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How the financial sector discovered how to make a fortune without causing inflation

Here are two very instructive graphs. The first is a graph of the annual changes in the UK Retail Price Index for the period 1948-2013 - courtesy of the Guardian.

You can see the amazing period that I remember well as a teenager in the early to mid 70s, when inflation exceeded 25% per year. Margaret Thatcher put a stop to that with Monetarist policies that severely restricted the growth in the money supply by dramatically increasing the rate at which the Bank of England lent to the Commercial Banks.  It was the time when everyone talked about M3 and M4. Controlling the money supply was the key to controlling inflation.

The second graph shows how various prices have increased for the period 1956 to 2010 - thanks to Alan Dick's number crunching. It shows how, while the retail price index (RPI) and the amount of cash in circulation (as measured by the number of on-month Treasury Bills - T Bills) were both kept under control from the early 1980s onward, two other measures have gone through the roof.

The first is the Nationwide House Price Index. As Alan Dick says, In January 1956, the average house price was £1,937, but this had increased to £167,364 by the end of september 2010. Inflation alone would have increased the value to £38,486.

That's not bad, and the returns were particulalry impressive during the massive property boom from 1997 to 2007. But the really big returns were to be found by investing in shares. The same amount of money invested in shares would be work £973,030 by September 2010. And I suspect that there are a whole pile of other areas where investing in the financial sector will have produced bumper yields for this period.

I get the impression that, back in the 1970s, the financial sector hadn't yet worked out how to pump large amounts of newly created money/credit/debt into the economy without producing inflation. But with the stimulus of Thatcher's monetarist policies, from the 80s onward, they discovered that by concentrating money creation on (a) the housing market, and (b) the financial markets, and in particular the stock market, they could reap fantastic amounts of money without causing too much inflation for the rest of us. Very crafty.

Since the only remit for the Central Banks was to keep inflation within bounds, and ideally at around 2-3%, this was all fine. The Banks were given the green light for generating colossal amounts of fresh money. The only thing that they should avoid doing was to let any of the general public get their hands on it. Yes, lend it to people to buy houses. That's ok, because most of them won't be able to spend the money because they actually need the house as a place to live. Sure, there will be a small percentage of relatively wealthy people, who will be able to make an absolute packet by buying houses to rent out, or by selling up and buying a nice farmhouse in the south of France. But those few people will not be able to cause serious inflation on their own.

Wouldn't things have been much better if the money creation process had been in the hands of an authority that had the interests of the general public at heart?