When Margaret Thatcher came to power in the UK, she made it perfectly clear that she intended to deal with inflation fast.
In the summer of 1979, she started setting a target of seven to 11% for money supply growth and a rise in the bank rate (then the MLR minimum lending rate) from 12 to 14%. In October, her chancellor, Sir Geoffrey Howe, reiterated the fact that the battle against inflation was to be won with monetary policy. And then, just in case anyone in the City hadn't been listening properly, Thatcher made the point again in her speech at the Lord Mayor's Banquet.
Two days later, on 15 November, the MLR was raised to a crisis rate of 17%. This was unprecedented stuff: it led the bond market in the UK to near-collapse and pushed the FTSE All Shareto 219.85, a nasty 23% below where it had been when Thatcher was elected, a mere six months earlier.
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If you had landed from Mars then and tried to figure out where to put your money, you wouldn't have touched either UK gilts or UK equities with a bargepole: as John Littlewood notes in my favourite history of the UK stockmarket, pretty much every sudden rise in the MLR in the past had "signalled an economic crisis".
And in the first part of the 1980s, it looked like that was exactly what the UK had. Inflation didn't appear to be listening to Thatcher and Howe. In April, it went over 20% again, staying there for three months. All the classic indicators of out of control inflation were on the rampage (this was when gold hit $850 for the first time, and when the Dallas-based Hunt brothers cornered the silver market and pushed the price to $50, utterly convinced they just couldn't lose).
But the rate rise didn't actually signal crisis. It signalled the beginning of the end of the crisis. The FTSE All Share never went lower than its level on 15 November 1979. The gold price only stayed above $800 for two days. The Hunt brothers lost everything. And inflation turned out to have peaked in May at a hard-to-imagine-today 21.9%.
In July 1980, the MLR was cut to 16%, falling to 12% by early 1981. In late August, the bond market staged a spectacular wobble when the Bank of England stopped publishing the MLR and the uncertainty about what interest rates actually were crashed prices and pushed gilt yields up (and so prices down) to the same levels as they had hit in the dismal years of the mid-1970s.
However, that really was the bottom for bonds. From there, interest rates just kept falling as they have pretty much ever since. By late 1982, the base rate (the new symbolic interest rate) was down to 9% and gilts had returned their slightly shell-shocked owners an impressive 40%. By 1985, when FT Weekend was first published, the great bond bull market was well under way.
Today, 30 years on, it is still with us, and interest rates are just as extreme across the Western world as they were back in the early 1980s, just in the opposite direction.
Not even the most brilliant of forecasters in 1982 could have predicted that in 2015, some government bonds in Europe could have negative yields; that the UK would have held interest rates at 0.5% for six long years; that the UK's institutions would have all but abandoned the equity markets for bonds; that central banks would be fuelling the bull by buying billions worth of their own bonds; and that the US and UK bond markets from 1980 to date would have returned as much as the equity markets (historically they have returned some four percentage points a year less).
But if we time-travelled that brilliant forecaster to 2015, there is also no way we would be able to force him to buy bonds at today's prices. He would, I suspect, take one look at the fact that more than half the world's government bonds yield less than 1%, be convinced that rates can go no lower and hence bond prices no higher. There is, he would say, absolutely no value in this market.
Would he be right? After 33 years of bull market, there is no shortage of people who would agree with him. But it isn't a given. For interest rates to rise, there needs to be a catalyst either good or bad. So markets have to demand a greater return to lend money to governments, inflation has to soar, economies have to do so well that central banks start worrying about overheating, or central banks have to change their policy structure. None of these things look that likely in the immediate future.
In the 1960s, the UK had what some of the press referred to as a "Birmingham problem". The city was too big. It was creating too many jobs. Too many people lived there. And too many more people wanted to live there. "The five counties in and around Birmingham lie at the strategic heart of manufacturing Britain," said the now-defunct Statist magazine. They have the "fastest rate of population growth and the highest ratio of working population to total population in the UK...they help to underpin the whole nation's economy by their output of capital goods, their direct exports and their supplies of products and work to other regions."
So it won't be overheating or inflation that start pushing up rates. It doesn't look like it will be policy change either: Mario Draghi hinted to the fact that quantitative easing (QE) has nasty side effects when he spoke this week. But central bankers are still very far from recognising that QE, instead of killing deflation, can create it.
How? By encouraging overinvestment in projects that would never get off the ground in normal times and so create oversupply (see the oil market). And by terrifying those who are dependent on income into spending less than they would have otherwise (if their capital is producing low returns, they panic-protect that capital).
All the obvious conditions are in place for a crash a complete lack of value, extreme prices, liquidity problems, oblivious authorities and over-concentrated portfolios. It all suggests that when the end comes it will be nasty. But as long as central bankers remain convinced that they can banish deflation with extreme monetary policy, I am loath to suggest that the end will come before FT Weekend's next birthday.
This article was first published in the Financial Times.
