My Lords, I would like to follow the structure of the speech of the noble Lord, Lord Lawson, although my arguments and conclusions will be a little different from his: how we got to where we are and what should be done about it. On how we got to where we are, as I understand it, the noble Lord, Lord Lawson, chiefly blames the failure of banking supervision, which enabled the banks to lend recklessly. Of course, that is a large part of the issue. The whole world became vastly over-leveraged. Ten years ago the world stock of financial assets, stocks, bonds, loans and mortgages was equal to the total of world GDP. When the crisis hit last year it was four times as much and financial derivatives, which are claims on financial assets, were 10 times larger than that. It was like an inverted pyramid: the more claims were piled up on top of real output, the more wobbly the pyramid became and eventually it collapsed.
Lack of banking supervision is important, but another crucial part, which was not mentioned, was played by financial innovation. Very clever entrepreneurs—mathematical whizz-kids equipped with computers—invented instruments of increasing sophistication and obscurity, which enabled debt to expand exponentially. I doubt if the banks themselves understood what was going on, and regulators and supervisors would have understood even less.
The second cause of the boom-and-bust phenomenon was the global imbalances that had been building up in recent years, starting with the collapse of the first Bretton Woods system. The key point has been the accumulation of massive reserves by east Asian countries. The counterpart of the consumption glut in the West was the savings glut in the Far East. Exchange rate undervaluation by Asian countries was the policy weapon used to carry out the accumulation of reserves and export-led growth. These excess Asian savings have been shovelled into the housing bubbles of America and Britain not directly, but by enabling our Governments to pursue expansionary monetary and fiscal policies that fuelled an unsustainable credit and housing boom. For the past 10 years the United States has, in effect, had no budget constraint, and what was true of the country as a whole was true of companies and individuals who piled up debt on the back of constantly inflating house and asset prices. Therefore, lack of bank supervision is not the sole explanation of things that have gone wrong.
What should we now do? Beyond the rescue operations the Government have already carried out, it is not completely obvious to me. Everyone agrees that the bank rate should come down, but how many people realise that lowering the bank rate is not the same as lowering interest rates? If the banks, on account of their bad debts, are expanding their cash balances at the same time as the Bank of England is lowering its interest rate, or, for that matter, that the Government are buying shares in the banks, there will not necessarily be a drop in the price at which banks are prepared to part with their money. That may occur even if the bank rate drops to zero. That is not just a theoretical possibility—in the theory, it is called the liquidity trap—as the Japanese experience in the 1990s gave it some empirical support. If we go back for a moment to the 1930s, the policy of cheap money, which started in 1932, only started to work once recovery had already started. In other words, the horse was willing to drink by that time. That recovery was started by Britain leaving the gold standard in 1931. Today's equivalent is the depreciation of the pound, which is one of the more hopeful aspects of the current situation. Therefore, I do not agree with the noble Lord, Lord Taverne. Depreciation has always been a shock absorber. It is very necessary and is coming into operation now. Thank God, we are not in the euro. For that, I am willing to give considerable credit to the Prime Minister, who held out against it.
I wish I could give him similar credit for fiscal policy, but I cannot. This has been a disaster area. He gave the Treasury a golden rule, which was to balance its current expenditure by taxes over the business cycle, so why, after six years of boom, are we entering this present crisis with a projected deficit of £60 billion, which the automatic stabilisers will bring to £100 billion? It is not the deficit as a percentage of GDP that is the issue, but the confidence factor. With this kind of fiscal background, people will lack confidence in government finances.
As to the global imbalances, we need to reduce the incentives for countries to accumulate such huge reserves. One suggestion that I am quite attracted to is the idea of some pooling of those reserves in an international body like the IMF so that they might be redistributed to countries in deficit.
My final point is more abstract. It is about economic theory. The heart of the issue is whether what we are experiencing is a once or twice in a century chance or an ever present possibility. If this kind of financial tsunami is a once in a century chance, we do not need to base our lives on the possibility that it is going to happen. We can have a theory that assumes that such tsunamis are outliers outside any normal distribution, and that is fine. However, if they are an ever present possibility, we need to guard against them. If we regard them as simply outliers, we keep Keynes in his cupboard, bring him out occasionally to be dusted down and, once he has done his rescue work, we put him back in again and everything goes on as before. However, Keynes believed that an unregulated and unmanaged market was always prone to such huge swings because the future is uncertain—the point made by the noble Lord, Lord Peston—and although we can insure against risk, there is no insurance against uncertainty, so these phenomena, with their accompanying swings of opinion, herd behaviour and so on are built into the operation of a market.
How seriously do we treat this volatility? Do we say that it is a price that we should pay for the greater efficiency of a deregulated market or is it a price too high? I shall end with a quotation from Keynes, who is endlessly quotable and whose quotations shed great illumination. He described economics as,
"one of these pretty, polite techniques which tries to deal with the present by abstracting from the fact that we know very little about the future".
We try to disguise this ignorance by assuming that the future will be like the past, that existing opinion correctly sums up current prospects and by copying what everyone else is doing. However, any view of the future,
"based on so flimsy a foundation ... is subject to sudden and violent changes. The practice of calmness and immobility, of certainty and security, suddenly breaks down. New fears and hopes will, without warning, take charge of human conduct ... the market will be subject to waves of optimistic and pessimistic sentiment".
I do not think anyone has bettered that as a description of where we are now.