow of gold from London (and the US treasury similarly). This then set up the problems of the 70s, the end of the Bretton Woods agreement, the cause of many of our current difficulties.

    • HookesLaw

      John Major and his Chancellor were following a policy the Labour Party supported, indeed demanded, – namely membership of the ERM.

      • HJ777

        Not entirely. Gordon Brown’s criticism at the time was that we didn’t go into the ERM at a higher exchange rate.

        That would have worked out well, wouldn’t it?

        • HookesLaw

          At the time or in hindsight?
          No doubt going in at a different level would have thrown up a range of other problems or maybe not made a hap’th of difference.

          • HookesLaw

            This is interesting from 2003
            http://www.samuelbrittan.co.uk/text166_p.html

          • HJ777

            At the time.

            Given that it is widely acknowledged that we went in at too high a rate, then our exit from the ERM would have been even more ignominious had Brown had his wish.

            Not that going in at all was good idea.

          • Andy

            Wouldn’t have made much difference. The ERM, like the damn Euro, was a stupid idea.

        • Andy

          Quite. Bernard Connolly’s book ‘The Rotten Heart of Europe’ should be required reading. He was spot on and has been re the Euro.

      • Mynydd

        Each prime minister makes and follows is own policy

        • HookesLaw

          Which in this case was supported and urged by the labour party.

        • Nicholas chuzzlewit

          Gordon Brown’ was to leave this nation with a structural deficit of £160 billion which no amount of distortion and dissembling on your part willl make it David Cameron’s deficit. No doubt you will respond with the usual rubbish about debt rising under the Conservatives. Inevitable when you inherit an economy which has contracted by 7.2% unless you are prepared to make cuts which would have leftist idiots like you screaming at your benefits cheque.

          • Andy

            Point of Order: the ‘structural deficit’ was not £160 billion. The actual deficit was that. The structural part of it was something like £78 + billion.

            • Nicholas chuzzlewit

              That was an early estimate it has since been revised quite considerably upward. You can rely on Brown to screw things up properly when the swine puts his tiny mind to it.

              • Andy

                He has a mind ?

    • HJ777

      Various people have pointed to the difficulty in measuring and targeting money supply measures.

      However, the answer to your observation (assuming we accept that the M4 measure is both accurate and the most indicative measure) is probably that M4 growth has to be considered relative to the level of the official inflation figure at the time. Compared to the official inflation measure at the time (CPI) M4 grew spectacularly fast over a long period of time under Labour – and it is the cumulative growth, not just the single year growth, that matters (in other words, fairly high growth over a longer period can be much more serious than rapid growth lasting just a short period because in the former case the total growth is much greater).

      • Mynydd

        “M4 grew spectacularly fast over a long period of time under Labour” You cannot deduce this from the graph because the base time span is different in all three cases.

        • HJ777

          I didn’t deduce it from the graph.

          • Mynydd

            My original comment was in respect to the graphs

            • HJ777

              My assumption was that you were questioning why the growth of M4 was seemingly lower leading up to a much bigger bust if excessive monetary (and therefore credit) expansion was the cause of the bust.

              I was explaining why that might have been the case.

  • Hugh

    Where’s the blue line now?

  • tommy5dollar

    Is the credit bubble the problem or just a symptom? It’s no coincidence that a bust comes when people have forgotten about the last one and think it can never happen again.

    • MrVeryAngry

      The credit bubble is the problem. It is also a symptom. A symptom of perennially failing central planning/banking.

  • dalai guevara

    act anticyclical.
    enact anticyclical policies.
    build homes when no one else is.
    spend when others save on spending.
    save when others spend.

    the state knows what to do, do it.

    • HJ777

      That neglects the issues of (i) the causes of the cycle (i.e. if it is government policies that are creating the cycle, then how can it act anticyclically?) and (ii) how you know where you are in it.

      • dalai guevara

        Oh, I will venture to declare that (ii) we’re in a bust phase.

        • HJ777

          We have had a bust already, but how far are we into the next cycle?

          It is very easy to forecast tomorrow’s weather most of the time. If you forecast that it will be pretty much the same as today’s, then you will be right about 75% of the time. But 25% of the time you will be wrong – often very wrong. Economic forecasting is like that. It is predicting changes in trends that is different.

          • dalai guevara

            Economic forecasting is not that difficult. Tractor and Champagne sales figures often provide better insights than official government unemployment/GDP figures. I do not anyone who still bothers with the latter.

            • HJ777

              It seems to have defeated most people/bodies since 2008.

              • dalai guevara

                I will not disclose what my real indicators are. That would require the agreement to a fee payable prior to disclosure 😉

            • Andy

              I like Champagne.

              • MrVeryAngry

                ….a lo!.

          • Tony_E

            I rather suspect that while all the ‘booms and busts’ are just the exaggerated feedback loop effects of adjustments made by governments – the general trend is towards one point: Total debt default and monetary collapse.

            Full franchise democracy has been accompanied by the inevitable ability of political parties to bribe the electorate with first, their own money, then other people’s money, and then the potential wealth of future generations

            This has then been achieved by monetary expansion (coin cropping) and then expansion of debt. That cannot go on forever, so it’s just a question of how many ‘adjustments’ we get along the way, and how long the eventual end takes to appear.

            • HJ777

              If you’re not familiar with the work of Hayek on this subject, then you may find him an interesting read.

              • Tony_E

                I read Road to Serfdom some years ago and have to admit it struck a chord with me. I haven’t read much of his work but I do tend to keep an eye on what the current ‘Austrian School’ thinkers are saying.

                • HJ777

                  The ‘Road to Serfdom’ is a significant work but to understand his economic analysis in detail it is better to read more about the Austrian theory of the business cycle and also his work on the ‘Denationalisation of Money’ (available at low cost on your Kindle, incidentally) and the arguments therein. As always with Hayek (and he fully acknowledged this), there are many points of discussion where he admits that his arguments could be refined further or alternatives put forwards (he certainly doesn’t claim to have provided all the answers) but his arguments and ideas are compelling and argue in terms of human behaviour and motivations (unlike many grand theories).

                • Tony_E

                  I will certainly seek that out. In return, might I suggest Stockmans ‘Great Deformation’, which is an interesting perspective on (mainly US) credit expansion, crony capitalism and the underlying fault lines in Western economic practice. I found it rather enlightening, especially in regard to some of the historical figures many free marketeers generally regarded as ‘on our side’ in the USA.

                • HJ777

                  Thanks for the tip – I shall try to read it.

          • Baron

            Economists are people who, if you forget your telephone number, will estimate it for you, HJ777. So, what should one expect if they have a go at forecasting, more to the point, forecasting something more testing than a number?

            • HJ777

              Not all economists are like that. Austrian economists, for example, point to the difficulties of making macroeconomic predictions from microeconomic behaviours and especially of trying to design economic outcomes from macroeconomic interventions.

    • MrVeryAngry

      That’s the whole point. The ‘State’ (aka government) does exactly not know what to do. The Government not knowing what to do is what got us into this mess in the first place. There is absolutely no chance that it will know now what to do top set it right – unless suddenly it shuts itself down.

  • HJ777

    Hayek had some pretty interesting ideas on monetary and economic stability.

    There is another lesson to learn out of this (for those that didn’t already know, or accept, the truth). The recent recession was not a simply function of misdeeds of bankers undoing an otherwise successful, prudently-run, economy – economic growth had been based on a credit boom that simply came to its inevitable end. Underneath it all, the economy wasn’t growing successfully – the credit boom merely concealed the lack of sustainable economic growth.

    • Holly

      You spotted that as well.

      • Baron

        But, boys, this is how the capitalistic model of economy ticks, the bust is there to weed out the bad, the ugly, the old, the uncompetative. You get rid of it, you cancel the growth years, too.

        • HJ777

          That is often assumed to be the case. But Hayek’s argument was that it is the fact that money is run as a government monopoly and that it is therefore manipulated and abused by governments (i.e. it is not subject to the free market disciplines) that creates booms and busts.

          His argument is pretty compelling. Whether you think that the alternative he proposes is practicable is another issue.

        • MrVeryAngry

          Wot HJ777 says.

          • Baron

            The 15 year span of uninterrupted, ‘no-boom-no-bust’ growth up to 2008 engineered by the ghastly Brown with the aid of the BoE, the FSA … isn’t a sufficient lesson for you then, or you’ve forgotten it?

    • Andy

      Clever boy. Here is a lollypop.

  • swatnan

    Carswell is absolutely right, but, whatever you try, you’ll never beat ‘boom n bust’,
    so its a waste of time trying. The only thing you can do is save for that rainy day, and hope its enough to get you through the tough times.

    • Tony_E

      You can’t beat it, but you can ameliorate the issues with a better monetary policy.

      But the issue that is now difficult to overcome, is the fact that money is no real store of value. This leaves the average man at a massive disadvantage to the rich man, or the institutional investor. Those who have great assets are largely insulated from the sudden drops in the value of cash that accompany each expansion of credit, whereas the average man who only has the assets he requires to live (i.e. his home, car and other assorted chattels or maybe less), cannot avoid the inevitable costs of paper money devaluation.

      This is why the rich are getting richer, and everyone else from the middle classes down is getting poorer.

      It is this reason why some people advocate a return to a ‘Gold’ or mineral standard – to reduce the ability for government to be able to increase the money supply and therefore reduce the value of individual savings – which is in reality a form of institutionalised theft by stealth.

      • Andy

        Indeed, which is why we should stop the political class debasing the coinage. Maybe we should force the State to run a balanced budget and forbid it from borrowing.

        • MrVeryAngry

          Trouble is it is not just the political class. Their is also whole class of parasitical functionaries whose sinecures depend on the continuation of fiat money.

      • Makroon

        Ah ! I see you’ve been studying your leader’s latest tract on “the middle classes”. Have a gold star.

        • Tony_E

          Which leader would that be – I tend to lean towards the Mises institute – have they issued a new ‘tract’ on thieving from the masses?

    • Baron

      Spot on, swatan.

    • HJ777

      It very much depends on your view of the causes of the “boom bust” cycle.

      If you tend to the Hayekian view, then the causes of the boom (and hence subsequent bust) can indeed be removed by reducing government involvement in the economy and removing its monopoly power over money.

      Are you familiar with these arguments? If not, then I suggest that you might like to investigate them. You might still disagree, but my point is that your statement is not self-evidently true and there is a branch of economics that disagrees.

      • MrVeryAngry

        It’s not strictly Hayekian. It is the view – or rather the insights – of Austrians generally. Probably Mises was the first to bring together all these insights.

        • HJ777

          That’s generally quite correct, of course, but it was Hayek who explored the concept of removing the government monopoly of the issue of money and tied it to previous insights.

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