The Courage to Act: A Memoir of a Crisis and Its Aftermath 
by Ben Bernanke.
Norton, 624 pp., £27.99, October 2015, 978 0 393 24721 3
Show More
The End of Alchemy: Money, Banking, and the Future of the Global Economy 
by Mervyn King.
Little Brown, 448 pp., £25, March 2017, 978 0 349 14067 4
Show More
Show More

Early​ in 2014, the Bank of England put out a quarterly bulletin entitled ‘Money Creation in the Modern Economy’ which put to bed one of the most persistent – and false – claims in the history of economics. According to orthodox economists as far back as Adam Smith, money originates in the need to exchange one good for another. I have produced more bread than I need, you have produced more clothing than you need, and we need some simple instrument by means of which to swap one for the other. Products and services different in kind can all be rendered comparable and tradable, once they are assigned a monetary price. Money is on this view first and foremost a means of exchange, and banks are like warehouses, storing and distributing it. If anything goes wrong with money, it’s almost certainly the fault of the state for borrowing and printing too much of it, which causes inflation. All this is what Mervyn King, governor of the Bank of England between 2003 and 2013, refers to as the ‘traditional’ theory of money. But ‘Money Creation in the Modern Economy’ explained that money can be created out of thin air, which is exactly what happens every time a bank makes a loan. Banks don’t wait for a customer to drop £100 into their savings account before lending it to someone else. When they lend £100 they add the figure to the borrower’s account while simultaneously recording it as an asset on their own balance sheet. Banks aren’t warehouses; they are more like alchemists.

The implications of this are profound and politically far-reaching. Since the late 19th century, economics has focused principally on the mechanisms of market exchange – consumer preference and price – while trying to ignore the inconvenient realities of how credit and debt are created. Money viewed in terms of exchange exists purely in the present tense, as the possibilities it offers me right now. It behaves as instructed. Understood as credit, however, it knits together past, present and future, with all the hopes, disruptions and uncertainties that go along with that. It’s here that money becomes caught up with ideas of progress and risk. It is also where money starts to misbehave.

Free marketeers have always tried wherever possible to neutralise money, to reduce it to something inert and predictable, and free from political meddling. The idea of the gold standard retains its hold on libertarians and economic conservatives alike because it seems to anchor money in something outside politics altogether, whose supply is determined by nature. For less dogmatic free market liberals, rigidly governed independent central banks are the more palatable alternative: the illusion can be maintained that they are apolitical, even while they control the levers of monetary policy. Displays of anti-democratic bravado, such as those made by the European Central Bank during the Eurozone crisis, both depend on the premise and deepen the sense that the rules of money are set in stone. The intended message is that money is under control, but not under political control.

In as much as they are unelected experts who exist at arm’s length from any parliament, independent central bankers might be described as ‘technocrats’. But to compare them to other technocrats (energy regulators, say) would be a gross mistake. Part of the task of running a central bank, at least until recently, has been to sustain the image of money and banking as tedious, technical matters, not political at all. Most technocrats can just get on with technocracy; central bankers have had to give a convincing performance of it for the public and the markets. When all goes to plan, money is something we all take for granted, and that owes something to central bankers’ carefully choreographed displays and neurotically crafted statements that there’s nothing to see here, please move on.

Why would the Bank of England publish a paper like ‘Money Creation in the Modern Economy’? The most immediate explanation is that the Bank itself has been engaged in the strategic invention of new money on a vast scale – more than £400 billion and counting – since Quantitative Easing (QE) was introduced in 2009. Just as commercial banks create money when they lend (which magically appears as an asset on their balance sheet), central banks can create money by buying government gilts from pension funds and insurance companies, and adding the cost to the liabilities on their own balance sheets. The expectation is that the pension funds and insurance companies, having sold their gilts to the central bank, will then use some of the money they receive to buy additional assets (such as equities) so as to rebalance their portfolios. Payment for the gilts is made into the sellers’ bank accounts, so that commercial banks’ reserves are increased at the same time, which in turn increases the amount those banks are able and (ideally) willing to lend. The idea is that flooding the financial sector with new money in this way will increase bank lending and capital investment. But the whole process begins with a technocratic diktat: the central bank decides to increase the quantity of reserves that commercial banks are deemed to hold with it, and does so merely by altering a figure on a screen.

If you’re open to the charge that you’re performing conjuring tricks in the public’s name, maybe it’s safest to fess up and explain how such tricks are managed. The Bank of England’s revelation of where money comes from was in keeping with an effort that central banks have been making for some time to demystify what they’re up to. This effort has been a guiding principle of the careers of both Mervyn King and Ben Bernanke, who was chair of the Federal Reserve between 2006 and 2014. The watchword of central banking since the early 2000s has been ‘transparency’, with ‘inflation-targeting’ the mechanism chosen to achieve it. Once a central bank has made known its target for inflation (meaning inflation can fall too low as well as rise too high), outsiders can form a pretty good idea of what it’s going to do next. The aim is to minimise the sense of surprise that accompanies announcements of monetary policy, so that the markets can ‘price in’ interest rate changes before they actually happen.

The policy was first introduced in New Zealand in 1989 and instituted by the Bank of England in 1997 when the incoming Labour government made the Bank independent. Combining central bank independence with inflation-targeting was the means chosen to kick politics out of monetary policy. The thinking was that while politicians, policy fads and whole governments may come and go, investors and currency traders can rest assured that over the long term interest rates will be set according to unbending institutional rules. Bernanke argued the case for inflation-targeting by the Federal Reserve for many years, and eventually got his wish in 2012. Most central banks set their inflation target at 2 per cent, the figure that is seen as offering adequate price stability to investors without throttling growth and employment. This figure is used to justify QE: inflation has been too low in many economies since the financial crisis, warranting ‘unconventional’ monetary policies in an effort to stimulate bank lending. In addition to an inflation target, publishing the minutes of monetary policy committee meetings further exposes the mechanics of how money is made and regulated.

For Bernanke himself, ‘transparency’ appears to have meant the cultivation of a dry and meticulous persona. Joining the Federal Reserve after a distinguished career at Princeton, he presented himself as an academic first and a policymaker second; it isn’t clear if he genuinely disliked the limelight that goes with being chair of the Fed, or if a veneer of scholarly introversion is also part of his act. ‘Monetary policy is 98 per cent talk and 2 per cent action,’ he writes in The Courage to Act, and he spends a lot of his time fretting about how best to talk. He longs to find a way of speaking plainly and unambiguously, but never quite manages it. Each speech and statement is sculpted for maximum clarity. He is dragged before Congressional committees that don’t understand monetary policy or financial regulation, and leaves exhausted by the politics of it all. After the conservative crazies in Congress get wind of QE and depict it as nothing short of a hyper-inflationary conspiracy, he reluctantly sets up a regular press conference in an effort to get his message across directly.

The dilemma of the central banker results from having to address two incommensurable audiences, the one political, the other financial. Should they employ what Max Weber called ‘charismatic authority’ and cloak monetary policy in the aura of political sovereignty, or speak to the markets in their own technical language? Bernanke opted for the second: he provided information and issued warnings with maximal precision (a political performance in its own right, and not necessarily a more honest one). This ethos was deliberately in stark contrast to that of his predecessor, Alan Greenspan, a man who told a Senate committee in 1987: ‘If I seem unduly clear to you, you must have misunderstood what I said.’ Bond traders used to try and work out what Greenspan was planning by studying the size of his briefcase as he arrived for monetary policy meetings. Before him came Paul Volcker, who, when Mervyn King asked him for a word of central banking advice, replied: ‘Mystique.’ Devotees thought of Greenspan as the chief architect of the ‘great moderation’, the long boom of the 1990s and the post-9/11 recovery, which were achieved without inflation. To critics, he was the man who told President Clinton in 1993 that if Clinton pursued the domestic policy programme on which he’d been elected, Greenspan would raise interest rates and a recession would ensue. Either way, Greenspan’s tenure was all about Greenspan. By the time King and Bernanke took their offices, the game had changed. As the 2000s wore on and the financial markets seemed to defy gravity, a little less charisma surrounding money and monetary policy seemed welcome. ‘Our goal was to make monetary policy as boring as possible,’ King writes in The End of Alchemy, and yet ‘it is fair to say that we failed in our ambition.’ What got in the way was the greatest financial crisis in eighty years.

When the postwar Keynesian model of economic regulation went off the rails in the early 1970s, it was publicly apparent what was going wrong. A macroeconomic theory which stated that unemployment and inflation could be traded off against each other had ceased to describe or predict reality adequately. With the appearance in the US and UK of ‘stagflation’ – the rise of unemployment and inflation simultaneously – it was obvious that conventional policy interventions in the economy were no longer working. In 1973 Nixon ended the postwar Bretton Woods system of fixed exchange rates. The value of national currencies was no longer under political control, but suddenly in the eye of newly empowered foreign exchange markets and bond-traders. Strong trade unions, which had once been viewed by Keynesians as a means of putting more money into workers’ – which is to say, consumers’ – pockets and thereby increasing market demand, were now regarded as a source of inflation, as they constantly pushed for higher wages. Inflation was so normalised that businesses began to anticipate increases in their own costing, driving prices ever higher. And where governments sought to tackle unemployment via the traditional Keynesian means of public spending and borrowing, this only drove inflation higher, without creating growth. Efforts to solve the crisis were only deepening it.

The paradigm that emerged in place of Keynesianism established the combating of inflation as the overarching goal of macroeconomic policy, regardless of what that meant for unemployment in the medium term. This was partly a response to the new wave of conservative economists from the University of Chicago and the think tanks of the New Right such as the Institute of Economic Affairs. From their perspective, the market could work as a reliable, apolitical information processor for everyone, governments included, but only if its main signalling tool – money – could be relied on to hold its value. These neoliberal theories also suited a particular ideological agenda: inflation harms those who are in possession of money, and benefits those who owe it. Clamping down on inflation had the effect of reasserting the sovereignty of financial capital.

Central banks occupied a pivotal position in the execution of this project from the late 1970s onwards. Thatcher and Reagan are remembered for smashing the trade unions, but nothing was more harmful to traditional industrial sectors on either side of the Atlantic than monetary policy, with interest rates heading above 16 per cent in 1980, and unemployment rising above 10 per cent not long afterwards. ‘The study of earlier periods [is] more illuminating than any amount of econometric modelling,’ King writes, but the grisly details of how inflation was conquered in the 1980s are absent from his account. On the road to the glory years of the ‘great moderation’, swathes of northern Britain and the American Midwest were the victims of a deliberately imposed monetary famine, and some have never recovered.

There​ has been a lot of talk over the last year, in the wake of the results of the EU referendum and the US election, of the demise of neoliberalism. But the neoliberal policy regime that emerged in the late 1970s hasn’t really failed – at least not on its own technical terms – in the way the Keynesian one did. It may have led to stagnating real wages, soaring executive pay, ballooning household debt, plummeting children’s wellbeing – take your pick – but the core idea, that macroeconomic policy should focus on controlling inflation and that unemployment will eventually take care of itself, has not been discarded, because in its own limited way it has continued to work. Indeed it has succeeded too well: over the past ten years, inflation has disappeared, and in some countries there is now a serious risk it will turn negative, producing a deflationary spiral that monetary policy may be powerless to arrest.

The financial crisis was unusual. It wasn’t caused by a collapse in the economic credibility of the state, of the sort that precipitates inflation and haunts the imaginations of central bankers. It didn’t start with collapsing public confidence in the banks, of the sort that triggers bank runs and terrifies financial regulators. It began with a crisis of interbank lending in the summer of 2007: the system lost confidence in itself. Money had been spiralling out of control in the years leading up to 2007, but not in ways central banks were attuned to or cared about. The explosion of credit (and exotic derivatives of credit) within the banking system rang no alarm bells among monetary policymakers, because it had no effect on the price of a pint of milk. That isn’t true of the costs of the banking crisis, which have spread well beyond the financial system and are visible every time a local library or children’s centre is closed. But the chain of causality between the two is too long and complex to trigger a traditional crisis of legitimacy.

Far from being discredited by the financial crisis, central banks were awarded more power. Over the course of the crisis, they played the role of heroic firemen containing the blaze – the action-packed story fills most of Bernanke’s book. Since then, their responsibilities have expanded beyond the setting of interest rates to encompass a far more extensive responsibility for financial regulation (which is essentially the oversight of risk). This is no longer merely a matter of the behaviour of individual institutions, but of the risk pervading the system as a whole – what’s known as macroprudential regulation. And then, of course, there’s QE. Aside from the stimulus packages that helped the US and UK economies through the worst months of 2009, governments have been unwilling to use expansionary fiscal policy to lift their economies, so that central banks have effectively had to do the work of treasury departments. The charade of ‘boring’ technocracy becomes ever harder to sustain. Reading King’s book in combination with ‘Money Creation in the Modern Economy’, you sense that central bankers have had enough of having so many political expectations dumped on their expert, ‘apolitical’ shoulders.

One cause of the crisis, King argues, was that monetary policy and financial policy were treated as separate spheres of responsibility. Monetary policy focuses on keeping things ticking over in good times, with the aim of having money keep its value; financial policy is designed to prevent catastrophic losses of confidence, both in individual banks and (thanks to macroprudential regulation) the system as a whole. Years of low interest rates leading up to 2007 resulted in escalating private sector debt and asset price inflation. In hindsight that should have looked risky, but in the absence of inflation there was simply no justification for doing anything about it, or not within the tramlines of monetary policy as they’d been established. The worry is that we’re still in the same trap, only now with the addition of ‘unconventional’ monetary policy flooding the banking system with even more money. One thing that neither Bernanke nor King mentions is the distributional effect of QE, which is sharply regressive. The Bank of England’s own assessment, in a paper published in 2012, demonstrates that by further increasing asset prices, the benefits of QE in the UK have flowed disproportionately to the 5 per cent of households that own 40 per cent of assets. But as unelected technocrats, they can scarcely be held accountable for distributional issues.

Success sticks to these monetary experts like glue, while failure always seems to attach itself elsewhere. Having first ‘conquered inflation’, then produced a ‘great moderation’, and then been tasked with stimulating the economy after the financial crisis, monetary policymakers can’t put a foot wrong. King, to his credit, senses that this is a problem. While still in charge of the Bank of England, he confessed he was baffled that the public wasn’t angrier about the costs of the financial crisis. What’s needed, he now suggests, is a ‘new equilibrium’, a euphemistic term for what Marxist economists might call a new mode of regulation, which is necessarily accompanied by a new regime of accumulation, i.e. a different form of capitalism altogether. Such a paradigm shift would probably be painful, but cannot even begin while policymakers continue to be insulated from the consequences of their actions. As long as monetary policy still ‘works’ in combating inflation, and financial policy continues to ‘work’ in preventing another major banking crisis, policymaking will be unable to process the substantial social and economic evidence that the economy isn’t really ‘working’ at all.

When​ it comes to reform, King argues, it is no more helpful to develop policy purely on the experience of the financial crisis than it is to do so wholly on the evidence of the ‘great moderation’ that preceded it. The question is not whether the truth lies in the ‘good times’ or the ‘bad times’, but how the good times led inexorably towards the bad, and will do so again. Policy must recognise this dynamic, and accept that the nature of money is implicated in it. King offers various policy suggestions, including the enforcement of lower leverage ratios for banks (requiring them to hold more equity on their balance sheets) and a switch in the function of central banks from ‘lender of last resort’ to ‘pawnbroker for all seasons’: lending institutions would place various assets with central banks as collateral during the good times, as a guarantee that they would then be lent money in times of crisis. This would avoid the ‘moral hazard’ of banks making bad loans in the knowledge that these questionable assets would have to be accepted as collateral by central banks during an emergency. The intention, here, would be to reduce the ‘alchemy’ at the heart of our financial system, which allows credit to morph into money, and then into assets, without anything of value – other than sheer trust – underpinning the initial promise. Interest rates should be set not just to combat inflation, but with a view to minimising financial risk. They should have been higher in the pre-2007 era. King doesn’t spell out the full implications of what he’s saying, but it all points to money being harder to produce, so that less wealth creation would stem from the financial sector. How, in this case, would Britain’s economy grow? Probably more slowly but maybe more reliably.

What if everyone were required to read ‘Money Creation in the Modern Economy’? Would capitalism survive? Of course it would. Once collective faith is invested in something, it becomes very hard to shake. ‘The process by which banks create money is so simple that the mind is repelled,’ J.K. Galbraith once said. Take a meat-eater around a sausage factory and they’ll most likely shut their eyes. Monetary policymakers today are struggling with the legacy of their predecessors’ triumphs. Since inflation was ‘conquered’ in the early 1980s, the credibility of money has been assured. Money, King reminds us, is nothing without trust, but it has become viciously successful in commanding that trust. The policy problem presented by deflation is how to reverse-engineer this confidence trick.

The truth, as King knows full well, is that many of us would benefit if inflation could be unconquered, at least for a while: it would eat into public and private debts and stimulate spending; it might also unleash some of the vast cash reserves currently sitting on corporate balance sheets. But no matter how many central bankers believe this, none would ever say it. King takes an arcane policy suggestion that central banks ‘promise to allow inflation to go above their normal target at some point in the medium term’ – what amounts to inviting the financial markets to a one-off 1970s theme night – and dismisses it as ‘literally incredible’. In the public performance of monetary policy, either you’re being sincere or you’re not. There’s no room for irony. Part of the vocation of a central banker is to combat inflation, even when there’s none left to fight.

You can put out signals that higher inflation would be welcome, but they don’t necessarily register. You can inform people that money is of no intrinsic value, and that they’d be better off just spending it, but you can’t make them do it. You can cut interest rates to zero – and even make them negative – but there is no guarantee that people won’t hang on to their money regardless. It partly depends whether there’s anything worth investing in or spending money on. Last summer Standard & Poor’s estimated that 500 million people worldwide are currently living under negative central bank interest rates. This has various undesirable side effects, such as pension funds being forced to shift long-term investments into riskier assets. When negative rates are passed on to consumers (such that savers are effectively charged a levy for depositing their cash with a bank), there are visibly more disruptive effects, such as the growth of a cash-based economy and all the security concerns that go with it.

The problem with trying to stimulate economic activity by cutting interest rates is that it becomes less and less effective over time. It’s one thing to use this tactic in an economic emergency, as occurred in 2008, and it can help to pull an economy out of recession, as it did in 2009. But the longer it goes on, the weaker the effect becomes. The purpose of cutting interest rates is to privilege the present over the future – to bring forward spending that might otherwise have been deferred. As a matter of principle, conservatives tend not to like this because it undermines the Protestant ethic of delayed gratification on which capitalism was built in the first place. The more tangible worry, as ever, is about inflation. But the reason interest rate cuts become less effective is that by privileging the present, they suck out demand from the future. And the more time passes, the greater the problem becomes. Monetary policymakers find themselves trying to stimulate an economy whose vitality has already been sapped, thanks to their own decisions. ‘The “headwinds” that the major economies are facing today,’ King says, ‘are not the result of a temporary downward shock to aggregate demand, but of an underlying weakness caused by the earlier bringing forward of spending.’ He compares the situation to that of a cyclist pedalling up an ever steeper hill. Or we might think of someone briefly prescribed painkillers following a nasty accident, who then becomes reliant on them in ever greater doses.

This ‘bringing forward’ of the future is another of money’s magical qualities. Without it, capitalist investment would be virtually impossible: most businesses would only expand through retained earnings; entrepreneurs would have to be born into money. Yet it also presents an opportunity for manipulation. The remarkable expansion of financial services – and the profits made on the back of them – over the last thirty years has been based on this capacity to extract value from the future. Derivatives (including the credit derivatives that triggered the financial crisis) turn the uncertainty of the future into a source of revenue. The accounting techniques used by banks permit them to value their assets on the basis of projected future earnings, rather than on what they’ve paid for them.

The problem with viewing the future as territory to be plundered is that eventually we all have to live there. And if, once there, finding it already plundered, we do the same thing again, we enter a vicious circle. We decline to treat the future as a time when things might be different, with yet to be imagined technologies, institutions and opportunities. The control freaks in finance aren’t content to sit and wait for the future to arrive on its own terms, but intend to profit from it and parcel it out, well before the rest of us have got there.

While independent central bankers were ultimately successful in their battle against inflation, it seems that the task of reversing deflationary stagnation is beyond them. Since the 1970s technocrats have shown themselves able to suck political hot air out of the monetary system, achieving price stability by acting predictably, boringly and apolitically. But they seem unable to blow it back in again, at least not without becoming the interventionist political figures they are supposed precisely not to be. The post-2008 groundhog day of low interest rates and QE could have carried on indefinitely, had political uncertainty not shaken things up again. The events of 2016 have churned up the rigid landscape of monetary policy in ways that couldn’t have been foreseen. Inflation looks set to be untamed once more, not least because the impact of Brexit on sterling will drive up the price of imported goods. The ‘apolitical’ status of technocrats is suddenly more dubious than it has been since the 1970s.

The populist groundswells that drove the Brexit vote and Donald Trump’s election shared an antipathy to ‘experts’ and ‘liberal elites’, whose lack of democratic mandate was used as a basis on which to oppose them. Inevitably, central banks have been sucked into this conflict. The present governor of the Bank of England, Mark Carney, was attacked by senior pro-Brexit politicians for the bank’s gloomy economic forecasts (he was accused of cooking the figures in service of Remain’s cause), and Janet Yellen, the chair of the Federal Reserve, featured in a Trump campaign ad as a representative of the Wall Street ‘elites’ that needed clearing out. Stuff of this sort was perhaps unavoidable. Central banks have never been democratic institutions, but under neoliberalism they became all but anti-democratic in their function, aimed specifically at insulating the financial world from the vagaries of politics. In their caution and their calculated manner of speaking, central bankers represent everything that Trump and Brexiteers are not, indeed everything that Trump and Brexiteers promise to overcome. The control that Leave voters were allegedly taking back wasn’t only from Brussels or over national borders. There was also an implication that power would be taken back from those such as central bankers who were perceived to have an excess of control – technical control, self-control, careful attention to consequences – and handed over to those who, frankly, seem a little out of control. Contrast a figure like Bernanke, poring over speeches to decide whether it’s time to use the metaphor of a market ‘bubble’ or persist with the milder ‘froth’, with that of Trump, from whom words tumble apparently free of all reflection or constraint.

Trump’s chief strategist, Steve Bannon, has said that the Trump administration will engage in a trillion-dollar infrastructure investment scheme, and seek to revive the very industries, such as steel and shipbuilding, that neoliberalism left for dead. Bringing jobs back to the industrial heartlands is the ostensible justification for this. Describing this as ‘economic nationalism’, Bannon recognises at least that zero or negative interest rates offer great opportunities for fiscal policy – something of which many central bankers have repeatedly reminded policymakers, but until now to no avail. Then again, it isn’t clear if economics is providing the rulebook in this new political reality: Bannon’s views on inflationary risk are as yet unknown, but it’s unlikely to keep him awake at night. In the present climate, any central banker who threatened to stand in the way of such schemes, as Greenspan did to Clinton in 1993, might not be in a job for very long.

Send Letters To:

The Editor
London Review of Books,
28 Little Russell Street
London, WC1A 2HN

Please include name, address, and a telephone number.

Read anywhere with the London Review of Books app, available now from the App Store for Apple devices, Google Play for Android devices and Amazon for your Kindle Fire.

Sign up to our newsletter

For highlights from the latest issue, our archive and the blog, as well as news, events and exclusive promotions.

Newsletter Preferences