An inevitable crisis

Viewed from a distance, the events of 2008 will be seen as a particularly dramatic example of the ag

Rarely in modern times has there been such a revolution in commercial sentiment as occurred in 2008, or such a display in government and business of panic and helplessness. Amid the collapse of stock markets, long-lived banks, principles, policies, fortunes and reputations, the

pre-eminent intellectual discipline of the modern west – economics – has proved of very dubious assistance. What was not supposed to happen happened all the same.

Yet, amid the debris, the events of the past year have been perversely reassuring. The year 2008 was a reminder to those who had forgotten that there is such a thing as history and that the cycle of famine and feast in commerce, first identified in antiquity and well understood in the Middle Ages, was not suddenly abolished in modern times. Those Gods of the Market Place, Guy Hands, John Paulson and John Duffield, turned out to be ordinary men. What Kipling called "the Gods of the Copybook Headings"- that is, the pettifogging, even tedious, patterns of commercial life - limp back into view.

Here is some consolation for the season. What is occurring is, in one sense, an ordinary commercial adjustment that comes late in the day but, as if to make up for that, is unfolding very, very fast. A period of capital overinvestment (Terminal Five, Beijing Olympics) and financial speculation unravels in a welter of pecuniary loss. Overstocked trades and professions (estate agency, banking) lose their capital and dismiss their redundant labour. In societies governed by fashion and luxury, the public finds there is almost nothing it cannot do without. Business grinds to a halt. Governments spend and spend but are flogging a dead horse.

Yet at some moment, perhaps sooner rather than later, prices will fall to such a level as to stir the imagination of ordinary human beings, and trade will revive. In Britain now, the Bank of England bank rate, at 2 per cent, is as low as in the 1930s and 1940s and a few scattered months in the latter part of the 19th century. In the US, the Federal Reserve has reduced interest rates to virtually zero. You can buy shares in a moderately well-capitalised US corporation for just a couple of years of its profits. In the future, these numbers will seem miraculous and be objects of profound regret. This crisis will end.

So what happened in 2008? Viewed from a distance, or through the eye of the All-Knowing CEO of the Universe, the crash of 2008 followed the usual pattern. A long-lived boom driven by cheap credit, going back as far as 1982 (though subject to interruptions in the mid-1980s and 1990s, and in 2001), came to grief because of a rise in the cost of borrowing money.

Profits in business always depend on the rate of interest: the higher the interest, the higher the rate of profit required. From a trough in 2004, US interest rates rose from 1 per cent to 5.25 per cent in 2006 as the Federal Reserve scrambled to prevent the speculative boom spreading from real estate and industrial commodities to consumer prices. At the higher rates of interest, the people who always come late to the festivals of credit – the poor, the unemployed, the minorities, the slightly bent – found they could not cover their interest payments and began to default.

What should have been confined to the suburbs of American cities was transformed, through the complexities of modern banking and securities markets, to every corner of the financial world. In trying to subvert regulatory restraints, bankers had so complicated their businesses and befuddled themselves that they could no longer detect where the bad risks lay and decided that they were everywhere. Yet there was no sudden awakening. As late as 3 July of this year, the European Central Bank, never an institution to rush its fences, raised its key interest rate (by a quarter of a percentage point) "to prevent broadly based second-round effects" on inflation (whatever they may be). Earlier this month, in one of those volte-faces for which central bankers are never punished, the ECB cut its rates by three-quarters of a percentage point.

Inflation, in its modern sense of a general and sustained rise in consumer prices, is now judged a mere apparition that has vanished into the financial shadows. In Britain, the price index of manufactured goods fell in November. The inflationary anxiety that set off the rise in interest rates has given way to a deflationary panic. Governments and business are now terrified that the stop in credit will cause prices of commodities and wages to fall. Debtors (including themselves) will be crucified on a cross of hard money.

Deflation is reflected in the price of loan securities. There are investors who are willing to lend to the US government for 30 years at rates so low they include no cushion at all for the possibility of any decline in the purchasing power of the US dollar over that 30 years. These prices are eschatological: they anticipate commercial Armageddon. The bubble in real estate, industrial commodities and crude oil of the first half of 2008 has burst, and a new bubble has blown up in low-yielding government securities. That the bubble in government bonds will burst is a certainty - and it may happen sooner rather than later.

So what else will happen in the year 2009? A prediction made now will be quite as useful as one made a year ago; that is to say, not useful at all. The wiseacres who saw the crash of 2008 coming were right only in the same way that a stopped clock is right twice a day. What can be said is that the direst predictions – deflation, a collapse in world trade, trade wars – are the least likely of possibilities.

With the large banks either part nationalised or guaranteed by government against failure, attention has shifted to the solvency of industrial companies and sovereign governments. It is all very well for the UK government to demand that the banks lend to households and companies, but nobody much wants to borrow when the outlook is so bad. Shops, restaurants and pubs are giving up the ghost, the motor industry has ground to a halt, office rents are falling fast and factories are cutting shifts. Rising unemployment further undermines the public finances and the exchange rate of sterling. As the speculative tide recedes, all manner of skulduggery and peculation is exposed in corporations and municipal government. These events will increase the public propensity to save and to stay at home.

Meanwhile, the world is awash with new money. That does not mean that governments - outside Zimbabwe - are printing it. The volume of US greenback dollars in circulation is not much more now than it was last year. What the Federal Reserve and other central banks are doing through their rescue operations is to create reserves that can be converted by the commercial banks into the folding stuff. The Federal Reserve doubled the size of its balance sheet in the crisis months of September, October and November.

At present, central banks are merely acting as substitutes for the inactive commercial banks, but as soon those banks return to lending, it will be extremely fiddly for central banks to prevent a rise in consumer prices. The descent into the financial abyss has not been pleasant. The climb out will not be much more fun, for it will be attended by all manner of inflationary phenomena. These are likely to trouble western societies for many years to come.

James Buchan is the author of "Frozen Desire: an Inquiry Into the Meaning of Money


Interest rates

December 2007: 5.5%

December 2008: 2%

Pound againST Euro

18 December 2007: £1 = ?1.40

17 December 2008: £1 = ?1.10

Pound against Dollar

18 December 2007: £1= $1.531

17 December 2008: £1= $1.53


31 December 2007: 6456

17 December 2008: 4291

Job vacancies

October 2007: 672,000

October 2008: 589,000

House prices

2007: £45 average daily increase

2008: £95 average daily decrease

Houses sold

May-August 2007: 118,165

May-August 2008: 54,488

Number of estate agencies

End 2007: approx 12,000

End 2008: approx 8,000

Household spending on food

2007: £89.88

2008: £68.33

Going up


2007: 1.61 million

Those seeking work

October 2007: 826,100

November 2008: 1.07 million

Household debt (including mortgages)

2007: £55,403

2008: £59,715

Home repossessions

2007: 27,100

2008: 45,000 (estimated)

Pawnbrokers' profits (H&T Group)

2007: £3.3 million

2008: £4.6 million

Pub closures

2007: 4 per week

2008: 27 per week

government borrowing

First half 2007/8: £21.5 billion

First half 2008/9: £37.6 billion

Support for Labour

December 2007: 31%

December 2008: 33%

2008: 1.82 million

Research: Nicholas Stokeld and Samira Shackle

So, whose fault was it? Take your choice

As we stumble from crisis to collapse, the list of those blamed grows longer and longer. Below are a few of the accused

The financial alchemists who claimed to have transformed "the lead of sub-prime mortgages . . . into golden products safe enough to get AAA designation", according to Joseph Stiglitz, professor of economics at Columbia University

The Reagan administration, which got rid of antitrust legislation

City bonuses, say Mervyn King, governor of the Bank of England, and Paul Volcker, former Federal Reserve chairman

The Isle of Man, says the Pope (right) in a Vatican policy paper inveighing against tax havens

"Militant atheism", which has left people without values or consideration for others, according to Melanie Phillips of the Daily Mail

"It's all the left's fault", according to a counter-intuitive Spectator cover line after the collapse of Lehman Brothers

Hormones - in particular, testosterone alternating with cortisol - was the conclusion of John Coates of the University of Cambridge, whose research showed that it really would have been different if women had been the chief financial players

Irresponsible bankers, according to Gordon Brown

Enron, which pioneered off-balance-sheet banking, is where it all started, according to Niall Ferguson

The media, which should have told us more (according to the broadcaster Evan Davis) or, alternatively, should have stopped going on about it (according to Richard Lambert, former editor of the Financial Times)

America, according to many, but particularly Gordon Brown, who told the BBC in October: "You know, it started in America; there was a lot of irresponsible lending taking place"

Gordon Brown himself was "the one who created this mess in the first place", according to David Cameron, who broke an initial all-party consensus on the crisis in October

Regulation, regulation, regulation, according to the Economist, sticking rigidly to its free-market guns

Alan Greenspan (left) , former chairman of the Federal Reserve, was blamed by many for encouraging cheap credit for so long. The person who was hardest on Alan Greenspan, however, was Alan Greenspan, who confessed in October that there had been a "flaw" in his free-market theory