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

This is a general impression and overview of the book as my knowledge on economics is rather limited.

“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,” writes Mervyn King in his book The End of Alchemy.  He must know something about it. As Governor of the Bank of England for a decade, and before that a leading academic economist, Mervyn King has long been at the heart of the British policy-making establishment.

We have seen this alchemy when subprime mortgage bonds were given triple A-rating and more recently, when John “Mac” McQuown created a hybrid security, called  eBond, which would embed credit default swaps (CDS) into corporate debt and will be able to transform junk-graded debt into the equivalent of AAA-rated notes. What could possibly go wrong?

Mervyn King says he is not interested in the blame game, which is probably just as well considering that he was governor of the Bank of England at the time of the great crash of 2007-08.

“Blaming Individuals is counterproductive, he says….. A generation of brightest and best were lured into banking, and especially into trading, by the promise of immense financial rewards and by the intellectual challenge of the work that created such rich returns and the crisis was a failure of a system, and the ideas that underpinned it, not of individual policy-makers or bankers, incompetent as greedy though some of them undoubtedly were. There was a general misunderstanding of how the world economy worked.”

Apparently, the “brightest and best” somewhere, somehow, lost their way.

Disequilibrium, radical uncertainty, the prisoner’ s dilemma and trust, are the four concepts that Mervyn King have run through this book in order to explain the nature of financial alchemy and the reasons for the present disequilibrium of the world economy.

Even though the largest banks in the biggest financial centres in the advanced world failed, triggering a worldwide collapse of confidence and the deepest recession since the 1930s, King insists “that nothing much has really changed in terms of the fundamental structure of the Western banking industry”. Just increasing the money supply after a crisis “only perpetuate the underlying disequilibrium.” Without reform of the financial system, another crisis, bigger than the last one, is certain, he adds.

King insists the merging of risk-taking investment banking with retail and commercial banks handling the taxpayer-guaranteed deposits of households and firms altered the business model and culture of banks during the Eighties and Nineties. Rather than breaking up banks retail and investment divisions, he suggests a reform based on the “Chicago Plan” of the 1930s. It is, basically, the IMF’s “Chicago Plan Revisited” by Jaromir Benes and Michael Kumhof, which envisages the separation of the monetary and credit functions of the banking system, by requiring 100% reserves.

In addition, he argues, it is necessary to embark into a major programme of raising productivity. It should be a global effort that would take many years, and will require small and deferent measures in each country, but as long as people believe that there is a coherent plan to boost productivity in the future, then they will have more confidence in willing to spend more today.

It won’t be easy. Faith in capitalism, understandably, has been badly shaken, and will require bold action to restore this faith. “Capitalism is far from perfect – it is not the answer to the problems that require collective solution, nor does it lead to an equal distribution of income or wealth.” But it is the best way to create wealth because 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.

The End of Alchemy is mostly a book about ideas.  A significant attempt to reach not only the economists but also a broader, more general audience.