The economy is still bubbling along


The London stock market has been soaring. Another sign that the recession is over, business is thriving, and investors are piling back in? Or evidence of a bubble?

The Bank of England has pumped £175 billion of new cash into the UK economy through 'quantitative easing'. Basically, it's been buying government securities hand over fist. So government IOUs look a lot healthier than they should be – given the profligacy of the public finances. Investors have had to look for other assets – like shares.

Go back to your Milton Friedman and you'll understand that the world is full of different sorts of 'assets', from government stock to shares, to houses, to machinery, to bank accounts, to cash. A monetary expansion, he thought, does not occur all at once all over the economy, but spreads from one lot to another. That is exactly what is happening here. New money is being pumped in to the financial markets, so financial asset prices are rising. House prices are also starting to rise, as investors seek something better than a bank account paying less than 1%. And the money will have to spread down through other assets too before it has much of an impact on the real economy. So the stockmarket is booming, while shops and factories are still closing down and laying off workers.

All this new cash must, of course, eventually have a reviving effect on the real economy. But now put your Friedman aside and read F A Hayek. The problem with new cash rippling through an economy is that price rises ripple through too. Prices rise, then fall, in one sector after another. So people invest, first here, then there, on the prospect of high returns, only for their hopes to be shattered by the ensuing fall. So real resources are wasted on investments that don't ultimately work. That is the real human cost of inept, boom and bust monetary policies. Policies of the sort that Gordon Brown told us he'd saved us from.