Following on my last post on the G20 protests, I thought it would be fair enough to give a chance to a trader's opinion on the whole economic world crisis. I had at work a very interesting conversation with some of my trader colleagues. When I asked them if they still believed that a pure, crude, free non-intervention capitalist market is the way to go they did not hesitate for a moment: yes.
I raised my eyebrow. 'Really?', I asked. They were outraged by how the governments are not only not taking more responsibility for what has happened, but also actually blaming the greed of the bankers for it. As they put it, this is a very naive way of shifting the anger of the public toward them (us, should I say).
For them, the reasons for this crisis is clear: the non-inclusion of the house prices in the inflation index, the CPI (Consumer Price Index). Let me explain: the only tool for intervention that governments have to control the markets and the overall economy are the interest rates. The interest rates are the rates that banks need to pay to borrow money from the Bank of England overnight to cover their daily mismatches. Banks borrow money from each other as well, at a rate that is slightly higher than the interest rate set by the BoE (for the added risk that banks can potentially default). Ultimately, the interest rates will determine (in a normal market) the mortgage rates citizens pay to the banks when they buy a house.
The other thing to understand is which rules does the BoE follow to change the interest rates. The main aim of the BoE is to maintain inflation under control, so prices are stable. The inflation is measured with the CPI, which is a basket of prices of several products, such as food, transport, fuel... Indeed, in the BoE website, we can read the quote The Bank sets interest rates to keep inflation low, issues banknotes and works to maintain a stable financial system.
So, in a nutshell, the BoE looks at inflation and changes rates accordingly, determining how much do we pay for our mortgages and, therefore, controlling how much money we have at the end of the month to spend in other things (clothes, food, shoes, holidays...). The less money we have, the less we spend, stopping prices from increasing. And vice versa. So if inflation increases, the BoE increases rates, and vice versa.
Now, once we understand that, does it make sense to anyone that house prices are not included in the CPI? Think about it: for years, the CPI index was under perfect control, while house prices were increasing at alarming rates (15%-20% a year for the past 5 years or so). Narrowmindedly, the BoE found no reason to increase rates because the CPI was within target, while the housing bubble was growing. Even if rates were not quite low, people found it easy to get massive mortgages, without stopping to think that they were paying stupidly high prices for their houses. Banks were happy to give money away because as long as house prices were going up, they would make a profit from reposessions as well.
And we all know the rest of the story: when the bubble burst, everybody was caught in underpants, and now the BoE rushes to lower rates (we are at 0.5% now) to get us to spend again. The point of my colleagues was that had the house prices been in the CPI calculation, inflation would have raised above target as soon as house prices would have started to go up, triggering the BoE's reaction of increasing rates much earlier and potentially stopping the housing bubble that eventually started it all in the US.
This is not to say that free capitalism is still the way to go, certainly not in my opinion. I believe that in the same sense that we have laws to control other human impulses, we should try and do our best to control greed, because it damages society ultimately. But it does tells us that most of us don't know near as much as we should before drawing hasty conclusions condemning bankers as full responsible for this situation.
I believe it is positive and legitimate to go and protest against capitalism as we know it (indeed, other socioeconomical systems are possible), but it may not be a bad idea to get out there again asking for a fair inclusion of house prices into the CPI: it is simply reasonable.