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Kirk Houghton

Author of The Dividing Lines and Bad Things to Good People

Kirk's Book Reviews

Kirk's Book Reviews

Review of The End of Alchemy: Banking, the Global Economy and the Future of Money by Sir Mervyn King

Posted on March 15, 2016 at 3:40 PM

The End of Alchemy: Banking, the Global Economy and the Future of MoneyThe End of Alchemy: Banking, the Global Economy and the Future of Money by Mervyn King

My rating: 4 of 5 stars

As ex-Governor of the Bank of England during the 2008-09 world recession, Sir Mervyn King is better placed than anyone to give an inside account of the financial storm that nearly brought the western world to its knees.
Thankfully, he is happy to let others do that and has no intention of writing a special plea to the Bar of History for a sympathetic hearing. Instead, The End of Alchemy is an ambitious attempt to bring the theoretical world of banking to the educated man on the street without alienating the armchair economist.
At the core of King’s study is the very essence of banking, which, as we (should) know, is a confidence trick. Banks borrow short and lend long, a process known as ‘maturity transformation.’ In other words the £500 I deposit in a current account with HSBC (a liability for the bank) is transformed into a product with a higher yield in the form of a loan to somebody else (an asset). The problem is liabilities can be withdrawn at any time, whereas assets are often illiquid, long-term and risky. Those occasions when depositors panic about the value of a bank’s assets result in the dreaded ‘run’ that has characterised commerce since medieval times. As we saw in 2008 during the run on Northern Rock, the rational desire to withdraw money results in a stampede and a potential liquidity crisis that can affect the whole of the banking system. But is the government right to act as a Lender of Last Resort (LOLS) or should the implicit tax-payer subsidy (or bailout) be reformed?
Of course, nobody but traders in securities, derivatives and futures believe the taxpayer should be on the hook for reckless gambling, and King is interested in developing a system where central banks will act as Pawnbroker for All Seasons (PFAS) to bring sanity back to the finance sector. The policy of forcing banks to insure their assets with an agreed ‘haircut’ to value risk sounds good in theory. In this hypothetical scenario an investment bank selling dubious CDO-type securities would have to accept a haircut between 90 and 100% on defaults, meaning investors could see how much a bank is loaded with risky, illiquid assets. All parties would understand the percentage of the assets insured under PFAS and would accept the loss dictated by the haircut agreement. This scrutiny should force banks to keep more equity capital and stay clear of loading their balance sheet with obscure financial products at the expense of other more liquid (and sane) investments. LOLS would be a thing of the past.
The theory is sound, but this book is much more than a guide to the future and is just as commendable for its rich history and economical writing. Everything from the definition of money to the difference between ‘money interest’ and ‘real interest rates’ are explained in a concise language that escaped the author during his interrogations on the House of Commons Treasury Select Committee. Indeed, for some this may come as the greatest surprise, for King was often a man of few words in public. But underneath the text is a latent desire for posterity with many epic quotes underpinning the tone of the book. The European Union’s calamitous mismanagement and lack of political union to support a common monetary policy is a case in point: ‘The tragedy of monetary union in Europe is not that it might collapse but that, given the degree of political commitment among the leaders of Europe, it might continue, bringing economic stagnation to the largest currency bloc in the world and holding back recovery of the wider world economy.’ Clearly no fan of German intransigence on the issue of Greek repayments via austerity, King is right to remind the reader of the Allied Powers’ generous write-down of its WWI debt of 132 billion gold marks. By the 1932 Lausanne Conference, Germany had paid only 21 billion marks ‘most of which was financed by overseas borrowing on which Germany subsequently defaulted.’
Indeed, the European Union’s attempt at Economic and Monetary Union (EMU) is the one subject where the ex-Governor of the Bank of England is keen to predict the future. As the most ambitious currency bloc in the history of the world, the Eurozone is a shoddy compromise between political ideals and half-baked integration. Greece is the best example of how this incongruous state of affairs is storing up trouble for the future. In King’s view, ‘The real challenge is not the state of the public finances but a country’s external competitiveness.’ He gives the German Government four choices, all of which are political suicide:
1. Wait for unemployment in Greece to continue until wages and prices are depressed enough to restore competitiveness
2. Allow inflation to make headway in Germany in combination with option #1. This would see the value of the Euro plummet in the wake of an export-led recovery.
3. Abandon the internal devaluation in options #1 & 2 and declare a transfer union where the rich northern states subsidise the weaker southern states to plug full employment deficits
4. Accept a partial or total break-up of the Eurozone
Add in the current migration crisis enveloping Europe and the future looks like a toxic combination of high unemployment, persistent deflation and a return to nationalist demagoguery. No wonder the author is quick to remind us that Capitalism – far from perfect, but better than anything else - is ‘not an answer to problems that require collective solutions, nor does it lead to an equal distribution of income or wealth.’
So, should we all start hoarding gold? Current solutions are short-term in scope, and the reliance on ultra-low interest rates and quantitative easing has run its course in stimulating the recovery post-2009. King is keen to stress the problem cannot be solved by constantly injecting liquidity into a fragile market fighting against deflation. Instead we need to concentrate on raising future productivity and encouraging relative prices to move in a more sustainable direction.
He’s not wrong there, but the alternative suggestions for a way forward are the usual mix of supply-side reforms we hear at every Conservative convention – less regulation, a reduction of monopolies, policies to encourage entrepreneurship, less distortion in the tax system. This is perhaps the most disappointing aspect of the book and the main factor preventing a five-star review. How many times have these platitudes been recycled in the same meaningless language?
Furthermore, the rebalancing of the global economy will take monumental co-operation. The G8 countries can keep advising China to move away from export-led growth in favour of boosting domestic demand, but can any nation force this proud Confucianist civilisation to reverse centuries of cultural tradition? King’s insistence on restoring floating exchange rates is more realistic, but, again, will take a huge collective effort. These policy recommendations are not original, but sensible. We all know what needs to be done, but don’t know how to achieve the means to this ideal end.
As a former Governor of the second-oldest Central Bank in the world, Sir Mervyn King is also prone to forget the awful record of his contemporaries, especially the US Federal Reserve, where a lot of his personal friends have worked over the years. Yet as James Rickards points out in his excellent book, Currency Wars (2012), the Fed has failed to fulfil its basic mandates. Since 1913 the Dollar has lost over 95% of its value; it allowed up to ten thousand banks to close or be taken over during the Great Depression while bank assets dropped by almost 30 percent; it bailed out many insolvent banks during the 2008-09 crisis, ignoring the Bagehot principles of taking strong collateral for high-interest loans; and it has failed to get anywhere near its 1983 target of achieving 3 percent unemployment. Yet none of this gets a mention for understandable reasons, as the back-cover of the book comes with praise from Paul Volcker and Alan Greenspan – not the type of people you want to criticise when searching for endorsements to propel your work to number one on the Current Affairs chart.
The End of Alchemy may not be a perfect work or have the same impact as John Maynard Keynes’ The General Theory of Employment, Interest and Money (1936), but that is to misread the author’s intention. King is not addressing fellow economists, but the educated masses that turn out to vote in democratic elections across the world. There is something for everyone here, whether it be Chapter Four as an introduction to the workings of high finance (‘Radical Uncertainty: The Purpose of Financial Markets’;); a history of monetary policy from early modern times (anybody remember the Latin Monetary Union of the nineteenth century?); or a concise summary of key macroeconomic topics that may have stayed on your shelf since undergraduate days.
Those disappointed by King’s refusal to write a personal account of the financial meltdown of 2008-09 should not be discouraged. This is not a cop-out, but an academic response from one of the key agents in the most recent financial crisis of modern capitalism. Historians will give a better analysis of his policies twenty years from now, but today we have an intellectual tour de force on our laps, and it would be myopic not to enjoy it.



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