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The End of Alchemy:
Money, Banking and the Future of the Global Economy
by Mervyn King
I review this book with a little trepidation. Not only was Mervyn King at the pinnacle of economic policy in Britain for more than 20 years, as Bank of England chief economist and for 10 years as its governor, but it comes with glittering endorsements. Our own Niall Ferguson joins Alan Greenspan, Larry Summers and Henry Kissinger in saying what a brilliant book this is. Short of roping in the Queen and Dalai Lama, he could not have done better.
All these endorsements are, however, rather alarming, given the ideas at the heart of the book. King has brought into the mainstream theories about money and banking that used to be confined to the wilder fringes of the internet.
King's book was inspired by a conversation in 2011 in Beijing with a senior Chinese central banker who, while saying his country had much to learn from the West, added: "I don't think you've quite got the hang of money and banking yet." The book is well written, though King's technique of going back to first principles and distant history can become wearing.
The alchemy in the book's title is banking. Bankers, over the centuries, have turned, not base metal into gold, but gold into paper money, then credit. The process goes back to a time even before goldsmiths discovered that not all the coins and bars in their vaults would be demanded at the same time. This would eventually evolve into a banking system that failed during the 2007-09 crisis.
According to King: "Money and banking are particular historical institutions that developed before modern capitalism, and owe a great deal to the technology of earlier times. They permitted the development of a market economy and promised financial alchemy. But...money and banking proved to be not a form of alchemy but the Achilles heel of capitalism - a point of weakness that threatens havoc on a scale that drains the life out of a capitalist economy."
Coming from a recent Bank governor, this very narrow, limited-purpose idea of banking is pretty remarkable. In this view, banks should go back to basics, because fractional-reserve banking, the basis of the system, is inherently dangerous. Money creation should not be the preserve of private banks, continues the thinking, but of governments and central banks.
Does this make sense? As a central banker, King was for most of his time at the Bank a very good economist. Only when the crisis hit, which took him by surprise, did he throw himself into banking. His suggestions would bring an end to banking as we know it. Narrow banks would be safe, holding liquid reserves exactly equal to customer deposits. 'Wide' banks would lend but would not take deposits, funding themselves through debt and equity. There would be what he calls a 'pawnbroker for all seasons' to provide catastrophic insurance when problems hit.
There are two problems with these proposals. One is that they are not going to happen. The other is that they throw the baby out with the bathwater. We can debate whether measures taken by regulators and central bankers, including King's successor Mark Carney, go far enough. But they go a long way to ensuring the once-in-a-100-year crisis we suffered in 2007-09 does not come around again for a few more decades. Money and banking made modern capitalism possible. Take too much away and the economic stagnation King fears could become permanent.
We should also take with a pinch of salt the sales pitch for the book, and the author's prediction that the world faces another big crisis. In his later years at the Bank, King was always the gloomiest person in the room, and his often-declared position is that nobody can predict the future. We should hold him to that.
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