How funny money takes our mickey
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We humans are a slow-learning species. In the 1980s we blew up what was then the world's second-biggest economy, Japan, with loose money. In the 2000s, we blew up the biggest economy, the US, with loose money.
Not content with that, in 2008 we went on to blow up the economy of most of the world. How? With loose money. Any intelligent species would learn from this experience. But look around.
Illustration: Rocco Fazzari.
The economies that account for 96 per cent of the world economy are today running loose money policies. Most are happily handing out free money. Some are supplying money at rates so low that it's actually cheaper than free.
It's done for good cause. When money is cheap, people are more inclined to invest or spend. So it aids economic recovery. The former chief of the US Federal Reserve, Alan Greenspan, was named as Time magazine's person of the year in 1999 for his ready resort to loose money.
But if there is too much for too long, it ends badly. Exactly a decade later, Time named Greenspan as No. 3 on its list of "25 People to Blame for the Financial Crisis". And I think they let him off lightly.
The evidence of the past three decades should be enough, but you can go back further. In fact, every major financial crisis in the four centuries of capitalism has had its origins in loose money.
How does it work? It's simple commonsense. The basis for value is scarcity. If scarcity is destroyed, so is value. And when money loses its value, it is abused.
Human societies have always abused commodities when they're provided too cheaply or free - free fresh water, for example - and money is no different. The loose money creates a "bubble" in asset prices, which ultimately collapses, dragging the economy into a recession, or worse.
The lyrics change from one episode to the next, but the song remains the same.
This time, it's happening in so many countries that it's much easier to list the countries where it's not happening. Brazil and Australia are the only economies of any reasonable size where money is not loose.
The standout champion of loose money in the world today is the US. For 2½ years now, the US Federal Reserve has been supplying money to America's banks at an official interest rate of 0-0.25 per cent a year.
Inflation in America is running at 2 to 3 per cent. So, in real terms, the American central bank is lending at an interest rate of minus 2-3 per cent. It is, in effect, subsidising the banks to borrow money.
The US is debasing its currency so effectively that the US dollar has fallen by 14 per cent in the past year, as measured by the Fed's major currencies index. But China doesn't want to lose export competitiveness to the US, so it has maintained its peg to the dollar. This means that China's renminbi is also depreciating in real terms against its other trading partners. So the US and Chinese currencies are debasing in tandem.
In the meantime, the central banks of the EU and Japan are handing out money cheaper than free. In sum, almost the entire world has gone monetarily mad. And the cheap money is forming a bubble in the price of commodities.
Central bankers in many countries are quietly worried about this. Each thinks that his bank alone cannot make any difference. So they leave their interest rates low. Yet their collective inaction guarantees that they are all facing a problem of growing inflation and a dangerous bubble in commodity prices. This is the same problem, the "prisoner's dilemma", that we see in the case of carbon emissions.
What can Australia do? The Reserve Bank is one of the very few central banks which is not running loose money, so it's not part of the problem. But the Australian government has a key part to play.
It's prudent for Australia to assume that the floodtide of global liquidity will eventually generate a crisis. Time magazine has already named Greenspan's successor, Ben Bernanke, as its person of the year, in 2009. We cannot pick the date of the next crisis, and it is probably years away, but we can identify the trend. And prepare.
When the global financial crisis rocked the world, the key to Australia's relative immunity was that we went into the crisis with zero federal government debt. This was Peter Costello's gift to the nation.
It allowed the Rudd-Gillard-Swan government to launch two stimulus packages without any danger to Australia's rolled-gold credit rating. It's now time for the Gillard-Swan government to roll back the debt and restore Australia's fiscal health.
Swan has been busy pointing out that his plan to return the budget to surplus by 2012-13 would be the fastest consolidation in federal finances in modern history. But as the accompanying chart shows, this is just as well. Because the run-up in Australia's debt was among the fastest in the world.
Australian government debt has risen by 250 per cent since 2007, in the comparison prepared by Ken Rogoff and Carmen Reinhart of the London-based Centre for Economic Policy Research. This is the biggest percentage increase of any ''non-crisis country'' and third only to two of the front-line "crisis countries", Iceland and Ireland. They have had to resort to emergency loans from the International Monetary Fund to stay solvent.
Among the nations classed as crisis countries - Iceland, Ireland, Spain, Britain, the US, Greece and Portugal - the average debt run-up was 136 per cent.
Australia was superfast in resorting to debt. It worked and we avoided a painful recession. But the government must now conduct a superfast rundown in debt. This is a prerequisite to brace Australia for the crisis to come.
Peter Hartcher is the Herald's international editor.