Let the market set the price of money – economies run better if they don’t have centrally set interest rates, says Matt Ridley.
When I told the office that Matt Ridley was coming in for an interview, an interesting thing happened. Several of my colleagues knew him only as Matt Ridley, former chairman of Northern Rock. They assumed he would discuss the many lessons we should have learnt from the financial crisis. The rest thought he was Matt Ridley, popular science writer – and something of a hero to some. The very idea of meeting the author of The Origins of Virtue was enough to turn Dan Denning, the publisher of MoneyWeek Research, into a simpering teenager.
“One of my favourite books ever,” he said dreamily, as Ridley was on the way up in the lift. In fact, Ridley is both these things – and more. His Northern Rock days are long past (as are everyone’s). But he is still a prolific author, an active member of the House of Lords (more than you can say for most of the 790-odd members) and a columnist for The Times. And his new book – The Evolution of Everything – picks up on all these subjects. So, once I have wrenched him away from Dan, that’s what we sit down to talk about.
I have been struck for years, says Ridley, “by the parallels between ideas about evolution and ideas about free markets and by the notion that spontaneous order occurs… a rainforest doesn’t have anyone in charge of it, and nor does the English language, and nor does the world economy. They emerge with complexity and purpose and sophistication through the interactions of lots of individuals, without any final design in mind… I wanted to explore how far you could take that idea in terms of explaining human society as an evolutionary phenomenon.”
It seems that everything changes, not by direction or big idea, but “by trial and error – another word for natural selection. And that ends up producing complex, purposeful design.” It’s human nature to think that individuals create change. We all “hanker after someone running the biological show… it’s been a long struggle to get people used to the idea that the eye wasn’t designed by a designer”. We make the same “creationist” mistake about society and economies. We think they can be directed for good or bad – by the chancellor of the Exchequer, or the governor of the Bank of England, or the chairman of the Federal Reserve.
We forget, says Ridley, what Frederic Bastiat said in the 1850s: “How does Paris get fed? How do all these millions of people get enough food every day and the right kinds of food just when they want it? Not because someone’s doing a brilliant job of planning the food for Paris, but because of all the interactions of lots of different individuals.”
How to mess up an economy
The truth is, it is hard to improve an economy by interfering with it. But it is pretty easy to mess one up. Take the crisis of 2008, says Ridley. The “unsustainable credit boom, particularly in the sub-prime housing market in the US, was not just a result of deliberate policy decisions, but was actually the purpose of deliberate policy decisions”. It was partly down to China: the way it kept its exchange rate artificially low made money cheap in America – which means credit bubbles.
But it was also about US policy: first the Federal Reserve bailing out the stockmarket whenever it got into trouble (the ‘Greenspan put‘), and second, the Clinton and Bush administration policies of forcing more lending “to people who couldn’t afford” it. The reasoning was “noble”: to “try and increase home ownership among ethnic minorities”. But it ended up being a congressional mandate that insisted all institutions offer a “specific proportion of their lending to people who couldn’t pay the money back”. Fannie Mae and Freddie Mac were then mandated to buy these loans in the mid-2000s. And that was that – the crisis was a given.
This doesn’t absolve the banks. They could have lobbied against it, and could have analysed their credit risks better. But it does challenge the notion that the crisis was a “bottom-up market phenomenon” or due to lack of regulation – in fact, “it was a crisis caused by top-down interference, not bottom-up emergence”. The response – more regulation – hasn’t been helpful. “The trouble with all crises is that they immediately lead to calls for more regulation, and the idea that regulation has perverse incentives very rarely” gets discussed.
For another example of the idiocy of overregulation, says Ridley, look at vaping – “a beautiful example of an emergent technology that is spectacularly good for public health”. Yet it is about to be hit by a European Union directive that says “every single machine must produce toxicological data on all the products that it produces. Cigarettes don’t have to do that.” So why vapers? I ask. Because the public-health lobbies see it as their job to stop people smoking – not the job of a new technology that they aren’t controlling, says Ridley.
He’s making this anti-regulation argument at a good time – one in which the VW crisis proves to anyone still in doubt that the more regulation you introduce, the more you invite the creative will to find both legal and illegal ways to circumvent it. Climate change is as much a classic of this as finance. The switch to so-called clean diesel may turn out to be “killing tens of thousands of Europeans every year”. Emissions testing has ended up destroying trust in one of the greatest car brands there is (was). The boom in biofuels – which means 5% of the world’s food crop has been put aside for “feeding cars rather than people” – has “probably killed 200,000 people a year, as well as put more pressure on the rain forest”.
Getting rid of central banks
This takes us to a bit of the book that will particularly interest MoneyWeek readers. We have asked here before why, when most people disapprove of price controls on most goods and services, they accept that governments should control the price of money – the interest rate – rather than let it be set by the market. Ridley (like us) doesn’t accept this idea. There is plenty of evidence, he says, that a banking system runs better if it doesn’t have a central bank or centrally set interest rates.
Look to Scotland from about 1720 to 1740. It had a group of senior banks, all of which could (and still can) issue currency. They took each other’s notes – effectively honouring each other’s commitments – on condition that they all behaved – “they regulated each other”. This worked well and drove innovation (which is why English banks under the Bank of England constantly lobbied for more regulation of Scottish banks).
America also had a kind of free banking in this style pre-1913. Did that work? Ridley reckons it did: “up until 1913, America had total inflation throughout its life of about 8%. Since then, it has had about 2,000%. If the job of a central bank is to control inflation, it doesn’t look like it’s worked very well”. The country that got through the 1930s in best shape was Canada, “which had no central bank at that time”.
There are endless problems with central bank interest rate-setting, says Ridley. But the key one is that, whether due to political pressure or incompetence, they tend to be pro-cyclical. They boost “liquidity when things are going well and clamp down” when things go badly. “They exacerbate the swings. If instead of creating the powerful institutions that now run global monetary policy (badly), we had allowed free banking to… evolve, we would be in a much better position.”
That said, central banks are now too deeply embedded in our systems they couldn’t be abolished without considerable pain. Might it be the case then, I ask, that a new system evolves to compete? Might the technology behind Kenya’s mobile phone currency M-Pesa, or Bitcoin, end up being used to bypass currencies issued by central banks?
We might not be able to get rid of them, but perhaps currency evolution will make them irrelevant in 20 years. Ridley thinks this is entirely possible. Currencies need a third party to verify them – to say that a pound note is worth a pound. Until now, that third party has been a commodity (the gold standard) or a central bank. The great thing about Bitcoin – or its blockchain technology – is that technology serves this purpose. It isn’t money yet (it has to be a trusted store of value and common medium of exchange first), but it has “huge implications for disintermediation in the global economy”.
Ridley is known as an optimist (his last book was called The Rational Optimist) but the world seems a tough place right now, I say. His reply is to question the idea that we are going through particularly hard times. “There’s all sorts of unsolved problems and it’s not much fun if you’re in the eurozone or in Syria… but globally we are seeing extraordinary levels of prosperity, compared with anything we’ve seen before… in my lifetime, the average person on the planet has trebled his income in real terms, and seen his life expectancy rise by a third… and that’s while the population has doubled.”
Better still, when “the greatest measure of misery I can think of is to bury a child…the world has stopped burying two-thirds of the children we used to bury”. There used to be evidence that suggested that happiness didn’t necessarily rise with wealth. That’s turned out not to be true. “There’s a correlation between wealth and happiness within countries, between countries and within lifetimes.” Global wealth is rising and so is global happiness. How’s that for good news?
Who is Matt Ridley?
Matt Ridley, 57, has enjoyed a varied career in banking and journalism, including stints as both the science editor and American editor of The Economist magazine. He has written a number of books on evolution, and in particular, how it shapes society, most notably The Origins of Virtue (1996) and The Rational Optimist (2010). He writes a weekly column for The Times that takes a libertarian economic and political view on current events. Ridley also served as chairman of the ill-fated Northern Rock between 2004 and 2007.
He resigned after a run on the bank, which came near the start of the financial crisis, and the bank was eventually taken over by the government. He inherited the title of viscount from his father, Matthew (who also served as chairman of Northern Rock), in 2012 (he is the 5th Viscount Ridley), and was elected a year later to a seat in the House of Lords as one of the 92 remaining hereditary peers with voting rights.