THE END OF ALCHEMY [3/3] – Money, Banking and the Future of the Global Economy



A phoenix out of the ashes. Without the audacity of pessimism, we may repeat the same old pains. There’s a serious urge on timing. No more delay. No more bail-outs. No more taxpayers’ money. No more policy failure by central banks based on the same intellectual frame. No more moral hazards of banks. The urge of social responsibility of banks. Who said central bankers are villains? I see a hardworking and well-intentioned former central banker boldly and courageously suggesting the end of an old system – the financial alchemy – and seeking cooperation among leaders for our future economy.

When we face a world with almost zero real interest rate, a desperate search for yield is bound to create a bubble with seemingly irrational exuberance. We are recently witnessing the unrealistic surge of bitcoins, as one example. Intelligent and clever speculators joining the queue for short immediate profit seems destined, but what about our innocent neighbours joining the queue? With our interconnected fragile banking system, any weak link is bound to crack. Who is dare to say no more market collapse?

In this regard, I consider this book is very timely in two aspects. First, it addresses ‘why and how’ we need to reform banking system now so as to prevent the coming crisis that can be more severe if nothing is done. Second, it provides perspectives why we need to develop new macroeconomic frame to deal with future uncertainty with proper policy response.

Something has to be done and something’s gotta give as the author says. What’s meaningful about this book is that it’s written by a former central banker who had to deal with the biggest financial crisis in our time in 2008, who observed policy success and failure, and who observed how intellectual frames affect governments and central banks’ policy responses with both positive and negative outcomes. He has a influencing power for this reason. And the ideas suggested in this book are actually out of his deep contemplation gained through his experiences in Bank of England for twenty years. People pay attention.

I especially appreciated a few aspects of his perspectives in this book as below.

First of all, his viewpoint characterising the past crisis in 2008 as a ‘narrative revision downturn’ rather than a Keynesian downturn is carrying great weight because it defines what the right policy response has to be in dealing with the crisis and post-crisis. Unsustainably high spending that was brought forward from the future based on optimistic and indefinitely sustainable life-time incomes had to be corrected, and once it’s done based on the bleaker new narrative, it’s not easy to bring spending back to its previous level. The author provides an illuminating perspective in diagnosing and understanding weak demand and recession we experience today. Failure to acknowledge this aspect has led central banks, especially in countries with higher spending, to complacently stick to Keynesian measures as the sole answer to the problem, when in fact the long term policy should be the other way around.

The Keynesian remedies have their place in dealing with a shock to confidence, such as we saw in 2008-9. But beneath the surface was a much deeper disequilibrium between spending and saving, as the choice between spending today and spending tomorrow had been distorted for many years by falling real interest rates. As a result, we experienced, first, the calmness of the Great Stability, then the turbulence of the crisis, followed by the Great Recession. Policymakers allowed the disequilibrium to build up, then correctly adopted a Keynesian response to the downturn in 2008-9 but failed to tackle the underlying disequilibrium. Understandably concerned with the paradox of thrift, they adopted policies that led to the paradox of policy-where policy measures that are desirable in the short-term are diametrically opposite to those needed in the long term. Short-term Keynesian stimulus boosts consumption, reduces saving, and encourages households to borrow more. But in the long run, policy in the US and UK needs to bring about a shift away from domestic spending and towards exports, to reduce the trade deficit, to lower the leverage on household and bank balance sheets, and to raise the rate of national saving and investment. The irony is that those countries most in need of this long-term adjustment, the US and UK, have been the most active in pursuing the short-term stimulus. – Causes and Consequences of The 2008 Crisis, Chapter 8. Healing and Hubris: The World Economy Today, p326

Second, the author’s claim that we need new intellectual frames – ‘the economics of stuff happens’ – highlights the importance of ideas in influencing and moulding a country’s or an economic union’s fate. The author derives the necessity of new frames mainly from two aspects. Firstly, the financial alchemy, which is the core essence of banking that helped humanity create wealth in capitalist economy, has become an Achilles heel that fails our system in radical uncertainty. The myth and the old belief that bank deposits are safe and can be withdrawn whenever they are demanded by depositors and that short term liquid bank deposits can be transformed to long term illiquid risky assets and vice versa is simply broken in radical uncertainty. I believe this is the most important and insightful point the author makes throughout the book. Secondly, the limitations in explaining booms and depressions, especially swings in aggregate demand, and the right policy measures. As the author said, crises are rather frequent than we assume. Future cannot be mathematically defined. It simply cannot be known. It’s time for a new macroeconomic frame for reform of our future banking and money.

Over the past half-century, mainstream macroeconomics has developed an impressive toolkit to analyse swings in aggregate demand and output. But by embracing so closely the idea of optimising behaviour, and by deeming any other form of analysis as illegitimate, it has failed to illuminate key parts of the economic landscape. Optimising behaviour is a special case of a more general theory of behaviour under uncertainty. And in situations of radical uncertainty, where it is impossible to optimise, a new approach is required. I have suggested a possible starting point with the idea of coping strategies; others will be able to take forward the study of macroeconomics under radical uncertainty-the economics of ‘stuff happens’ rather than the economics of ‘stuff’. – The Audacity of Pessimism, Chapter 9. The Audacity of Pessimism: The Prisoner’s Dilemma and The Coming Crisis, p366

Why has almost every industrialised country found it difficult to overcome the challenges of the stagnation that followed the financial crisis in 2007-9? Is this a failure of individuals, institutions or ideas? That is the fundamental question posed in this book. As a society, we rely on all three to drive prosperity. But the greatest of these is ideas. In the preface I referred to the wisdom of my Chinese friend who remarked about the western world’s management of money and banking that ‘I don’t think you’ve quite got the hang of it yet.’ I have tried to explain how we can get the hang of it. For many centuries, money and banking were financial alchemy, seen as a source of strength when in fact they were the weak link of a capitalist economy. A long-term programme for the reform of money and banking and the institutions of global economy will be driven only by an intellectual revolution. Much of that will have to be the task of the next generation. But we must not use that as an excuse to postpone reform. It is the young of today who will suffer from the next crisis-and without reform the economic and human costs of that crisis will be bigger than last time. That is why, more than ever, we need the audacity of pessimism. It is our best hope. – The Audacity of Pessimism, Chapter 9. The Audacity of Pessimism: The Prisoner’s Dilemma and The Coming Crisis, p370

Third, the coping strategy the author suggests provides meaningful clues about how individuals, businesses and central banks behave or should behave in uncertainty. I loved two aspects in his proposition of the PFAS. Firstly, the idea as part of central banks’ coping strategy is practical and realisable due to the fact a few countries already are working toward the direction. Secondly, the author’s stance toward banks as part of market economy, who have a duty to bear social cost they impose on society during the crisis, makes it a critical justification for banks to take out compulsory insurance and have sufficient ‘loss-absorbing capacity’. Banks are not an extension of the state since it’s possible only in centrally planned economies as the author states.

Fourth, audacious pessimism. The author never considers capitalism as the utmost panacea but never gives up hope in capitalism either. I strongly agree on his perspective on what capitalism is to us: It is the best way to create wealth. This is what gave him motivation to write this book and to urge collective efforts for solution to restore faith in capitalism.

Equally, there is nothing predetermined about the inevitable triumph of capitalism. Improbable as it seemed after the fall of the Berlin Wall, faith in capitalism has been badly shaken by subsequent events. To restore that belief is both necessary and possible. Capitalism is far from perfect- it is not an answer to problems that require collective solutions, nor does it lead to an equal distribution of income or wealth. But it is the best way to create wealth. It provides incentives for the innovation that drives productivity growth. Only when people are free to pursue, develop and market new ideas will they translate those ideas into increased output. To restore faith in capitalism will require bold action – to raise productivity, rebalance our economies, and reform our system of money and banking. At present, the world’s finance ministers and central bank governors, well intentioned and hardworking, meet regularly and issue communiqués rededicating themselves to achieving the objective of ‘strong, sustainable and balanced growth’. Whatever can be said about the world recovery since the crisis, it has been neither strong, nor sustainable, nor balanced. There seems little political willingness to be bold, and so perhaps we should fear that the size of the ultimate adjustment will just go on getting bigger. But as Winston Churchill remarked in 1932, ‘there is still time … to bring back again the sunshine which has been darkened by clouds of human folly. We can roll back the black cloud of uncertainty and allow the rays of supply-side sunshine to peer through in order to return to a more balanced and sustainable path of economic growth. – The Audacity of Pessimism, Chapter 9. The Audacity of Pessimism: The Prisoner’s Dilemma and The Coming Crisis, p365-6

As Jim Rogers in his book Street Smart also pointed out, the next crisis would involve more severity due to higher debts in financial industry. Through government bail-outs, some failed banks and institutions were not allowed to die under ‘Too Important To Fail’ slogan in the past crisis and we may have to pay bigger price in the next crisis. Do we want to experience it? At the taxpayers’ expense again? Even if the author doesn’t see the next crisis would happen in New York or London, little political willingness to be bold we see today may make us fear that the size of the ultimate adjustment will just be bigger. Now is the time we need to be bold and act collectively and here’s why the author’s idea and voice through this book is very timely.

Lastly, on a separate note and also as a closing remark, I personally want to add one perspective on this book.

It seems lots of discourses are being made about the cause of weak demand we experience today. Klaus Schwab, the founder of World Economic Forum, in his latest book The Fourth Industrial Revolution mentions on current weak demand and low productivity in terms of the Paradox of Productivity in the New Digital Economy. His finding is that we may be in the early stage of digital investment and only time will confirm the exponential rise of productivity in the New Digital Economy. That can add the explanation of the weak demand and seeming recession today. Joshua Ramo, in his book The Seventh Sense, also points out that the cause of disappeared output and demand after the crisis till today stems from the changed economic models on digital economy that can be represented by the Sharing Economy and other factors. These may be off the context the author develops in writing this book, but I believe they will expand our scope in understanding the weak demand in multi-faceted aspects.


If we think the conventional intellectual frame fails to address our economic problems the world face today, and especially if a former central banker raises this question, why not listen to him? Through this thoughtful book, the author provides good perspectives and bold ideas for our collective action to restore our faith in capitalism. However, this book is not about heavy theory building. Neither a memoir by a retired central banker. Rather, this book is about sharing various ideas to better our understanding of the conventional economic models such as financial alchemy, the importance of radical uncertainty, the recessions we experience today, and central banks’ efforts in dealing with crises based on macroeconomic models. I appreciated his deep contemplation on how to understand long history of money and banking that became the weak point in capitalist economy today, how to correctly diagnose the past crises, finding missing links, how and where to improve our perceptions to deal with the coming crisis with a bold audacious pessimism.



Economists, Policy Makers, Leaders in Banking and Financial Services

RATING: 4 out of 5


Business, Finance, Economics


Author(s): Mervyn King

Published: 2016, Great Britain

Publisher: Little, Brown

Paperback, 370 pages

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