Hunting season has started

By: Wolfgang Münchau

Whenever we have a crisis in financial markets, we ask some committee of central bankers to draw up a list of policy recommendations. We already know Alan Greenspan thinks. He blames the credit rating agencies. They are in fact easy targets, partly as a result of their own stupidity. But are they really the deep reason for one of the most extreme bubble in economic history? I have my doubts.

I think we are not yet in a position to explain exactly what happened, and I would be very reluctant to draw up any list of measures at this stage about how to prevent a re-run of the credit crisis. All the lists that I have seen are at best incomplete, at worst an attempt to deflect own mistakes, to point the finger at others. This is what Mr Greenspan has been doing during his book promotion tour. And that is also what others have done in respect of Mr Greenspan himself, when they blame himself personally for everything.

 

Before we draw any policy recommendations, or point fingers at any particular group of market participants, we need to understand is whether this is purely a market event, or whether this is a wider policy-related. I suspect it is the latter. By this I do not mean the 1 per cent Fed Funds rate between 2003 and 2004, but a policy that may have too narrow on a single inflation measure. It is not only a problem for the US, but also Europe as well.

 

This is only a hunch at this stage. I am in not in a position to prove it. In particular, we need to look at the role that central banks played in the run-up to the credit bubble 2004-2006. For example, is it an accident that the US interest rates preceded the credit boom in time? Did they cause, did they contribute it, or is this a coincidence of timing?

 

Robert Shiller, professor of finance at Yale University, made the point in a recent article that the property boom in the US could not have conceivably have been caused by the Fed, since the boom was well under way before the last rate cutting cycle set in.

 

Even if there is a non-monetary causes for the start of the property boom in the US, it is still worth asking the question to which extent monetary policy played a part in prolonging the boom, or encouraging distructive lending practices. These are questions we need to answer before we start to hunt down the rating agencies, or Mr Greenspan, or anybody else.

 

It would therefore not be such a great idea for any in depth official investigation into this crisis should to be carried by central bankers themselves through any of the multiple number of forums in which they come together. I fear another whitewash coming from the august Financial Stability Forum. I also fear that the outgoing German Group of Seven presidency will once again try to blame the hedge funds for everything, a proposition that is so obviously wrong that one wonders whether they are really interested in solving the problem. A consensus also appears to be building that the problem is a lack of transparency in the market, or the originate-and-distribute business model of some of the lenders. While I do not want to deny that there may be some important technical problems in the operations of the markets, it seems to me that the apologists for the expansionary monetary policies of the past are in desperate need for a scape goat. Blaming market intransparent on products they do not understand in the first place is so utterly convenient.

 

There used to a time when people blamed inflation on shopkeepers. We know the ultimate cause of inflation is not bad behaviour by some individuals, and not in most cases not related to product market regulation. We know that it is a monetary phenomenon. If inflation goes up, we rightly blame the central bank, or the government.

 

In his biography on Ludwig Erhard, Alfred C. Mierzejewski writes that during the early 1930s the great Erhard blamed industry cartels for the Great Depression. It took many years until the world arrived at a rather different understanding of the 1929 stock market crash, and the policies that led to the Great Depression.

 

We are in a similar situation now. Erhard was a shortsighted in the early 1930s, as Greenspan and others are today. I suspect that economic historians in the middle of the 21st century will laugh at the idea that our present crisis was due to hedge funds or rating agencies. I do not pretend that I have a consistent explanation for it either. I would instead assume that we are also dealing with a set of complicated issues that we do not fully understand at this stage. So before we arrive at definitive answer, let us begin to ask questions. And surely one of them has to be: Did monetary policy cause, or contribute to, this crash.

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