The library is a great labyrithe ....You enter and you do not knwo whether you will come out.
..a character in Umberto Econ's The Name of the Rose
“He believed in individual choice exercised through the market place, and that people must accept the consequences of the choices they made ... At the same time he was well aware that there were many people who needed protection from the unintended but indisputable negative aspects of a market economy” such as unemployment, financial hardship in illness, and lack of access to the essentials of life if certain market prices rose to unaffordable levels.
This was the belief of Peter Thorneycroft, an unjustly forgotten UK Conservative party politician prominent in the 1950s and 1960s, summarised by Stanley Crooks in a belated and well merited biography (George Mann Publications, £25), enlivened by some of Thorneycroft’s own engaging sketches and watercolours.
The simple creed just stated served Thorneycroft well enough as president of the board of trade in Winston Churchill’s first postwar cabinet. But it required supplementation when, as chancellor of the exchequer in 1957, he was hit by a run on the pound; a badly divided official Treasury was in no position to give it. The resulting confusion and lack of support from Harold Macmillan, the prime minister, led to his resignation.
Today there is more of a consensus on what might be called, to coin a phrase, “steering the economy”, focusing on ideas such as central bank independence, inflation targets, long-term budgetary guidelines and floating exchange rates. The consensus may not be all it is cracked up to be. But the embarrassment to supporters of a market economy now lies in a different direction, namely the instability of credit and banking.
It does not matter how many times the more sensible economic liberals have stressed the importance of stable monetary and financial conditions as part of the background conditions necessary for markets and prices to work satisfactorily. Any failures on the financial side are sure to bring the opponents of capitalism out of their burrows. Pundits who until recently conceded that “capitalism is the only game in town” are now rejoicing at what they hope is the longed-for death agony of the system.
Recent events have also caught many mainstream economists with their pants down. They have too readily assumed that central banks can make at least short-term nominal interest rates what they like and have concentrated on esoteric exercises on the path they should follow.
The beginning of wisdom is to recognise that financial booms and busts have been a feature of capitalism from the very start. Indeed they are as deep-rooted as human gullibility and greed. This is impressively documented in Charles Kindleberger’s Manias, Panics and Crashes, the last edition of which appeared in 1989. He has a table listing more than 30 such events, starting with the South Sea bubble of 1720 and ending with the New York Stock Exchange crash of 1987. Although some analysts have tried to discern a periodicity in their occurrence, I can only see an irregular succession with some crises succeeding each other at intervals of about a decade so beloved by old-fashioned business cycle theorists, but others coming hot on the heels of their predecessors after only a couple of years. Their frequency tempts one to parody Churchill: capitalism is a bad system, but the others are worse.
Kindleberger does not claim to have a rigorous theory of such crises, but he does discern a pattern. Basically some event – or events – changes the economic outlook. New opportunities for profit are seized and overdone “in ways so closely resembling irrationality as to constitute a mania”. Once the excess is realised “the financial system experiences a sort of distress, in the course of which the rush to reverse the expansion process may become so precipitous as to resemble panic”. In a panic the reverse movement takes place “with a crash in the prices of commodities, houses, buildings, lands, stocks, bonds – in short whatever has been the subject of the mania”.
The mention of commodities alerts us to what is different about the present panic, perhaps ominously so. The author has no panacea; nor does he claim that these crises are harmless. But he does not believe that policy is impotent and he strongly supports central bank lender of last resort operations, if possible at an international level. He does not discuss regulatory reform very much: perhaps he suspects that it is mostly an attempt to bolt the stable door after all the horses have fled.
One striking feature of recent events is how slow they have been to hit the real economy. Although the credit crunch was first discerned last August no major area has yet recorded a downturn in activity, as distinct from a growth slowdown. This suggests not that the crisis is coming to an end but that it is slow-burning. The ominous feature is the one I have already hinted at in my reference to the continued trend rise in commodity prices, which could well be part of a long-term shift in the terms of trade against the industrial west, as well perhaps as part of a shift in political and economic power. Here is an area where it will be necessary to adapt to market movements rather than to attempt to reverse them by ill-considered intervention.
More columns at www.ft.com/brittan