End Of Alchemy

by Mervyn A. King

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Genres: Economics, Finance, Nonfiction, Business, History, Politics, Money

464 pages, Paperback

First published April 11, 2016

About the author

Mervyn Allister King, Baron King of Lothbury, KG GBE FBA was the Governor of the Bank of England and Chairman of its Monetary Policy Committee from 2003 to 2013. He had been Deputy Governor from 1998 to 2003, Chief Economist and Executive Director from 1991, and a non-executive director of the Bank from 1990 to 1991.

King is a Fellow of the British Academy, an Honorary Fellow of King's and St John's Colleges, Cambridge and holds Honorary Degrees from Cambridge, Birmingham, City of London, Edinburgh, London Guildhall (now London Metropolitan University), London School of Economics, Wolverhampton, Worcester and Helsinki Universities. He is a Foreign Honorary Member of the American Academy of Arts and Sciences, sits on the Advisory Council of the London Symphony Orchestra, is a President of Worcestershire County Cricket Club, Honorary President of Ekenäs Cricket Club in Finland, and a Trustee of the National Gallery.

King left his office as the Governor of the Bank of England on 30 June 2013, and was replaced by Mark Carney. He was appointed a life peer by Queen Elizabeth II for 'contributions to public service'. King entered the House of Lords on 22 July 2013 as a crossbencher, taking the title Baron King of Lothbury.

Reviews

[Athan Tolis · Rating 5 out of 5]

Stop what you’re doing, drop everything, buy and read this book. Twice. I’ll start my second reading as soon as I’m done writing down my thoughts.

I’d gladly swap all ten books I’ve read about the crisis (“mine” at ten) for this modest and mischievous masterpiece.

Mervyn King does not go looking for villains or victims here. You will not find the words “greed” or “fear” in this text, nor do you get any history recounted, unless it is to illustrate a point. What you get is an informal, comprehensive, passionate and witty treatise on the origins, purpose and future of money, banking and monetary policy.

And yes, you do also find out what he thinks about the crisis. As a former central banker and protagonist in the crisis, he not only accepts blame for wrongheaded policy at the BOE, he also proposes changes to the banking system that address the problems he identifies with the status quo and will hopefully enhance the system’s stability in the future.

That is, indeed, the bit of the book that gives it its name: the “End of Alchemy” is a proposal to move from a “lender of last resort” model to a “pawnbroker” model of central banking; endorsements of the book by Summers, Volcker and Greenspan testify to its validity. The main idea is all bank assets at all times should be pre-assessed for central bank “haircut” while nerves are calm and heads are cool; second, banks should only ever have current liabilities equal to the “pawned,” post-haircut amounts that could be pre-positioned to raise cash in a crisis. Neat, if insufficient at current levels of liabilities.

Single events (dunno, the failure to bail out Lehman for example) do not merit mention in this narrative. This sets apart “The End of Alchemy” from pretty much every other account of the events. My favorite book about the crisis is Blinder’s, and by a mile. But throughout my reading of that account a question kept coming back to my head that Christopher Hitchens once put in the mouth of Montesquieu: “If a great city or a great state should fall as the result of an apparent accident, then there would be a general reason why it required only an accident to make it fall.” Mervyn King goes looking for that general reason. My view is he does not come back empty-handed.

If you’re looking for a villain, on the other hand, you’ve come to the wrong place. In Mervyn King’s tour de force, even the word “markets” does not get a look-in. Much as there are improvements that he thinks ought to be made to the banking system, much as he does not find it was a tremendous idea to respond to all economic problems by cutting rates (and decries that they remain at emergency levels seven years later), much as he was no big fan of allowing the banks to become “too big to fail, sail or jail,” much as he finds great fault with the sundry “FX” and “LIBOR” scandals, he argues very persuasively that the financial crisis was nothing but a symptom of political crisis. If we do not change our politics, he claims, if we do not address the microeconomics (as opposed to the macro), we will find ourselves in crisis very soon again in the future.

His “pawnbroker” model of central banking would by itself be a valuable contribution, but it would be inconsistent for him to say our problem is political and leave things there. The problem, he believes, lies in our societies’ and our governments' collective willingness to accept uneven growth if the alternative is no growth at all. China has been happy to allow consumption to languish at a minuscule level and has emphasized growth through investment and exports. It was about to countenance a rebalancing, but when that threatened growth itself, the engines were quickly reversed and stimulus was redoubled on the old investment and export axis. The US knows that interest rates at zero only allow those to benefit who are set up to borrow at that rate (he does not name the private equity owners and the CEOs of the S&P 500, but you know he means them) but if inequality is the price of growth, it’s happy to take it. And he puts up his hand and admits that under Eddie George the BOE where he was the Chief Economist was prepared to endorse a “two speed economy” over a “no speed economy.”

The result is the winners in this game of uneven growth end up saving their winnings. In doing so, they accumulate “assets” backed by the future sweat of those who fail to grow as fast, the losers. And if you don’t stop, the “assets” become “permanent transfers,” unless by some miracle the losers in this game of growth find a way to grow as well. Like Micawber, the strategy it to wait for something to come up and the slow growers to discover a growth model. It has not worked out. Neither the Greek government nor your average subprime borrower will pay in full, but our model is to carry on as if they will. Upheaval ensues.

Our desperate efforts to subsequently stimulate growth at all costs get poor returns, he adds. QE, for example amounts to exchanging cash for assets. But at the point where 10yr rates are zero, you are merely exchanging cash for cash. You are no longer adding liquidity. Not only that, but you are suspending the market economy in the price of money. You are suspending capitalism itself if the government gets to set the price of one of the most important inputs, money.

The sundry solutions we read about in the newspaper he also thinks are past their sell-by date and he goes debunking them one by one. He starts by rejecting the 4% inflation target. Quite simply, the moment you hit it, you’ll go straight back down to 2%. The policy has zero credibility.

He gives short shrift to the “negative natural interest rates” that are part and parcel of the Larry Summers / Paul Krugman “secular stagnation” mantra by in essence saying “yes, you can go tweak by a few basis points and set a negative administered rate to match this “natural” rate, but what if you cause a radical uncertainty shock from people observing the government is raiding their bank accounts?” Yes, some might do the rational thing and move the spending from the future to the present. But some might just panic and batten down the hatches, Greek style, in anticipation of the next way the government will raid the piggy bank. Why take the risk?

In summary, he believes we have hit a new limit:

The “paradox of policy” is that you cannot overuse any type of macroeconomic policy. Same way if we all save we end up hurting the economy via the “paradox of thrift,” same way the rational expectations critique says that you cannot tax and spend your way to prosperity if you cannot point to direct benefits of yours spending because people understand what you're doing (and here he does concede that in the US for example it would not be a disaster to fix the odd airport), you also need to understand that all policies need to have a beginning and an end. Zero rates forever is especially silly for the non-US countries in particular, as it amounts to a permanent currency war. It is but another “prisoners’ dilemma” problem whereby we could all agree to stop debasing our own currency to steal growth from abroad, but probably never will. And in messing with our rates and currencies we get in the way of markets.

A glancing look at the most recently fashionable “helicopter drop” proposals also comes back with the same result.

In Mervyn King’s view, the way forward is to work on the only bit of growth that matters, which is productivity growth. He’s read all the books about how we’ve picked the low-hanging fruit, but he’s agnostic about it. What if some of the miracle developments pan out in biotech or nanotech or whatever. You never know. More importantly, you’ve got no choice. The adult response to crisis is to re-focus all our economies toward growth by going through the detail work of eliminating each economy’s idiosyncratic inefficiencies and artificial rigidities.

He thus proposes three important changes to the politics: First, he argues that structural changes to ossified economies are not issues to be tackled in the future, after we have fixed the macroeconomy. The time to tackle historically entrenched monopolies and historically built-in rentseeking, to tackle distortions in the tax code that affect the balance between spending and saving, or favor the public sector over the private sector, for example, is now.

Second, he comes out batting for free trade.

And third, for the abolition of fixed exchange-rate regimes (for example, the EUR).

The reviews I read in the press made this third point their main focus, of course. That is a crying shame, because it sells the book short. As far as I’m concerned, “The End of Alchemy” enters the charts at #1.

Broad, irreverent, groundbreaking and wise, this is the treatise that should finally replace Bagehot under every central banker’s pillow.

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SPOILER ALERT, next comes my summary of his main points, it's NOT my review

He starts by posing the question outright: What’s money good for? Mervyn King’s answer:

First of all, you need money to get “stuff” now. That’s what we all want money for.

This gives rise to the need for money to be acceptable by all as a means of exchange, or else you won’t get your “stuff.” In turn, this means that the concept of “private money” issued by private banks has historically always faded away. Once upon a time every bank in the US could issue its own money. While the economics of this practice was sound (the free market did indeed provide an appropriate discount for every bank’s “dollars” versus the best banks’ “dollars”) the practice was rather uneconomic, as every American needed access to a cheatsheet telling him what his private dollars were worth and where. The need for money to be an easy way to facilitate exchange eventually led to one type of dollar / pound / kroner dominating, the one issued by the most important bank in the realm. In many countries, this bank eventually became the “central” bank, though in other countries the central bank was created, but always modelled on the precedent from the countries where the model originated, namely as a bank.

Second, you need money to avoid having to make up your mind now about what “stuff” you want to get later, with two factors making this necessary: 1. (Incomplete markets) there might not be a “market” for you to secure flexible tickets to your kid’s college graduation in three years’ time; 2. (Uncertainty) what if you hit the jackpot and in three years’ time you might want to take the whole clan by chauffeured limousine? Money can act as a store of value for you and allow you to make that decision later, when you know your circumstances (resolving the uncertainty) and somebody can sell you a ticket (the market for the relevant tickets finally exists).

This second use of money gives rise to the additional need for the money to be acceptable under all circumstances, good and bad. To actually provide cover in uncertainty, it needs to be “money good” in all future imaginable scenaria.

Third, you need money to put a price on things. Only in prisoners’ camps would you care to use packets of Marlboro as a unit of account. To fulfill this third purpose, money needs to have a stable price, of course, and this comfortably segues into Mervyn King’s discussion of inflation and why we need to keep it in check and how we lost control in the seventies due to “paradox of policy,” his symmetrical rebuttal of the “paradox of thrift,” and a much cooler way to say (among other uses of this pithy aphorism) that there is no such thing as a long-run Philips curve.

This looks a lot like the traditional answer to the question, but a seed is already planted: in the world of “radical uncertainty” we actually inhabit, where many outcomes are possible (you could win the lottery and buy yourself a jet to fly your family to the graduation or you could go bust and pull your kid out of school and be grateful for any savings you had scrounged) money is more valuable than in a world of more measurable uncertainty where you can put a probability on all outcomes: in some states of the world, money is the ultimate necessity.

The economic models we use (and, more significantly, the economic models central banks use) have no use for money, because they do not account for radical uncertainty. They work under the assumption that you can plan for that graduation now. In reality, Mervyn King explains, when crisis strikes, a need for money arises that normally is not there and is thus nowhere to be found in our models.

Next, he asks, what is it that makes something “money?”

The loser-type answer to the question is that something is money if all economic agents believe it to be money. Others say money needs to be scarce. Others that it must be based on something real and tangible, like for example gold.

Mervyn King shoots down the first answer as a tautology (“OK, cool,” he’d say in my dialect of English, “but what is it that makes the economic agents believe?”) and has some fun debunking gold (metallic, tangible, but ultimately “barbarous” and unsuitable as a basis for our economy, read the book if you want to get the whole story), and Bitcoin (what’s to stop a million people from creating a million strands of otherwise very scarce cryptocurrency) and focuses on the main driver of what makes money, erm, money: Power.

He offers proof by example: In Iraq there were two monies between the 1993 and the 2003 invasion: Saddam-sanctioned money used in the South and the older “Swiss” notes used in the northern no-fly zone Saddam was kept out of. The northern “Swiss” notes were pure paper. You could not use them to pay tax anywhere, there was no central bank supporting them anywhere, they were legal tender for nothing. Yet people used them for a full decade, in expectation of the fact that the West would at some point invade again and restore their status. It was the expected imposition of foreign political power that lent value to these notes, and it was even vindicated when Paul Bremer exchanged them for dollars after the 2003 invasion.

Politics is very much what makes the EUR “money” in Mervyn King’s view. On p. 227 he notes that Draghi’s “whatever it takes” impromptu speech from July 26, 2012 may well have “reverberated around the world, but just as important was the joint statement made the following day by Chancellor Merkel and President Hollande, indicating their full commitment to the Euro and support for Draghi’s intention. It was clear the ECB would buy, or was actively considering buying, Spanish and Italian government debt.”

By that as means of introduction, we arrive at the main issue that lends its title to the book: Who makes money? What is the chemistry involved?

Answer: Money may require political support to actually be “money good,” but it continues to be made privately, exactly as it would have been made in pre-Fed America. Most money that exists in the world (all of M1, M2, M3 etc. a fair bit more than 90% of all money in the world, basically) arises in the very private act whereby you walk in the bank, ask for a loan, the bank looks at your credentials and (poof!) an account is opened for you and the money you asked for is sitting in there as a deposit. Your deposit!

Out of thin air, the bank has decided that it has a liability to you, namely the amount that is now sitting in your account. At the same time, it also holds an asset: the fact that you need to pay that money back (with interest) at some time in the future. That is how most money on earth is born, basically. Privately. The government imposes some rules on the bank, and will stand behind the currency you and the banker have just created, but it does not sit there in the room with you and your bank manager.

And then you can go buy a taxi, for example. The bank’s liability moves from your bank account to that of the Mercedes Benz dealer, and the bank’s asset remains your promise to pay back the loan one day. If the car can be offered as collateral for the loan, chances are you get a much better rate. If it’s a piece of real estate you financed, even better. The dealer now has money that did not exist before you walked into the bank for that interview. And you owe the bank some money you did not owe before either. The cash that’s sitting in the dealer’s account is freshly-made money.

Next, suppose word gets out that your bank really does not know what it’s doing. All sorts of customers, like your friendly Merc dealer, get in line to pull their money out. What next?

Regardless of whether this perception is true or not, the bank has a problem. It cannot call you and ask for your money back now. You can very legitimately point to the terms of your loan and say “call me in three years’ time.” It will be keeping some precautionary cash to one side, but if every single depositor turns up, the last few will be gravely disappointed.

This is where central banks step in.

What it will do is

1. Go through the bank’s books to see if the rumor is correct that the bank made bad loans in excess of the value of the shareholders’ equity
2. If the rumor is false, it will lend the bank all the money it needs to pay off the worried depositors
3. If the rumor is correct, on the other hand, the central bank will
(i) explain to equity holders in the bank that they no longer own shares in the bank
(ii) explain to all bond holders in the bank that they may suffer partial or total loss
(iii) move all the good loans of your bank’s to a healthy bank, adding to its assets
(iv) move deposits equal to the above amount to the same healthy bank, adding to its liabilities
(v) if the excess of deposits over good loans is more than the bonds outstanding wipe out all bondholders and the necessary amount of deposits
(vi) otherwise pay to bond holders the difference between the value of the bonds and the excess of deposits over good loans
These are two very different outcomes. In the first case the bank faces a liquidity issue and the central bank will step in and stand behind it. In the second case the bank has a solvency issue: it is insolvent / bankrupt / choose your favorite word.

Which brings us to the nexus of the problem. The manual for central bankers says that when faced with a liquidity crisis, a central bank must actively go in, accept the assets of the solvent banks on its own balance sheet and lend against those assets the necessary money to the bank to pay all its depositors. Moreover, it must do so at a very expensive price (a high interest rate), to make sure banks think twice about having to rely on this backstop.

So your car loan will spend some time on the central bank’s books until the crisis has gone away. Meanwhile, your bank will be given some (very expensive) liquidity. That is, in short, the “Lender of Last Resort” model of central banking.

Two things happened in finance, one in the run-up to the crisis and one during the crisis that made it impossible to implement this model:

The first, Mervyn King sees as an example of “prisoners’ dilemma.” Banks knew that the assets they were accumulating were increasingly poor. But any bank that was not willing to carry on playing the game (“dancing” in the words of Citigroup CEO Chuck Prince) was at risk of not only falling behind its competitors, it was at risk of getting bought by a competitor. The option to remain prudent was simply not available to any self-respecting banking CEO. “While the music’s playing, you’ve got to get up and dance.”

OOOOPS, I'M OUT OF SPACE, BUT IT'S ON AMAZON

[Domhnall · Rating 5 out of 5]

‘For centuries alchemy has been the basis of our system of money and banking. Governments pretended that paper money could be turned into gold even when there was more of the former than the latter. Banks pretended that short term riskless deposits could be used to finance long term risky investments. In both, cases the alchemy is the apparent transformation of risk into safety. … For a society to base its financial system on alchemy is a poor advertisement for its rationality. The key to ending the alchemy is to ensure that the risks involved in money and banking are correctly identified and borne by those who enjoy the benefits from our financial system.’ [pp250,251]

‘Four concepts 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: disequilibrium, radical uncertainty, the prisoner’s dilemma and trust. It is hard to think about money and banking and their role in the economy, except in these terms.’ [p367]

Mervyn King seems to enjoy quoting Horace Walpole saying ‘the world is a comedy to those who think, a tragedy to those who feel.’ [p369] Once we appreciate that King belongs to the former category, we can appreciate his thoughtful book for the valuable insights it does contain and tolerate – though with difficulty in my case - the lack of feeling which makes him so relaxed about the unfolding tragedy it describes so clinically.

He was Governor of the Bank of England in the dreadful years of the financial crisis and as such can offer a privileged insight into matters of banking and economic management at the very highest level but there is a danger in feeling excessive deference. When the book slows down to provide readers with a basic introduction to the theory of money, banking and global economics, the fear is not that we are being patronised (it is always helpful to go over the fundamentals) but that we are being nudged towards a particular way of thinking. While one can hardly challenge King on his areas of expertise, one does have to be aware of the topics he does not focus on and does not expose to scrutiny. He is not only explaining the financial crisis but also framing it, inviting us to see it as a technocratic challenge for which the solutions lie in the expertise of our central bankers, beyond the grasp of ordinary mortals. His is a world of economic mistakes, not economic crimes. It is a world millions of light years apart from (say) Ship of Fools: How Stupidity and Corruption Sank the Celtic Tiger by Fintan O'Toole or perhaps Treasure Islands: Uncovering the Damage of Offshore Banking and Tax Havens by Nicholas Shaxson.

We have to respect King’s position among the key decision makers of the global economy and he gives the sense that, from practical experience, he is impatient with classical economists and so, it seems, are his colleagues. He writes for example: ‘Bob Bernanke, then Chairman of the Federal Reserve, said in January 2014, that ‘the problem with QE is that it works in practice, but it doesn’t work in theory’. Perhaps there was a problem with the theory.’ [p183] He mocks winners of the Nobel Prize for Economic Science in a way that suggests he is not expecting to win in the near future. For instance: ‘In 1998, the hedge fund Long Term Capital Management (LTCM) failed, although its senior management team comprised two Nobel Laureates in Economic Science, Myron Scholes and Robert Merton, and an experienced practitioner in financial markets, John Meriwether. ...The choice of assets was based on sophisticated statistical analysis of high frequency date over a decade or more. But ...when a rare but significant event occurred – the Russian default and devaluation of 1998 – past correlations proved a poor guide to asset returns….At the heart of modern macroeconomics is the same illusion that uncertainty can be confined to the mathematical manipulation of known probabilities. To understand and weather booms and slumps requires a different approach to thinking about uncertainty.’ [p121]

Another example was the alleged resolution of the search for Adam Smith’s “Invisible Hand” which to my own mind recalls Douglas Adams’ Restaurant at the End of the Universe: ‘Then, in the early 1950s, two economists , Lenneth Arrow and Gerard Debreu, both working in America, finally produced a rigorous explanation for the invisible hand (for which they were subsequently awarded the Nobel Prize). They imagined a hypothetical grand auction held at the beginning of time in which bids are made for every possible good and service that people might want to buy at all future dates. … Because the auction at the beginning of time has done its job, no market needs to reopen in the future. ... Central to the Arrow-Debreu view of the world is a special way of dealing with uncertainty about the future. ... In other words, radical uncertainty is ruled out by assumption. Obviously there are many ways in which the world is very far removed from this abstract description, apart from the obvious impracticability of organising the grand auction. Two are of particular importance – the need for institutions to police a market economy and the nature of uncertainty.’ [pp79/80]

As a banker, King seems especially annoyed at the failure of classical economics to appreciate the importance of money and the sterling labours of a central banker like himself. In discussing the Arrow-Debreu grand auction he writes ‘… There is no need for money to act either as a medium of exchange (the ‘double coincidence of wants’ problem is circumvented by the auction), a store of value (there is no requirement for a reserve of savings), or indeed an absolute standard of value (consumers bidding in the auction need only know the relative prices of different goods and services, including labour). Money has no place in an economy with a grand auction. ...’ [p79] Elsewhere he moans: ‘It is ironic... that economists who believe that money matters (for example, Milton Friedman) argue that ‘the demand for money is highly stable’, whereas Keynesian economists argue that money does not matter because demand is unstable. Both groups are wrong – money really matters when there are large and unpredictable jumps in the demand for it.’ [p182] This of course is where our caped crusader comes in.

What King complains about in classical economics is – or includes – the delusion that there can be a well defined, rational explanation for economic behaviour which, once properly understood, permits prediction and hence effective economic management. He contrasts this unduly rationalist model with an irrational one: ‘The main challenge to the economists’ assumption of optimising behaviour comes from ‘behavioural economics, a relatively new field associated with Daniel Kahneman, Richard Thaler and Amos Tversky. It studies the emotional and psychological dimensions of economic choices. … Daniel Kahneman suggested that decisions are made by two different systems in the mind: one fast and intuitive, the other slower, deliberate and closer to optimising behaviour. In this way he was able to explain aspects of behaviour that appear anomalous in the traditional approach.’ [p132] But King is not impressed by this perspective and writes ‘But simply patching up the optimising model by making the decision process more complicated – adding an intuitive to a rational self – in order to explain particular observed anomalies does not mean that it is likely to perform better in explaining future behaviour. … A complicated explanation of the past makes it no more likely that we can predict the stock market over the coming year than simply tossing a coin.’ [p132-133] He is clearly right to say that one cannot deploy Kahneman as a technical fix to repair the classical model of the rational market, but he is wrong to equate “irrational’ with ‘stupid’ as he does. Indeed, he cites evidence that, in practice, many financial decisions are based on emotion and not pure reason. Kahneman did not say we are stupid but that in practice it is not possible to make decisions in a deliberative, rational manner and we need other strategies. These may lead us to make characteristic types of mistake for which we may find some protection when we understand them better, but those mistakes are often a fair trade off in order to enable us to make decisions at all and not be paralysed.

This matters because King continues to argue: ‘… we need an alternative to both optimising behaviour and behavioural economics. What does it mean to be rational in a world of radical uncertainty? Once we are liberated from the view that there is a single optimising solution, rules of thumb – technically known as heuristics – are better seen as rational ways to cope with an unknowable future. … Ignoring information is rational when it is likely to be of little help in solving the problems we confront – sometimes less is more. Heuristics are not deviations from the true optimal solution but essential parts of a toolkit to cope with the unknown.’ [p134] He is certainly right but this is more or less what Kahneman was saying in his classic book, Thinking Fast and Slow. Actually, it is also a variant of what is argued in another book that is not mentioned: Fuzzy Logic: The Revolutionary Computer Technology That Is Changing Our World by Daniel McNeill, Paul Freiberger. King really does need to join up with Goodreads. The essence of fuzzy logic is that instead of a rational plan dealing with all eventualities, which will almost always turn out to be problematic, decision making is a process that continues across time, continually adjusting to meet changing conditions.

‘A coping strategy comprises three elements - a categorization of problems into those that are amenable to optimising behaviour and those that are not; a set of rules of thumb, or heuristics, to deal with the latter class of problems; and a narrative. … [135] .. The narrative is a story that integrates the most important pieces of information in order to provide a basis for choosing the heuristic and the motive for a decision.’ [136] For example, Dennis Wetherstone, CEO of JP Morgan, made it a rule that if he could not understand a new financial product after three, 15 minute presentations, then the firm refused to sell it.

‘Delegating monetary policy to an independent central bank with an inflation target is a coping strategy. Its clarity and simplicity mean that the target provides a natural heuristic for central banks and the private sector. … The great attraction of an inflation target is that it is a framework that does not have to be changed each time we learn something new about how the economy behaves. [p170]

King provides a positive account of the achievements of banking in general, and central banks in particular, with the implication that, of course, we need to continue learning from experience and improving over time. He offers possible modifications to the way Central Banks regulate money and finance which will certainly have a keen audience and may even save the world – who knows? However, mistakes are unavoidable and King explores a range of different financial crises over several centuries from which he observes: ‘Each crisis has its own distinctive pattern. No two are the same.’ [p307] He also remarks that it is a general rule that each country learns only from its own crises – which leads to the wrong solutions offered for the wrong crises. He makes an especially important distinction between financial crises arising from lack of liquidity – a type of problem for which central banks have excellent solutions – and those arising from structural problems that are unsustainable - which require political and economic solutions that may be at odds with the first. The latter danger arises when a financial crisis which requires economic adjustment is held at bay by throwing more money into the ring, not only deferring the necessary adjustment but also allowing the structural problems to escalate.

On this basis, King looks at the financial crisis of 2007/8 and suggests that the immediate crisis, in which central banks supplied the liquidity necessary to prevent economic catastrophe, masked a major, structural defect in the global economy which is not yet getting the attention it requires and for which different solutions are essential. This can be simplistically stated – China and Germany have economies which export too much and consume too little, leading to massive savings that are invested in other countries which save too little and consume too much. This structural disequilibrium is not sustainable and a correction will have to take place one way or another. For example, he writes: ‘ Unless it finds a way to allow its real exchange rate to appreciate – by leaving the euro area or somehow engineering a much higher rate of wage inflation than in other parts of the euro area – Germany will find that continuing trade surpluses mean that it is accumulating more and more claims on other countries, with the risk that those claims turn out to be little more than worthless paper. That is already true of some of the claims of the euro area as a whole on Greece. Both China and Germany are discovering that being a country in surplus is a mixed blessing in a world that is on an unsustainable trajectory.’ [p364]

King is thus able to point a very striking finger at governments that argue to their own electorate that their responsible management of the local / national economy is being put at risk by the crazy policies of Johnny Foreigner. ‘The weakness of demand across the world means that many, if not most countries can credibly say that if only the rest of the world were growing normally then they would be in reasonable shape. But since it isn’t, they aren’t.’ [p347,8] This is one reason why King puts a lot of weight on the Prisoners Dilemma in his book. He argues that there are no national solutions and only international ones, which governments are sadly unwilling to entertain. Instead, they are pursuing economic policies that put off the day of reckoning to beyond the next election but which will inevitably alienate and enrage their electorates, who are turning – he feels as a direct consequence – to fringe political parties out of disillusion with the mainstream political elites.

If governments are unwilling to make the key economic choices, one possible remedy might be to delegate economic management to central banks and rely on their technocratic expertise to sail the ship. In fact, King seems to believe this is entirely wrong and politically irresponsible and dangerous. Central banks have a valuable role to play but so does democracy and accountable government. For example, writing of the European Central Bank [ECB] and the euro, he says this:

‘...The ECB has had to choose between allowing the euro to fail and becoming a politicised institution. Naturally it chose the latter. In years to come that may return to haunt the bank if there are attacks on its independence for straying into political territory.’ [p231]

‘… in the euro the fight for survival has become a battle between politicians and arithmetic. Although the future outcome is unknowable, history is on the side of arithmetic. 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. It is at the heart of the disequilibrium in the world today.’ [p248]

On the broader economy, if King’s recommended policy measures are the correct ones and the only available ones, then there is no good news for the political Left, although there is not a lot of comfort either for the political Right. That makes it all the more helpful that he is so clear about the importance of the political process and democratic accountability in the decisions that need to be taken. If we adopt his concept of a coping strategy, which I feel is excellent and non ideological, then we could potentially agree with his strategic goals – to resolve the unsustainable disequilibrium in the global economy and to ensure that the risks involved in money and banking are correctly identified and borne by those who enjoy the benefits from our financial system– while offering alternative ways of arriving at a more sustainable vision for the future, something less like a plutocracy and less environmentally destructive. It is always best to be wary of writers who claim to think more than they feel.

[Mehrsa · Rating 4 out of 5]

King could not have had better view of the banking sector for the past several decades and if you haven't read an analysis of the crisis, this would be the one to read. It's not just that though. He also covers the basics of money, banking, and central banking. The premise is that though we seem to know capitalism well, we don't quite understand money and banking. In fact, the field of economics has stopped talking about it altogether. King wades in as a clear thinking guide. It will likely take us many years to figure out what went wrong in 2008 and what the crisis revealed about the flaws in the system and what to do about it. As we do that, I hope more people come out with books like this. I am glad he didn't write another "This is how I saved the world" book, but instead focuses on how he can use his inside perspective to design a better system. Part of his better system is getting rid of Beghot's Lender of Last Resort dogma and requiring banks to put up collateral before the emergency and turning the Fed into a pawn broker for all seasons. This is the only way to reduce the alchemy in the system

[Vishal Kale · Rating 2 out of 5]

For starters, this is a book for westerners, written by a westerner, and on a western topic. This is exclusively a Western / Developed Economy book only. While the pluses are distributed throughout – as in a brilliant paragraph on Page 360; the fact remains that the arguments presented in the latter half of the book do not make any sort of sense. I am sorry, I know he is a highly adept expert, but there is no other way to phrase this..The solutions are half-baked, not thought through, and error ridden. For example, on Page 353, he argues with ending Veto power of the IMF biggies, and reinforce its reforms, calling this a reform! This wont work, as we all are aware of American arm-twisting dependent countries, ensuring voting in their favour without using Veto.

On Page 361 he advocates Western countries push liberalization in trade of services; this without taking into account the EMs internal realities; you cannot just open up an Economy just coz Governor of the Bank of England says so! And you further should not issue blanket recommendations without a proper analysis of both sides. On page 263 while assessing a sample reform plan, the author implies that wide banks lending, financed by equity would eliminate alchemy [my take – possible], removing risk of bank Worst of all, the reform plan he proposes – ex Pg 360 – is Brilliant, but… hampered by a pro-west, one-sided anaemic look and incomplete analysis of its import. Further, its complete miss on all real-world and real economy factors – like crony capitalism. Vested interests, demand and supply scenarios, comparative competiveness on a national scale, available resources, PCI, Poverty, rampant illegalities, inequality in real terms from an eastern POV, make this entire book a pie in a biased western sky book.

Read full review : https://reflectionsvvk.blogspot.com/2...

[Marks54 · Rating 4 out of 5]

Somebody wise once advised me to read books in clusters that were somewhat but not completely related. Given the proliferation of books about the financial shocks of 2007-2008 and following years, that seemed like good advice and that is why I have read this in conjunction with Stiglitz's book on the Euro. Both are excellent and well written books that do a wonderful of communicating some complex issues and convoluted fact patterns.

King is the former head of the Bank of England and addresses the vast array of problems associated with the crisis in terms of banking - especially central banking. This is not to minimize the role of political, technological, and other economic matters but more because that banking, while having a central role in the crisis, is the medium through which all the other crisis areas interact as policy makers seek to cope. The intuition is laid out at the beginning as an observation from a Chinese official that the west has figured out how capitalism works but still has issues coming to grips with problems of banking and finance. By "alchemy", King is referring to many of the central function of banking that rely on stable expectations and routines but that lead to chaos in times of "radical uncertainty" and significant instability. For example, banks lend out their deposits for longer term uses, so that if depositors all wanted their money back at once, it would not be there and the bank would fail. But most of the time, depositors don't want their money all at once, so there is no issue. Deposits can be lent to riskier purposes to increase returns and there is little worry, since depositors will not want their money all at once - until they do. Another example of this comes from the subprime crisis - bankers did not really worry about the capacity of borrowers to pay their mortgages, since in the event of a default the house could just be sold and the value applied to the load. ...and since mortgage customers are diversified, the losses from one default would be offset by the gains from the many more who repaid -- until they were not, since large number of subprime mortgages all failed at around the same time. Alchemy refers to banking practices developed in stable times to provide a return for bankers that lead to ruin with global bank consolidation and financial instruments premised on extremely rational parties who ended up not acting rationally. This gets developed in detail in the book and is well worth the effort to follow.

King is skillful at linking together the various strands of the overall financial crises. He does a good job linking the fall of Communism after 1989 to the rise of China and the influx of excess money into the financial system looking for high returns. He also ties in problems with the Eurozone, the US subprime and banking crises, the reduced productivity that seems to be further limiting growth worldwide, and the changing politics of nations and international organizations that are trying to address all the problems at once. A key claim he makes is that all of these factors combine in the context of "radical uncertainty" (following Knight's distinction of uncertainty versus risk) to produce a world where fundamental institutions need to be changed if future crises are to be avoided or at least mitigated.

The trouble is that King is convincing about the scary complexity of all of these balls being in the air at once, leading to the question of how fundamental institutional reform will occur when the major players have enough trouble just badly "muddling through" the mess. King seems to come to this conclusion at the end, where he hopes that the direness of failing to reform should scare policy makers into making hard choices (good luck with that). King makes a provocative link between developments in the recent crises and the trajectory globally following the Great Depression of the 1930s. History does not repeat itself, but the similarities are troubling.

My only major issue with the book is that in a volume like this, it is an accomplishment to get all the issues clear out on view. To tie everything together will take more detail - and more books. I hope King is up to the task and I look forward to his observations on how matters develop. This is one of the more stimulating books available on the global crisis anywhere.

[Diego · Rating 5 out of 5]

Mervyn King has the experience to back up his theories regarding the cause for the global recession and potential solutions for the future success in global banking. Being the former governor for the Bank of England, he has a view that is lacking from most books on banking. Most books focus on the issue in Wall Street only, but the issue and impact is worldwide. He discusses the problems in the European Union with a common currency and other members’ debt. Sounds as though much of their issue is lack of communication on the purpose of the union of countries. Very political.
But what makes this book a five star is that he has the experience to provide logical solutions. Some books are written by cocky professors whom lack extensive global experience and provide their theories and no real solutions to provide, and if they do, it’s more U.S. focused. Likely from fear of being rejected by their community. Weak sauce.
But I agree with him that while capitalism is not at all perfect and can allow for income inequality, it does create wealth to provide innovation that drives productivity growth. I however believe that capitalism should be government regulated to prevent corporations from perverting and taking advantage of tax reform. Simply opening the flood gates to corporations is too much of an assumption that companies have the greater good in mind, or even their long term success in mind. Greed rules. Capitalism can work for the greater good, if regulated. Not at all easy. This book is a good source to understand current global banking. The audacity of pessimism is a start to understand change.

[Skylar · Rating 3 out of 5]

Mr. King clearly knows what he's talking about on monetary policy and bank regulation, but his public and fiscal policy recommendations detract from that knowledge. He dismisses the utility of government stimulus in the Great Recession, ignoring the fact that the US stimulus should have been much bigger, and could have been much more punitive on the banks. He also places too much faith in the IMF for dealing with crises in the developing countries, ignoring completely the IMF's role in causing those crises through their draconian austerity requirements.

[Tuncer Şengöz · Rating 5 out of 5]

One of the best books on money, banking system, economic crises, and central banks, I have read recently. It took only one week to finish the book, though I read some paragraphs twice to grasp the idea. Yet this book is worth reading twice.

[Pedro L. Fragoso · Rating 5 out of 5]

I’ve been a frequent reader of books about our current financial predicament, which entered into high gear in 2007/8. Prof. Michael Hudson’s “Killing the Host” was and still is the best of the lot, but the books by James Rickards and Varoufakis’ “And the Weak Suffer What They Must?: Europe's Crisis and America's Economic Future” were also particularly remarkable. There were a number of others (and more in the reading list, even if right now my priority is travelling to the moon and accompany the travails and adventures of the remaining elements of the Corta family). I’m stating this to give a punch line and here it goes: “The End of Alchemy”, by a ultimate insider, the former governor of the Bank of England from 2000 to 2013, is among the very best and definitely, for anyone interested in understanding the fundamentals of our present and the winding roads of our immediate futures, required reading.

In The Economist’s March 10, 2016 review of the book it is stated that Mervyn King “does a good job of putting complex concepts into plain English. The discussion of the evolution of money—from Roman times to 19th-century America to today—is a useful introduction for those not quite sure what currency really is. He explains why economies need central banks: at best, they are independent managers of the money supply and rein in the banking system. Central bankers like giving the impression that they have played such roles since time immemorial, but as Lord King points out the reality is otherwise. The Fed was created only in 1913; believe it or not, until 1994 it would not reveal to the public its interest-rate decisions until weeks after the event. Even the Bank of England, founded in 1694, got the exclusive right to print banknotes (in England and Wales) only in 1844.”

This is indeed one of the most fabulous aspects of the book, the nonchalant way complex concepts are competently explained in simple, understandable phrases. As in: “The prisoner’s dilemma may be defined as the difficulty of achieving the best outcome when there are obstacles to cooperation. Imagine two prisoners who have been arrested and kept apart from each other. Both are offered the same deal: if they agree to incriminate the other they will receive a light sentence, but if they refuse to do so they will receive a severe sentence if the other incriminates them. If neither incriminates the other, then both are acquitted. Clearly, the best outcome is for both to remain silent. But if they cannot cooperate the choice is more difficult. The only way to guarantee the avoidance of a severe sentence is to incriminate the other. And if both do so, the outcome is that both receive a light sentence. But this non-cooperative outcome is inferior to the cooperative outcome. The difficulty of cooperating with each other creates a prisoner’s dilemma.” Or: “Over the past twenty years, a wide range of new and complex financial instruments has emerged, expanding dramatically the scale of financial markets. These new instruments are elaborate combinations of the more traditional debt, equity and insurance contracts, and as such they are known as ‘derivative’ instruments. They package streams of future returns on a wide variety of investments, ranging from housing to foreign exchange. They are claims on returns generated by the underlying basic financial contracts and play a valuable role of filling in gaps in markets, offering new ways both to hedge risks and speculate on future price movements of the underlying contracts, such as stock prices." (…) “Examples of derivative instruments include forward and futures contracts (the purchase of a commodity to be delivered at a future date), options (the right to buy, or sell, a basic contract such as a stock at a given price on or before a given date), and swaps (where two parties exchange a stream of cash flows in different currencies or for different profiles of interest payments to hedge their other exposures). Many of these instruments have real practical value. For example, the Wimbledon tennis championships receives payments in dollars for broadcast rights in the United States. But almost all the costs of running the tournament are in pounds sterling, which creates a risk from unknown future movements in the pound–dollar exchange rate. That risk can be reduced, at a price, by contracting today to sell dollars for pounds at a specific date in the future and at a particular exchange rate. Many, if not most, companies benefit from similar transactions.” (…) “These included credit default swaps (CDS, where the seller agrees to compensate the buyer in the event of default of some named party), mortgage-backed securities (MBS, a claim on the payments made on a bundle of many hundreds of mortgages, sold to the market by the originator of the mortgages, often a bank), and collateralised debt obligations (CDO, a claim on the cash flows from a set of bonds or other assets that is divided into tranches so that the lower tranches absorb losses first and the higher last, with investors able to choose in which tranches to invest).” And, to the point, “Derivatives also allowed a stream of expected future profits, which might or might not be realised, to be capitalised into current values and show up in trading profits, so permitting large bonuses to be paid today out of a highly uncertain future prospect.”

This alone makes this the go-to book to start any reading list on the subject. Not only do we get an unsurpassable contextualization of the crisis, we also get clear elucidations, instead of obfuscations, of all the relevant concepts at play to fully understand what’s actually going on. I find this an amazing, almost unbelievable achievement.

Then, we have quotes, anecdotes and little stories that are as delightful as they are relevant, delivered in elegant writing. This is when deep admiration for the intelectual prowess we are witnessing becomes unmitigated awe. I mean details such as: “It is rather like watching two old men playing chess in the sun for a bet of $10, as one can in Washington Square in New York, and then realising that they are watched by a crowd of bankers who are taking bets on the result to the tune of millions of dollars. The scope for introducing risk into the system rather than sharing it around is obvious. And that is why Warren Buffett described derivatives as ‘financial weapons of mass destruction’.” Or: “Charles Dickens’ novel A Tale of Two Cities has not only a very famous opening sentence but an equally famous closing sentence. As Sydney Carton sacrifices himself to the guillotine in the place of another, he reflects: ‘It is a far, far better thing that I do, than I have ever done …’ If we can find a way to end the alchemy of the system of money and banking we have inherited then, at least in the sphere of economics, it will indeed be a far, far better thing than we have ever done.” Or: “This observation leads to what we might call the Maradona theory of interest rates.” (N.B.: Read the book!) Or: "The old world was illustrated by Lord Cunliffe, the Governor of the Bank of England during the First World War, who, when giving evidence before a Royal Commission on the size of the Bank of England’s gold and foreign exchange reserves, replied that they were ‘very, very considerable’. When pressed by the commission to give an approximate figure, he replied that he would be ‘very, very reluctant to add to what he had said’.”

There is much, much more, but I can hardly quote the whole thing…

The book is an important analysis. At times, I was reminded of the arguments of Rickards and Varoufakis, only presented with even more forceful reasoning, and this by a former governor of the Bank of England! (I can’t quite get my head around that; even Paul Krugman, in the New York Review of Books piece published in the July 14, 2016 issue recognizes that “King takes sides in a long-running dispute between mainstream economic analysis and a more or less radical fringe that rejects the mainstream’s methods—and comes down on the side of the radical fringe.” – huh, not quite, but let’s let it at that.)

The alchemy of the financial system, as diagnosed by the author is thus: "For centuries, alchemy has been the basis of our system of money and banking. Governments pretended that paper money could be turned into gold even when there was more of the former than the latter. Banks pretended that short-term riskless deposits could be used to finance long-term risky investments. In both cases, the alchemy is the apparent transformation of risk into safety. For much of the time the alchemy seemed to work. From time to time, however, people realised that the Emperor had far fewer clothes than the Masters of the Universe wanted us to believe. Once confidence in the value of money or the soundness of banks was lost, there was a monetary or banking crisis. As Bagehot wrote in Lombard Street, ‘The peculiar essence of our financial system is an unprecedented trust between man and man; and when that trust is much weakened by hidden causes, a small accident may greatly hurt it, and a great accident for a moment may almost destroy it.’ For a society to base its financial system on alchemy is a poor advertisement for its rationality. The key to ending the alchemy is to ensure that the risks involved in money and banking are correctly identified and borne by those who enjoy the benefits from our financial system.”

There are priceless pages about the moral hazard of the current banking arrangement, as in: “They would run down their liquid assets, relying instead on cheap central bank insurance – and that is exactly what happened before the recent crisis. The provision of insurance without a proper charge is an incentive to take excessive risks – in modern jargon, it creates ‘moral hazard’.”; or “The debate about whether banks are ‘too important to fail’ boils down to a simple question. Are banks an extension of the state, as they are in centrally planned economies, or are they part of a market economy? If the latter, then to correct for the social costs they impose on society in a crisis, banks should be made to take out compulsory insurance through the PFAS and have sufficient ‘loss-absorbing capacity’, on the liability side of their balance sheets, to reduce the implicit taxpayer guarantee to bank creditors. Only equity finance guarantees that capacity.” On Europe: “When confronted with such a range of unpalatable choices, the leaders of Europe react by saying, 'We don't like any of them.' So they have responded by muddling through and adopting the coping strategy of Mr Micawber (in Charles Dickens' David Copperfield), waiting for something to turn up. Since the future is wholly unpredictable, it is certainly possible that something might turn up. But it is hard to believe that it would be an improvement on facing up to the problem and providing a sustainable economic basis for monetary union.” And, “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. It is at the heart of the disequilibrium in the world today.” And much, much more, all of it of the same calibre. Like in: “Germany faces a terrible choice. Should it support the weaker brethren in the euro area at great and unending cost to its taxpayers, or should it call a halt to the project of monetary union across the whole of Europe? The attempt to find a middle course is not working. One day German voters may rebel against the losses imposed on them by the need to support their weaker brethren, and undoubtedly the easiest way to divide the euro area would be for Germany itself to exit. But the more likely cause of a break-up of the euro area is that voters in the south will tire of the grinding and relentless burden of mass unemployment and the emigration of talented young people. The counter-argument – that exit from the euro area would lead to chaos, falls in living standards and continuing uncertainty about the survival of the currency union – has real weight. But if the alternative is crushing austerity, continuing mass unemployment, and no end in sight to the burden of debt, then leaving the euro area may be the only way to plot a route back to economic growth and full employment. The long-term benefits outweigh the short-term costs. Outsiders cannot make that choice, but they can encourage Germany, and the rest of the euro area, to face up to it.”

There is a very concrete proposal, which is admittedly not so revolutionary, to extinguish the “alchemy” factor that characterizes current banking arrangements worldwide, but I do not believe in its feasibility, as it entails giving more power to “high-quality public servants” instead of a more market based solution (I am with Bill Bonner in this: “an honest society needs honest money”), not that I don’t understand where he’s coming from, so no, thank you very much. Nevertheless, this is an immensely readable and genuinely important reflection, for which Mervyn King deserves recognition, admiration and gratitude.

“For centuries gold has been the most widely accepted form of payment. It is independent of government, and, ironically, governments themselves want to hold reserves in gold because they do not trust other countries to maintain the real value of claims denominated in their own paper currency.”

[Andrew · Rating 5 out of 5]

The End of Alchemy: Money, Banking, and the Future of the Global Economy is a book by former Bank of England Governor Mervyn King, who was a principle participant in the global effort to combat the Great Recession of 2008. King has since retired from his position, and has written his first (and hopefully not last) book on the crisis. This isn't, however, one of the many timeline books of the recession, or about placing blame, or even absolving himself of responsibility. King instead focuses on needed reforms in global central banks that could successfully combat potential economic downturns, and help economies become more dynamic.

King first explains the in's and out's of banking, and then talks about major principles of banking, such as monetary policy, liquidity of capital, Lender of Last Resort tactics, panic, and monetary unions are all mentioned. King focuses in detail on the UK, USA and European Central bank, but also offers detail on banking in other nations, such as Australia, Japan and Canada. King has written a book on central banking policy itself, not necessarily focusing on any one region. King goes through each individual principles in a chapter, offering a history and explanation of the concept, and then proposed changes that could lead to greater financial stability. For example, he offers potential reforms of the European monetary union, such as allowing southern Periphery states to "burn out" and eventually recover, or greater political integration in Europe, or a transfer of capital from richer northern states like Germany to shore up southern nations, or harsh austerity measures until capital and confidence return, or a disintegration of the union itself. Another example is his critical take on Lender of Last Resort (LOLR) principles, which may help solve a banks immediate financial issues, but will encourage others to pull funding, and may even speed up a bank run. Instead, King talks about a Pawnbroker for all Seasons principles, where central banks proactively offer haircut backing to banks before any financial crisis happens.

King's book offers insight and reform ideas on everything from inflation targeting, to interest rates, to the relationship between government monetary policy and central bank independence. The End of Alchemy is an excellent read for those interested in monetary policy, and offers insight and reform options from a veteran central banker from one of the worlds largest economies. King's book is complex, however, because it is written entirely in economic lingo. There are few mathematical equations, but there is a lot of side research one may need to do if they have little experience or depth of knowledge in regards to global economic policy (read: me). Even so, the book is well worth your time. It is interesting, well written, and surely will be influential as governments seek to avoid a large scale downturn a la the Great Recession, and look to prevent crisis from happening again. A great read, and highly recommended.

[Ayoub · Rating 5 out of 5]

Great book from Mervyn King, ex Bank of England governor. His main idea is that the magic of finance is governed by four main ideas : Radical uncertainty, disequilibrium, the prisoner's dilemma and trust. He also gives potential solutions to the stagnation of the world economy

[Mbogo J · Rating 5 out of 5]

A full library has been created out of the 08/09 global financial crisis. The books might differ in content and in prose but they all have a unifying theme. Blame game. There are those that blame Wall Street's greed and the folly of human nature, some blame regulators for being too lax and the tragedy of repealing the Glass-Steagall Act, others just blame the effects of too much debt... This book is not numbered among them.

If you want to understand the financial crisis and the general underpinnings of the global financial system this book is the blue print. Mervyn even had time to explain to us the concept of money. Yeah, it is not as simple as having notes in your wallet.

What made the book better is the fact that Mervyn has traversed both circles; academic and practitioner which means he understood theory but rather than produce a polemic associated with academics, his recommendations were more pragmatic tempered by seeing the action first hand as the governor of the Bank of England. He had many good policy proposals such as the central banks being the pawn broker of all seasons rather than the lender of last resort. His other recommendations on how to sort out the Euro mess and the global disequilibrium though merited require too much political capital to be ever implemented. I guess we have to wait for the next crisis to find out but King's warnings should not go unheeded.

[Janp · Rating 3 out of 5]

"Brimming with new ideas....brilliant" reads the cover of the paperback I bought. There's two main ideas: one being the central banks functioning as a 'pawner for all seasons' as opposed to a 'lender of last resort', second is more cooperation between central banks and simplifying the systems (end alchemy) to structure the economy better and thus preventing large crises like the one in 2008. (The latter being discussed very elaborately, sometimes repeating certain systems and events two or three times throughout the book).

My main point with all this is: dude, you were the boss of the central bank of the UK and are NOW telling everyone in a book what went wrong and how it needs to be fixed?? I have to admit that my knowledge of the economy and its magical ways is limited, which is one of the reasons I bought this book, but I was disappointed and could not help thinking that captain Hindsight is always right. And he also makes money by selling this book, rather than using all this wisdom in a time when he was actually in power and in a position to do something about it. I did learn a thing or two and ought the style in the book was ok, but simply cannot agree with the marketeer that designed the cover of my paperback...

[Tariq Mahmood · Rating 4 out of 5]

The author has produced a very pessimistic view of the current state of economy before and after the great credit crunch of 2008. If the then Governor of Bank of England has categorised the western economy as inherently at fault than more doom and gloom is certainly on its way. The Far Rights slowly taking over power in the western world should start addressing these issue instead of blaming the Immigrants for somehow creating the current glum before their public really start to lynch them. The main issue is that the power of the financial lobby, how can any government no matter if it's political leaning, take on the mighty banks and investment houses?

[Erick Rosas · Rating 4 out of 5]

When I read, I start very slowly. Especially with non-fiction. It is like moving to a new country every time, so I seem to drift in adapting to the specific language of the author. It was the same with this book, which saw me two years stuck on page 30, and took about two months once I managed to read at a decent pace.

Once I settled in this "country", boy was it worth it. Mervyn King writes what looks to be two books in one. One, brilliantly exposed and comprising the majority of the text, describes the global contradictions in our money and banking system, which led us to the financial crisis of 2008-09. Such disequilibriums have not yet been solved. Two, the policy recipe to get out of this jam. As a lot of economics papers, the policy recommendation section does not follow from the analysis containing the meat of the argument. He recommends –surprisingly, given the relative heterodoxy of his main reasoning– more trade and exchange rate liberalization, as well as the fostering of productivity growth. Alas, nothing new.

At its best, however, the "first" book made me realize the importance of narrative –of story- in the ideas that underpin the social sciences and thus the policies we believe in and that influence political and economic outcomes which are vital to our wellbeing. I believe the relevance of the use of analogies and metaphors in explaining and creating economic theory is not fully salient to its practitioners. The title of the book is a metaphor, and one that really is a central part of the argument too: banks create money by converting short-term safe liabilities (deposits) into long-term risky assets (loans). And believing that is as sound as believing in alchemy, in the illusion of liquidity.​ When you start to think about it, the systems that support our society are also narrative in their nature. Money is also a story ("Accept this piece of paper and you will be able to buy stuff"), and believing in it is fundamental for it to function.

That is why I think this is a great book, and I recommend it to anyone interested in this topics. Despite its technicalities it is an awesome read. Give it time.

P.D. There are a lot of Keynes quotes on this. He is truly brilliant and his use of rhetorical figures is, and will be, undefeated.

[Ben Irvin · Rating 4 out of 5]

This is now my fifth book in the series on macroeconomics. I do recommend it although I initially was not so sure. King was head of the UK central bank from 2003-2013, so he certainly has experience and deep knowledge of what can and did happen with banking and the world economy. I liked the book ultimately because of the several good insights I gained and because it challenged, to some degree, the predominant thinking that earlier books in the series had tended to agree on. King's writing is fluid and relatively crisp, though not all parts are equally engaging. So what did I learn:
- alchemy here has a very specific meaning: King uses it to characterize the conversion of short-term into long-term obligations, specifically the fact that banks accept deposits which they are obligated to return upon demand (short-term) and they make risky loans on which they agree to accept repayment over the long term. He proposes a specific path to eliminate the risk inherent in this enterprise which involves making sure that the value of a bank's assets (loans and reserves) _as collateral_ is at least equal to the value of their debts (deposits). With that value established, the Central bank can trade cash for those properly valued assets like a pawnbroker at any time that the bank might need liquidity to satisfy its depositors demands. This notion is not so radical since banks are already going this way with the large reserves that they have with the central banks as a result of the Quantitative Easing operations of the last few years. (The money created by central banks in this process has almost all gone into reserves rather than being "spent" in the economy the rest of us see, thus it has not stimulated demand directly). Whatever the means, as long as we rely on this alchemy, we will be subject to banking crises of the sort that developed in 2007-2008 and have occurred for centuries as long as banks have been allowed to operate this way.
- King incorporates much of the best literature on banking and economics going back into the 18th, 19th and 20th centuries. None of this stuff is new at some level, smart people have been warning of the risk and temptations of creative financing for a very long time. And there are lessons to be drawn from the history of crises.
- He posits that not all recessions are the same (kind of like cancers) and so the remedies are not all the same either. What works for some may not work for others. The example of the recession in the US that followed WWI is one that basically healed itself, and is often cited by people who claim government or central bank involvement is not needed to help end recessions. But he explains why that recession was a type that was self-healing while others are not.
- The deepest theme of King's work here is the necessity to cope with what he calls "radical uncertainty" in contrast to the notion that economic outcomes can be improved by just rationally optimizing choices to maximize the probability of achieving desired results. He contrasts these two in the pithy terms of an economy of "stuff" and an economy where "stuff happens." Radical uncertainty means no quantitative model can get you very far because the stuff that happens cannot even be imagined, much less quantified and modeled. I think related to this shortcoming of contemporary economic theory is the absence in its models of the roles of money and banking. Indeed they are very hard to model and, it seems, not very well understood in any scientific sense.
- Anyhow, in a world of radical uncertainty, one is better off the follow heuristics than to rely on complex mathematics, since the latter will seduce you into thinking you understand better than you do, while the latter, as obvious approximation and coping tools, can be more readily questioned and adjusted, at least in the best case.
- He identifies a key characteristic of an economic regime in the "narrative" that the participants tell themselves. Before the 2008 crisis many participants (households) subscribed to a narrative in which their growing spending could be sustained more or less indefinitely through borrowing because house prices would always rise . After the crisis hit, that narrative was replaced by one where more savings was needed along with the requisite unwinding of debt. I think his point is that monetary or fiscal stimulus may not be very effective to increase demand, for example, if the players in the economy don't buy the change in narrative that such stimulus is supposed to drive. Furthermore, the heuristics that are dominant are a function of the narrative. These qualitative concepts may be more effective in trying to manage through economic developments than flawed mathematical models.
- But I think King's politics may be steering him around certain factors that other writers have called key to the problems in current developed economies. Only one time in the entire book did I see the term "income inequality" cited, and that was in a laundry list of ills. In many of his characterizations of how economic forces play out he ignores the existence of the large chunk of society that has little capacity to save or to borrow but is instead living hand-to-mouth. I found his arguments and logic to be pretty good when thinking about the actions of a person in the upper middle class or above, but not so much for those whose spending is simply income-constrained. I take issue with his early (in the book) characterizations that pre-2008, spending was getting ahead of what was sustainable and that spending was "digging a hole" in future spending since it was debt-enabled. I ask (along with Adair Turner, author of Debt and the Devil) why should it be that healthy growth rates can only be sustained by increasing debt? King just seems to accept in a passive way that if debt was required to fuel the growth then it was excessive. Turner and Reich point to the excessive capture of growth by the top earners, who save rather than spend, as a source of the accumulating deficit in capacity to spend by the rest of the population, which leaves them with the choice of reducing spending trends or turning to debt.
I think King actually has some good insights into the difficulties of maintaining growth, but in ignoring the role of the distribution of spending power and the different ways the wealthy handle their income vs. the masses, he leaves a critical hole in his story. Since with many other competing views he is ready to explain (often convincingly) why they are flawed, his silence on this one is puzzling.

[Cheenu · Rating 5 out of 5]

I started reading this book with some apprehension that it'd another book on the 2008 financial crisis, a topic on which there is a never-ending amount of literature. However, I was pleasantly surprised by the scope of the book - rather than being just another book vilifying greedy bankers, this book actually illustrates

1. the structural issues with fractional reserve banking
2. the long term unsustainability of having an export-led or trade deficit growth policy
3. why economic forecasting models are extremely poor tools in both predicting the future of the economy & also as a base for fiscal and monetary policy decisions.

While I don't know whether the solutions that he suggests in the book are going to be correct (don't really know enough about macroeconomics to even have a clue), his book really provides a good overview of why the global economy is struggling to grow since the 2008 financial crisis.

[Rori.Cantall · Rating 2 out of 5]

Really disappointing. Long-winded, dreary, boring. It's about as "white old man" as you can get.

King was part of the financial crisis insofar as he was in charge of the Bank of England at the time. He seems to want to avoid blaming anybody, and simply reduces the crisis to rational people responding rationally to a rational world. However, he fails to pinpoint the aspects of greed that drove the crisis and currently drive the financial markets which have not changed much since the crisis.

It's not worth your time. There are better books that cover the material in less convoluted ways while actually addressing the real political and economic causes of the crisis.

He gets 2 stars for discussing economic principles, but it was nothing that you can't learn elsewhere.

[William Schram · Rating 4 out of 5]

The End of Alchemy is a book by Mervyn King, the former Governor of England's Central Bank. Alchemy refers to the central banks controlling interest rates to maintain the status quo. The End of Alchemy covers the Great Recession. The events and missteps taken collectively by the world, in general, are easy to see in hindsight.

The mistakes are easy to see in hindsight, but when they made them, they did not seem to be in error. If someone had stopped for a moment to think about the path they were taking with the markets and derivative products, they would have lost their jobs. Everyone was doing it, and all anyone could see was the rising spiral.

What is money, exactly? It is something you can use to purchase goods and services. What is the difference between an ordinary piece of paper and a banknote? Banknotes issued by a country's central bank are accepted as legal tender because the central bank says they are legal tender. The core of money lies in trust. Society as a whole accepts that money has value. Money is convenient. No one wants to trade some goats for bread or a car. King points out that money is insurance against the future.

Money was pegged to the gold standard in the United States until 1971 when President Richard Nixon ended the Bretton Woods system. Now, most countries follow a fiat currency system.

I enjoyed the book. Mervyn King does a marvelous job explaining the role of money and central banks in the economy. Furthermore, King talks about the role of derivative financial instruments. I'll be honest with you readers; I didn't follow the Great Recession's causes too closely at the time. I found the news depressing, and I had enough on my plate. King covers the story of Greece, too. I vaguely remember those events.

Finally, King discusses possible fixes for the economic system we use today.

Thanks for reading my review, and see you next time.

[Diego · Rating 5 out of 5]

Desde la crisis financiera de 2007-2009 y la gran recesión que plago al mundo se ha escrito mucho sobre sus causas, soluciones y sobre la naturaleza de las economías de mercado y del sistema financiero. Se han producido grandes debates sobre la necesidad de hacer reformas en la conducción macroeconómica de los países y se han tomado medidas de política pública alrededor del mundo con el propósito de remediar tales problemas.

Muchas de esas políticas han fracasado como el caso de Europa, en otros lugares como Estados Unidos han producido recuperaciones muy lentas. En cualquier escenario es claro que no se han tomado las medidas necesarias para prevenir que nuevas crisis en el sector financiero sean recurrentes. Quizá la naturaleza del capitalismo es tener crisis cada cierto periodo de tiempo, esa idea es la que explora Mervyn King en The End of Alchemy.

King parte de la premisa de que la banca central y el sistema financiero han hecho un uso del dinero que raya en la alquimia y esa es la fuente de los desequilibrios y problemas del sistema de pagos que pueden hacer recurrentes las crisis.

Es uno de los mejores libros que se han escrito sobre estos temas, cuenta con una agenda ambiciosa sobre como intentar reparar las economías del mundo y como ponerle un final a la alquimia monetaria y financiera. Un libro muy recomendable, lleno de historia de los bancos centrales en el mundo y de conocimiento producido en la amplia experiencia de King al frente del Banco de Inglaterra.

[Adrian · Rating 4 out of 5]

The former Bank of England Governor gives a suprisingly readable account of his understanding of the serious underlying faults in modern finance. While there exists a plethora of books on finance since the crash of 2008, this one stands out for 2 reasons. First, it's by a former Central Bank chief, Second, Lord King has some interesting recommendations.
King suggests that Central Banks, rather than being Lender of Last Resort, should instead be Pawn Broker for All Seasons, and in the last chapter, Lord King outlines the need for essentially a new Bretton Woods, as the current direction is unsustainable in King's eyes, and indeed, the eyes of many.
The book itself is surprisingly readable, and is not as tiring or engrossing as this reader had previously imagined.
If one has already read many books since the Crash of 2008, and wonders if they should read this one, the answer is simply, YES!

[Sarah Toney]

An incredible book on the role of central banks, how money and our economies work, and the intrinsic nature of boom/busts in our current system. While I don't agree with everything, this book provides a real foundation for understanding our economic reality and what needs to be done to shift to a more stable money system that will support the real economy and real people. I believe it's important for us to understand our economic world so that we can powerfully stand up for our own best interests.

[Tamim Diaa · Rating 5 out of 5]

Strongly recommended for anyone seeking to understand the world of money and banks or interested in the state of the world’s economy. The book is Written in an easy language and is very informative and full of insights and ideas.

[1]

leído esto me queda clarísimo que me voy a dedicar todos mis recursos humanos a acabar en aquél lugar central de cierta ciudad al lado de un río

[Carlos Salazar · Rating 4 out of 5]

A good book to know more about the financial system and specifically about causes of the 2007-2009 financial crisis. I attended multiple courses about economics during my undergrad and master degrees, and still found value in this book written by the former head of the bank of England.

[Nilesh Jasani · Rating 3 out of 5]

A disappointing book mainly because who it comes from. If a person with all the policy power possible, who could so clearly see whatever was wrong in the policymaking and still could do nothing, he should have written on practical issues that confound the decision-making and ways to get around them rather than offer more theories and theoretical solutions.

Theory, as is invariably the case with great economists, is good even if presented in the laymen language garb. Other academicians may find holes in the way money, finance, alchemy (lovely definition - illiquidity in real assets converted into financial liquidity) etc are defined. Practical critics may have issues with the liquidity-based capital adequacy formula provided for banks. Yet, those would be sparrings that economists will always do. One cannot take away anything from the author’s great understanding of the world of banking and finance, ability to describe his ideas most lucidly and provide a consistent framework.

The author’s failure is in recognising the real problem: it is not in economists’ faulty understanding or inability to agree. This is a real problem when looked from the viewpoint of the incessant bickering amongst them. Yet, every now and then, some Mr Keynes or Mr King do get the highest power. And yet, they are unable to implement what they believe in. There is more to policymaking than sound economic understanding. A point completely missed by the book.

Think about the three solutions presented towards the end for the global economy to begin growing:

- boost productivity by removing economic inefficiencies. Really? Isn’t this a solution to everything, everywhere!! To be fair, the author has a handful of statements against monopolies and for tax reforms but this is not befitting as a suggestion for a book of this calibre
- boost free trade through agreements like TPP…hmmmm (this review is in the Post-Trump era)…
- force everyone to have free-floating exchange rate. Really? One, who will get that done and two, how can the author forget about the carnage this can create to at least 190 out of 200 countries every decade or so.

Once again, maybe these are the solutions. And they must have been known to the author when he was in the powerful seat. A better book would be if the author explained why he could not do what he thought was right. Despite the beautiful paradox of policy explained in this book (succinctly, any economic policy that is overused fails), this reviewer strongly believes that there are many decent solutions to the current economic malaise. Almost all solutions have one thing in common: they need strict adherence to one single way of thinking rather than muddled mishmash of reactionary ideas. But in practical life, it is just not possible to stick to one way with the focus only on the long-term. There is a paradox of this reviewer here. Call it the paradox of policymakers: Any policymakers that simply focus on the long-term perfect solution dies as a policymaker long before he is able to implement anything.

[Ajay · Rating 3 out of 5]

"It is rare to encounter a book on economics quite as thought-provoking, clever, and brimming with new ideas. Agree or disagree, Mervyn King's arguments deserve the attention of everyone."

"A Former Governor of the Bank of England, King proposes an account of the recent financial crisis focused on the underlying causes of what went wrong. By taking a longer view on the series of financial crises that have become the cornerstone of modern capitalism. The End of Alchemy explains why, ultimately, this was and remains a crisis not of banking - even if we need to reform the banking system - nor of policy-making - even if mistakes were made - but of ideas."

These are the reviews from as storied figures as Niall Ferguson and Lawrence H. Summers that drew me to read The End of Alchemy. My conclusion upon completing this literary journey is that it was enjoyable, clever, and thought-provoking; the reviews were right in this regard. The book's scope is very broad and filled with insightful anecdotes from a well-read and well-connected individual in the world economy.

My criticism begins with a passage I found on Pg. 148 "After a painful post-mortem, it was agreed that the banking system should go back to its traditional role… more people needed to work in fishing, to invest in the making of nets…. Clever people realized that their reputation would in future be enhanced by adding to the social value of production rather than diverting resources from other people's pockets into their own. Some of them even moved out of finance into teaching. They recognized that they had a responsibility to write the history of this episode, and to convey it to future generations."

This is the true reason why Mervyn King has written this book, not because he has some amazing insights into the inner-workings of things, suggestions for change, or untold histories to share. But because he feels responsible for shaping the official history in a way that benefits his future reputation.

This book asks many of the right questions, but answers it with apologies and excuses for the current capitalist system. This is not the book of an island financier who is ready to divert their resources into positive social value, it is the book filled with conventional economic ideas [perhaps with a better understanding than most as to the complexity and shortfalls of that world-system].

What really raised my ire was the way in which King dismisses emergent concepts like Blockchain, 100% Fractional Reserve Banking, or a re-emergence of some form of the Gold Standard with unimpressive analysis and biases opinion. I understand there are political implications to the views espoused in this book, so perhaps King couldn't facilitate a more nuanced understanding. [imagine the headlines] But, it substantially detracted from the integrity of this book as a case for an intellectual revolution.

This is why I knock three stars of my review of this book, a combination of selfish interest, misaligned integrity, and misleading marketing detract from an otherwise ingenious writing.

[Sammy · Rating 3 out of 5]

I am a master's student in economics, although my specialisation is not macro economics. I bought this book because I wanted to see how macroeconomic theories play their role in real life. I thought I knew a bit about macroeconomics, until I read this book.
I see no review about the actual readability of the book. I guess either everyone finds the book easy to ready or no one is willing to admit that they simply did not understand most of what Mervyn King is talking about. I will be honest then.
Although in the forewords, Mervyn King explicitly told readers that his book was not meant for "economists" or those in the economics field, unless you have some advanced understanding in economics and finance, you will find it extremely difficult to comprehend this book.
Mervyn King is an expert. And as an expert who has worked at a high level in the Bank of England since 1990s, Mervyn King inevitably commands knowledge and wisdom he himself took for granted. This is, I presume, why reading this book makes me feel stupid--imagine having a conversation with Albert Einstein as he off-handedly explains how relativity works as if it is the simplest thing in the world.
You might have to just teach yourself macroeconomics if you want to understand only about 70% of this book. Though contrary to what he claims, Mervyn King assumes that the readers have a advanced level of knowledge of monetary policies and macroeconomics theories. This is not a book where you learn macroeconomics/financial market. You have to do that before you read this book. If you do not understand how money creation works through open market operation, or how Keynesian economics models work, or how interest rate, inflation and price are correlated with each other in a macroeconomic context--save yourself some time and read other books first.
I am glad my training in economics has given me the tools to learn what is necessary to read this book. But I struggled, a lot. Of all the time I devoted myself to this book, 80% of the time is spent in re-reading the paragraphs I didn't understand, reading my macroeconomics textbook to revise economic theories, reading other literature to understand the jargons Mervyn King mentions so casually. Only 20% of the time is spent in making progress in this book.

[Pieter · Rating 4 out of 5]

The year 2008 led to the worst financial crisis we have ever had at least since 1929. Until now, both central banks and governments struggle to recover. Money has been used unwisely, because politicians were unwilling to take unpopular decisions. Like doping, trying to hide overconsumption, increasing private and government debt.

A case study is the European Monetary Union for which it was not longer required that inflation would converge or budget deficits would belong to the past. Germany forced itself into a 'cheap' conversion rate while Southern European countries used increasing prices to further inflate the ever lower interest rates. Since WW II, Europe has not been as divided as it is today due to the euro.

It is most enlightening to hear the opinion of the former Governor of the Bank of England who was captain at a rough sea. And how interesting the book may be, in the end the question remains why has Mr. King not been able to lead the British vessel into safer waters after all?

I fully support his opinion that banks should be split up between 'narrow' and 'wide' banks, whereby the one focus on deposits while the other takes more risk. Banks should be better capitalised and be more prudent. It is not the task of the national tax payer to help out any corporate bank who focused on high bonuses at any risk, but at the same time looking for a cheap bail out.

But I wonder whether the author's idea to let the banks offer the central bank sufficient collateral (central banks as pawnbrokers) is the right solution. It is correct that the value of the collateral is not necessarily related to the creditworthiness of the bank. But take the case of a bank owning a portfolio of houses and vessels as collateral. The moment hell breaks loose, the bad economy will lead to a fall of the housing and vessel prices too. Wonder which central bank would then be willing to provide the suffering banks with liquidity?

Solvency should be key for any bank and regulation should be in place to make sure no freeriders join the rally, central banks could cool down the financial markets with sufficient liquidity if required.

[Kevin · Rating 3 out of 5]

There are a number of problems with Mervyn King's book. The first is the rote recitation of Adam Smith's origins of money in barter that are a fantasy that economists cling to despite extensive evidence pointing to money as credit, both social and otherwise as the start of a monetary system. (see Debt: the First 5000 years for a comprehensive look) While he does comment on the endemic fraud around the crisis, he does not address the role it played in and around the crisis. (Though I am unfamiliar with the Bank of England's role in this, maybe they have an SEC type organization so it was outside his purview running the central bank) And he completely ignores that while GDP rose before the crisis the gains were unevenly distributed, most workers' saw no real gains from 1980 on which would play no little part in a lack of demand. (covered up by increasing debt until the wheels fell off the bus) Despite these flaws it was still an interesting examination of the banking system from someone who would know what was going on.