Economies are naturally evolving things – we can’t improve them by interfering

When I told the office Matt Ridley was coming in to do an interview with me, something interesting happened.

Several of my colleagues turned out to know him only as Matt Ridley, ex-chairman of Northern Rock. They assumed he was coming in to talk to me about the many, 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.

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The truth is that Ridley is both of 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 say for most of the members) and a columnist for The Times. And he has a new book out The Evolution of Everything that one way or another 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 in the world. That 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. And so 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, which is 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", for example. "It's been a long struggle to get people to get used to the idea that the eye wasn't designed by a designer."

But we tend to make the same "creationist" mistake in terms of society and economies. We think they are directed and that 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 what Frederick 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."

The real truth is that it is hard to improve an economy by interfering with it. It is, however, pretty easy to mess one up by interfering with it.

Take the crisis of 2008, says Ridley. The "unsustainable credit boom, particularly in the sub-prime housing market in the United States, was not just a result of deliberate policy decisions, but was actually the purpose of deliberate policy decisions." It was partly a result of Chinese policy: the way they manipulated their exchange rate (keeping it artificially low) made money very cheap in the US and cheap money 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 bizarre policy pushed by the Clinton and Bush administrations of "forcing up the lending to people who can't afford to borrow".

The original reasoning behind this was "noble" to "try and increase home ownership among ethnic minorities". But it ended up a congressional mandate that insisted that all institutions offered 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 entirely absolve the banks, of course. They could have lobbied against it, and they could have analysed their credit risks a lot better.

And the response to it 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 a look in, in the debates."

For anotherexample of the idiocy of over-regulation, says Ridley, look at vaping. Vaping is "a beautiful example of an emergent technology that is spectacularly good for public health". Yet it is about to be hit by an EU directive that says "every single machine must produce data on exactly the 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 they aren't controlling, says Ridley.

He's making this anti-regulation argument at a good time one in which the VW crisis is proving to anyone still any doubt that the more regulation you introduce the more you invite the creative 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' might 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). And 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." Is this all worth it? "I'm not sure it is. So again top down interference in the market is often what causes the problem rather than what solves the problem."

This takes us on to a bit of the book that will particularly interest MoneyWeek readers.

We have asked before why, when most people disapprove of price controls on most goods and services, they also completely accept that governments should control the price of money the interest rate rather than leaving it to 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 and it doesn't have centrally set interest rates. Look to Scotland from about 1720 to 1740. It had a group of senior banks, all of which could issue currency (and which still can). They took each other's notes effectively honouring each other's commitments on the condition that they all behaved. So "they regulated each other", something that worked beautifully and drove innovation (which of course is why the English banks under the Bank of England constantly lobbied for more regulation of the Scottish banks).

The US also had a kind of free banking in this style before 1913. Did that work OK? Ridley reckons it did: "up till 1913, America had total inflation throughout its life of about 8%. Since then it has had about 2,000%. Now, if the job of a central bank is to control inflation, it doesn't look like it's worked very well." It is also worth noting that the country that got through the 1930s in best shape was Canada, "which had no central bank at the time".

There are endless problems with central bank interest setting, says Ridley, but the key one is that whether it is down to political pressure or incompetence, they tend to be pro-cyclical. So they "increase liquidity when things are going well and clamp down on liquidity when things are going 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 develop (and) evolve we would be in a much better position than we are. That said, Matt and I decide not to fall back on the Nirvana fallacy. We are where we are, and the central banks are too deeply embedded in our systems to be abolished without considerable pain (to say nothing of intense vested interest oppositions).

Might it be the case then, I ask, that a new system evolves to compete with global central banks? Might the technology behind Kenya's mobile phone currency, Mpesa, or bitcoin end up being used to bypass the 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.

The key thing about currencies is that they need a third party to verify them to say that a pound note is worth a pound. That third party until now has been a commodity (the gold standard) or a central bank. The great thing about bitcoin or its blockchain technology is that the technology serves this purpose. It isn't money yet (for that it has to be a trusted store of value and common medium of exchange) 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 like a tough place at the moment. I end by asking him just how tough things are. His reply is to question the very idea that we are going through particularly difficult times at the moment. "Sure, there's all sorts of unsolved problems, and it's not much fun if you're in the eurozone or in Syria or whatever, 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 they used to bury." There used to be evidence that suggested that happiness didn't necessarily rise with wealth. That's turned out to be not 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?