It’s Been Too Good for Too Long

It’s only when the tide goes out that you can see who's been swimming naked, remarked the billionaire investor Warren Buffett. The world has been swimming in super-cheap liquidity for the past five years.

The worst deals, the lousiest companies and the least credit-worthy countries have had no trouble raising cheap finance. And countries which spend far beyond their means - Australia and the US each consume 106 per cent of their income every year, borrowing ever larger sums to close the gap - have had plenty of investors keen to finance their overconsumption.

But central banks around the world have decided that the days of super-easy money are over. They have started to take money out of circulation, pushing interest rates up.

The big price falls on Wall Street in the past week, quickly mimicked in markets everywhere else, are a clear signal that a sharper appreciation of risk has returned.

The tide has started to turn. Who will be found to be naked? The sudden new fear is most visible in the US. It finds its expression in an acute concentration on the intentions of the man who sets the price of money, the new chairman of the US Federal Reserve, Dr Ben Bernanke, who replaced the long-serving Alan Greenspan in February.

"The market is being weaned off the delusion that, under Alan Greenspan, everything's going to work out fine," said the publisher of Grant's Interest Rate Observer, Jim Grant. "By recklessly admitting that the future is not an open book, Ben Bernanke has sown anxiety where before there was reassurance."

When Wall Street's frenzied technology mania collapsed in March 2000 and swiftly pulled the economy into recession, Greenspan cut official US interest rates from 6.5 per cent to 1 per cent, their lowest in 40 years.

These super-low rates, so low that after adjusting for inflation they were actually negative, helped stimulate a strong recovery in the US economy. That done, the Federal Reserve has gradually brought interest rates back to a more normal level.

The concept of a normal or "neutral" rate, neither stimulating growth nor stifling it, is a slippery one. With the last rise in US official rates to 5 per cent, there was a general consensus that the Fed had definitely arrived there. But Bernanke has been sending mixed signals about his intentions, and an unexpectedly strong inflation report in the US on Wednesday was enough to panic investors into thinking there would be more rate increases ahead.