Market turmoil heralds the end of the something-for-nothing era

Rising interest rates will inject some much-needed sanity into a world that has lost its moral bearings

Do you remember Wile E Coyote, dear readers? He was that Looney Tunes character who was able to defy gravity for what appeared to be an eternity when running over a cliff. His legs continued to move pointlessly as he floated in mid-air, until suddenly he crashed to the ground, greatly amusing Road Runner, his nemesis.

The financial markets have likewise been in a state of cartoon-like suspended animation for years now, propped up by central banks that continue to behave, ludicrously, as if we were still in the midst of a financial meltdown. One simple, magical ingredient has been giving the markets their wings: cheap and easy money.

The market chaos of the past few days, the extreme volatility, was an early, partial realisation that the world is changing, that the cost of borrowing is about to rise in earnest, and that the forces of gravity are starting to reassert themselves. Economies are accelerating and, crucially, workers are starting to benefit from proper pay rises again in America, still where all economic trends begin and end. Whether this triggers inflation or not, interest rates will be hiked, and governments will no longer be able to dump their IOUS on supine central banks.

All of this can mean only one thing: we are at the dawn of a more conservative, more disciplined era. The cost of borrowing is going up, perhaps even by a lot, and we are finally emerging from the shadows of the financial crisis. This is a welcome development, and will inject some much-needed sanity into a world that has lost sense of its moral bearings, but it will also be a massive shock for a system now entirely hooked on cheap credit. The weaning process will be painful.

The market turmoil of the past few days should thus be seen as little more than a dry run: the economy is resting on a bed of nitroglycerin that is potentially far more potent than when Bill Gross, the great bond investor, coined the phrase almost a decade ago, and the real day of reckoning, when it comes, will be far nastier than the minor local difficulties of recent days.

If you think I’m exaggerating, consider this. Do you really believe the stock market will remain at its present, elevated levels if the cost of borrowing hits 3 or even 4 per cent? What will happen to firms and people with too much debt? And when companies and investors realise that many of the projects they were pursuing only made sense when interest rates were zero, and that they would now be better off simply sticking their cash in the bank? What about house prices? Would they really continue to rise if interest rates shoot up, and with them the cost of servicing mortgages?

The real answer, of course, is no, no and no again; higher interest rates will hit the price of all such assets. The only question is by how much, and how many people and firms it will wipe out. I’m no perma-bear: the corporate sector is in a much healthier place than it used to be, and the tech revolution is about to engineer an upsurge in productivity and genuine wealth. Even if wages go up as a proportion of GDP, and that of profits goes down, as is both likely and desirable, canny investors will continue to make a lot of money. A successful, thriving UK economy after Brexit will be good news for property owners and sterling assets on a 10-year horizon.

My point is just that we shouldn’t fool ourselves that the looming normalisation of monetary policy won’t have a major impact. It will, and it will change everything, including our politics and culture.

It has paid, over the past eight or so years, to throw caution to the wind. In a world of easy money, buying almost any asset was a one-way bet, except for the desperately unlucky. It made even mediocre investors feel good about themselves but it was hardly proof of any kind of skill. Every so often, the authorities would threaten to take away the punch bowl, but they never really meant it, and the party carried on. Free money became the new normal: those with homes or financial securities got used to seeing their wealth rocket, while the have-nots became increasingly bitter and disillusioned with capitalism.

The most extreme indication that investors had become anaesthetised to risk was the preposterous Bitcoin bubble, which perfectly encapsulated the zeitgeist of our insane times. It is no surprise that its crash preceded the stock market turbulence of the last few days. The Bitcoin madness was your typical late-bubble craze: people had switched from believing that it was easy to make money to assuming that it was automatic, something that is never true.

The reality is that our present economy is a giant bubble, a false market, albeit one engineered for the best of reasons. Interest rates, property values, share and bond prices, currencies: all have been massively distorted by years of ultra-aggressive intervention and pump-priming by central banks, politicians, sovereign wealth funds and a global economic establishment convinced that it has the power and ability to bat away every downturn. Supply and demand have not been allowed to adjust freely, and capitalism has been prevented from fully unleashing the creative destruction which makes it both just and efficient.

It has therefore become nigh-on impossible to work out what the “right” value or interest rate should be for almost anything.

There will be many nasty surprises when the latter-day Wile E Coyotes return to earth: some investments and giant companies will collapse, and not just the obvious zombie firms. There will be more Carillions. We will probably also uncover another epidemic of wrongdoing, the sort of thing that JK Galbraith described as the Bezzle.

Over time, and when the immediate fallout passes, the world will start to look fairer again, dimming the appeal of populist parties. Cash savers will be rewarded. More young families will be able to afford to buy their own homes. Real capitalism will make a return, rewarding hard work, thrift, sensible risk-taking and entrepreneurial skill.

There may be no such thing as a truly happy ending in economics, but I for one will not mourn the end of the something for nothing era.