"Dining on the Edge of the Abyss": An American cartoon predicting the Wall Street Crash in 1929 © Peter Newark America Pictures/Bridgeman Images
The End of Alchemy: Money, Banking and the Future of the Global Economy by Mervyn King, Little, Brown, £25
I have known Mervyn King for over 20 years. We worked together at the Bank of England in the 1990s. We then worked opposite each other when I was Chairman of the Financial Services Authority. I have observed him in his preferred habitats: a beautiful library attached to his home in Kent, and the
Directors’ lounge at Aston Villa Football Club. Yet until now, I had never suspected that he bought his socks at Harrods.
A thrifty man, King buys only in the sale, of course, but it is a surprising fact to discover in a treatise on money and banking in the 21st century—especially one which is as far from the “kiss-and-tell” memoirs of other central bankers and politicians as is possible. So I should explain that his socks enter the story as a kind of metaphor for sub-prime mortgage securitisations. In the sale, Harrods sold socks in packs of five and “when you got home you would discover at least one pair you would never wear (in my case, orange socks)… the set of five pairs was rather like a Collateralised Debt Obligation (CDO) that bundled socks instead of sub-prime mortgages.” The analogy is not exact. In the worst-performing CDOs, four and a half of the five pairs were unwearable, so to speak, but the point is well made.
As revealed in a decade of speeches while he was Governor of the Bank of England from 2003 to 2013, King has an enviable talent for describing complex problems in a straightforward and often witty way. It helps that he is remarkably well read. The End of Alchemy is dotted with apposite quotations from Charles Dickens, TS Eliot, Thomas Carlyle and John Bunyan, not to mention Vladimir Lenin and Mrs Patrick Campbell. Aston Villa, where he is now a Director, cannot be found in the index, but references to it have infiltrated a chapter on Economic and Monetary Union (EMU), where he notes that Greece may be better off leaving the eurozone, “because sometimes premature promotion can be a misfortune and relegation the opportunity for a new start.” He will soon be putting that theory to the test since Aston Villa are all but relegated from the Premier League—a rare real world experiment for an economist.
The book is a joy to read. One cannot say the same for some of the other door-stops produced by the financial crisis. Too Big to Fail by Andrew Ross Sorkin had the breathless immediacy of a first draft of history. The memoirs of Ben Bernanke and Hank Paulson will be useful quarries for future historians, but none has quite the verve or intellectual fizz of King’s.
"The real causes of the rise in debt were the savings glut and the response to it by western central banks"But he is not seeking literary accolades: he has a far more serious purpose. He offers a provocative analysis of how the financial world got into the pickle it did in 2007, explains why nine years of ultra-loose monetary policy has left us little closer to solving the underlying problems and sketches out a set of reforms to the international monetary system, to central banking and to banks, which he believes are necessary if we are not soon to lurch back into another crisis.
His diagnosis of the original sins that led to the meltdown of 2007-8 is not far from the Bernanke thesis. While acknowledging the rapid build-up of debt—especially mortgage debt, and giving generous credit to the activities of venal and myopic bankers in making a bad mess worse—he sees the global imbalances that built up between chronic surplus countries like China, and the United States as the consumer of last resort, as the prime culprit: “The real causes of the rise in debt were the savings glut and the response to it by western central banks that led to and sustained the fall in real interest rates.”
When the bubble burst, the Federal Reserve and its counterparts did what they had to do, flooding the market with liquidity. They had learnt the lessons of the 1930s all too well. It helped that Bernanke himself had devoted much of his academic career to a study of the Great Depression. King does not oppose any of those responses—he was, after some hesitation in 2007, an enthusiastic participant in the rescue efforts. He even accepts, while holding his nose, that the foolish bankers had to be rescued to avoid damaging contagion. But he notes that even zero (or now negative) interest rates for seven years, accompanied by trillions of dollars of quantitative easing, have not restored western economies to their previous growth path, and that in many parts of Europe growth has barely restarted. Diminishing returns have set in. Mario Draghi, the President of the European Central Bank (ECB), may well say that he will do “whatever it takes” to defend the euro, but there is little sign that he can alter the relative positions of debtors and creditors within the eurozone, with the former condemned indefinitely to low or no growth.
In an attempt to break out of this modern-day version of John Maynard Keynes’s liquidity trap, King proposes a set of radical reforms designed to address the global imbalances directly. The need is for concerted action as each country faces a version of the prisoner’s dilemma. If it seeks to rebalance its economy—perhaps by lowering its exchange rate to encourage exports and discourage domestic consumption—it may provoke a sharp reaction from its trading partners. As King puts it, “there is a real risk of an implicit or explicit currency war.” So he recommends a major strengthening of the International Monetary Fund (IMF), which must involve wresting the US veto out of its hands, a permanent system of swap agreements between the surplus and deficit countries and a global commitment to floating exchange rates. At the same time, there must be renewed impetus for trade liberalisation, involving the restarting of the Doha round and extending it to services, and implementation of the Trans-Pacific Partnership (TPP) and the Transatlantic Trade and Investment Partnership (TTIP). Furthermore, governments should commit to a major programme of policies to improve productivity, which has stagnated since 2007, including investment “to improve public infrastructure to support the rest of the economy.” I am sure that only reasons of space caused him to omit a specific reference to the need for another runway at Heathrow. The alternative to such a radical plan is “a return to a multipolar world with similarities to the unstable position before the First World War.”
What are the chances of such a programme being agreed? One would have to say they are low. As King himself acknowledges, the initial post-crisis enthusiasm for globally concerted solutions, which reached a peak at the London summit in April 2009, has ebbed away. G20 summits come and go, normally with worthy and wordy communiques full of sound and fury, but ultimately signifying nothing.
There has been a far-reaching programme of work to re-regulate the banks, but King thinks little of it. He notes a wave of detailed and costly new regulations, which few understand, while the “alchemy” of the banking sector remains in operation. He would prefer to dispense with most of the regulators’ rule book and replace it with an obligation on banks to match their liquid liabilities with liquid assets at the central bank, pledging collateral of all kinds with the central bank imposing judgemental haircuts. It would, he acknowledges, take banks 20 years to reach this state of grace.
But if global change of the sort King advocates looks about as likely as Aston Villa winning the Champion’s League, or Worcestershire the Cricket County Championship (our hero is a patron of many lost causes), is there a better chance in Europe?
King has never liked EMU. He worked hard to ensure the UK did not join the euro. Left to him there would have been 500, not just five tests to meet. And in The End of Alchemy he does not hold back on his critique of the incoherence of a monetary union without fiscal stabilisers, which locks chronic surplus and chronic deficit countries together in an increasingly loveless embrace. The options, as he sees it, are stark. Either a fiscal union is constructed and approved by the peoples in the union, or some countries—Greece, certainly, and probably others—must leave. The third way is continued stagnation and recession in countries that cannot expand demand without running unfinanceable deficits, and which cannot hope to pay off their accumulated debts. King’s is not a lone voice. He aligns himself several times with Otmar Issing, the former Chief Economist of the ECB, but so far the EU consensus has been to do what is necessary to sustain the currency union, and nothing more. Draghi is left in the inelegant posture of the Dutch boy with his finger in a dyke, which may give way at any time. Not for the first time, King quotes Keynes: “it is foolish to suppose that any means exist by which one modern nation can exact from another on annual tribute continuing over many years.” No doubt Yanis Varoufakis can provide a Greek translation.
Since King argues that global solutions are needed to allow the prisoners to escape from their dilemmas, he says relatively little about the UK. The names Gordon Brown, Alistair Darling and George Osborne are absent from the text. But he is clearly sceptical about the role of the new Financial Policy Committee (FPC) in the Bank of England, with its shiny new instrument: macro-prudential regulation. The FPC has been flexing its muscles recently in the mortgage market.
His principal concern, which I share, is that the consensus which emerged in the 1990s in support of delegation of interest rate policy to an independent central bank may be destabilised. “The entry of central banks into the field of direct controls on mortgages, and lending more generally, is bound to raise the question of whether this is taking delegation too far… decisions on that type of interference with the market should properly be left to elected politicians.” King is rightly nervous about where the extension of the Bank of England’s powers will end, especially when it is being invited to try to correct market distortions that arise from a macroeconomic imbalance, or indeed from tax policies favouring debt over equity.
With a knowing allusion to Barack Obama, the final chapter is called “The Audacity of Pessimism.” In an interview with the Financial Times on his retirement from the Bank of England in 2013, he explained that “only when things look bleak will people get round to doing anything.” At that time, Aston Villa had just finished 15th in the Premier League with a five point cushion above the relegated sides. In 2014 their position was identical; in 2015 the cushion was three points. This year, disaster has struck: they are almost certain to be relegated. So we may expect the next financial crisis in 2019. You have been warned.
Since this article went to press Aston Villa have been relegated from the Premier League and Mervyn King has resigned from the club's board
