THE ALCHEMISTS
Inside the Secret World of Central Bankers
Neil Irwin
Headline Business Plus
430 pages; Rs 599
"Not all Germans believe in God, but they all believe in the Bundesbank."
Jacques Delors,
former president, European Commission
The book, a commentary on the recent global financial crisis, consists of four parts: "Rise of the Alchemists (1656-2006)"; "Panic (2007-2008)"; "Aftermath (2009-2010)"; and "The Second Wave (2011-2012)". It concludes with "Afterword: Back to Jackson Hole". The collection of material was a massive effort by the author, a Washington Post staffer, in 27 cities across 11 countries between January 2011 and October 2012.
The section on history makes it possible to understand the anti-inflation sentiment built into the German psyche after the hyper-inflation of the 1920s and, as a contrast, the scare of deflation in the US after the Great Depression. There were occasions when the euro zone was on the verge of dismemberment not only because of PIIGS (renamed GIPSI, to avoid the pejorative expression) but also because the Germans did not easily agree to play ball owing to their ultra-conservative attitude to the creation of money. The moral strength of the German central bank is well captured in the quote at the beginning of this review.
Some of the "secrets" referred to in the title were unknown at the time, some not well known, and some are titbits. At one time, foreign central banks borrowed $580 billion of Federal Reserve money - it was a quarter of the Fed's total assets. Besides, it lent to individual foreign banks that had US subsidiaries amounting to $309 billion at the peak. These facts came to be known after two years under the Freedom of Information Act. It meant that, unintentionally, the US Fed had become the lender of last resort for much of the world. When the Fed's board of governors announced a plan to buy up to $500 billion in mortgage-backed securities guaranteed by government-sponsored enterprises like Fannie Mae and Freddie Mac, it did not realise that it was not within its power. Since it was a form of monetary policy, it had to be decided by the full Federal Open Market Committee. The Committee includes the presidents of reserve banks in the country. In 2010, Mervyn King, governor of the Bank of England, secretly met at his office with George Osborne, the shadow chancellor of the Exchequer, and, David Cameron, future Conservative prime minister, five times to discuss his policy in the context of the ongoing crisis (the Conservatives were in opposition then).
The author acknowledges the "rare clarity" in Raghuram Rajan's presentation at the Jackson Hole Conference of 2005. He "had an astute understanding of the ways in which the financial industry, with misguided compensation policies that encouraged risk taking, was making the world a more dangerous place."
The author has done a comprehensive survey of all the developments during the crisis, including what happened in confidential negotiations to resolve the problems facing the US and Europe.
Here are a few thoughts. In the first place, money matters, as Milton Friedman said. Despite the emphasis on interest rates as a weapon of monetary policy in the post-monetarist world, the West had to resort ultimately to pumping money into the system to resolve its intractable problem due to the liquidity trap. Can we say that it was a triumphal return of monetarism, not necessarily of the Friedmanian variety, though it may be camouflaged under exotic names such as "quantitative easing"? International co-ordination is a sine qua non for dealing with the crisis of even a small country like Greece because of the total integration of the markets around the world and the domino effect. The norms and principles of central banking were thrown overboard with the US Fed resorting to unusual, unorthodox and innovative ways of injecting money into the system, thereby turning central banking on its head on many counts. The European Central Bank played its part in this transformation of central banking by agreeing to the purchase of government bonds in the secondary markets, getting around the prohibition in the Maastricht Treaty of financing the government through created money. The Fed chairman usually flies by a commercial airline. If he were to routinely catch a ride on the treasury secretary's Air Force jet, it could be seen as compromising central bank independence. But he had no compunction about addressing a press conference with the treasury secretary. Unlike in the past, press conferences by central bankers have become the norm now. For the record, in his 19 years as the head of the US Fed, Alan Greenspan never addressed a press conference. The only exception was his participation in a Larry King TV show.
It is also worth noting that Indian government securities are now yielding a much higher return compared to those of some GIPSI countries in their worst hours. Finally, the need for close coordination between monetary policy and fiscal policy has been brought out more than ever by the crisis.
This book, written in a racy and engaging style, is unputdownable - like an Arthur Hailey novel.
The reviewer is an economic consultant and a former officer-in-charge in the department of economic analysis and policy at RBI
