Money, central bankers, and recession
History - World Released - Oct 05, 2014
“It was something none of us had experienced. It was as if your entire life you turned the spigot and water came out. And now there was no water.”
That was how one executive of a major global bank described it, and he couldn’t have put it better. Liquidity was exactly what was disappearing in the banking system that day: dollars, euros and pounds had stopped flowing. And when banks fail to lend money, the economies they serve also fail. The date was August 9, 2007, the beginning of the world-wide recession. To understand what happened and why, is the subject “The Alchemists: Three Central Bankers and a World on Fire,” by New York Times correspondent Neil Irwin.
The three central bankers were Ben Bernanke, chairman of the United States Federal Reserve; Jean-Claude Trichet, president of the European Central Bank; and Mervyn King, governor of the Bank of England. These were the men at the controls when the world economy began to unravel in 2007, and Irwin’s book is about what they did to prevent a complete financial collapse.
To understand what went wrong, you must first understand what money is. Money is not a thing; it’s an idea. For most of human history it was thought of as a thing, riches taken from the ground: gold, silver, copper, and precious stones. Such thinking led to the belief that wealth was limited, a zero-sum game, one in which if any player gained, another lost in proportion. Wars were fought to rob another country of their riches. Alchemists, meanwhile, looked for ways to create wealth by turning mundane materials into silver and gold. Two things changed that limited outlook: the printing of paper money, and the introduction of securities--government stocks and bonds. It turned out the secret to creating wealth was in paper, a printing press, and a central bank, imbued with power from the state. Today’s alchemists are the world’s three central bankers who control the flow of money.
Money is a measure of human resources. It’s no accident that nations with highly productive economies like the U.S. are the ones with money that holds its value. The U.S. dollar has been around since our nation’s founding. It’s value is not based on the gold inside Fort Knox; that stopped in 1971. It’s value is based on our nation’s annual Gross Domestic Product of $14 trillion. It’s also no accident that the most productive nations have the freest economies, and are for the most part governed democratically. Free nations make the most of human resources, and on a per-capita basis produce the most wealth. Nations that restrict human resources through political or religious ideology, restrict wealth. Indeed, the least productive economy is one based on slavery. Slavery squanders human resources, a point illustrated in “The Wealth of Nations” by Adam Smith, a book published, coincidentally, the same year as the U.S. Declaration of Independence. In times past, when slave economies were the rule, the amount of gold and silver held in a nation’s treasury was the measure of a nation’s wealth. In today’s free economies, that is no longer the case. Yes, gold and silver are more precious than ever, but as a “thing” they are heavy and cumbersome. There isn’t enough to go around, and you can’t eat it; in order to spend it, you must exchange if for something more convenient--paper money. Gold, silver and precious stones are of another age, an age of static wealth and slavery. Money, stocks and bonds are of the modern age, of free economies and democratic governments. As a measure of human resources, money, stocks and bonds are forever creating new markets and increasing wealth.
Sweden was the first country to print money, which revolutionized that nation’s economy. Other western nations followed suit, including England, which took the concept several steps further, with the creation of money markets. Off by itself on an island in northwest Europe, England didn’t have a lot going for itself. It had a short growing season, and coal reserves deep within mines that were constantly flooded and therefore difficult to exploit. Like many emerging European nations, England had lots of debt. It also had a banking genius named Robert Walpole who as Britain’s Exchequer (equivalent to U.S. Treasury Secretary) converted the nation’s debt into government securities that were insured by the central government. These securities increased in value and among businesses exchanged hands like money. Banks all over England and Scotland began buying them, thereby concentrating all the nation’s wealth in London. An individual can’t build a rail line from New Delhi to Mumbai, or even from Scotland to London, or erect giant textile mills capable of clothing millions, or build steam engines to pump water from flooded coal mines. But if you put together the savings of an entire country and have a smart banker choosing the projects that deserve financing, suddenly you have the nation’s savings going out to fund large, complex endeavors that are essential to an industrial economy. By 1873, total bank deposits at the banks in London amounted to 91 million pounds, compared to 15 million in France, and 8 million in Germany. A nation with 2 percent of the world’s population, commanded an empire that stretched from New Delhi to Toronto, Hong Kong to Johannesburg. While Japan built wooden ships powered by the wind, England built steel ships powered by steam. When China needed locomotives and thousands of miles of steel track, it purchased them from England. The magic that made it possible was the management of paper money in all its forms.
Fast forward to our day and Great Britain is no longer the economic giant it once was, but it’s still a major player. Today, the world’s major money managers are located on the ninth floor of the New York Fed building in Lower Manhattan (representing the United States), at the German Bundesbank in Frankfurt (representing the European Union), and on Threadneedle Street in London (representing the United Kingdom). While these central banks represent the world’s great democracies, the men who manage them are not elected--they are appointed. These central bankers uphold one end of a grand bargain that has evolved over the past 350 years. Democracies grant these secretive technocrats control over their nations’ economies; in exchange, they ask only for a stable currency and sustained prosperity (something that is easier said than done). Centrals bankers determine whether people can get jobs, whether their savings are secure, and, ultimately whether nations prosper or fail.
What started the recession in August of 2007 was the announcement by gigantic French bank BNP Paribas that it was suspending withdrawals from three funds it managed. The funds were invested heavily in U.S. home-mortgage-backed securities that had become nearly impossible to value. While the funds didn’t amount to much, the announcement confirmed the worst fears of bankers across Europe. They’d been worried for weeks about the loses they were facing on U.S. home loans. It’s not for nothing that the word “credit” derives from the Latin creditus, “trusted.” Banks use highly rated securities as almost the equivalent of cash--whenever they need more dollars or euros, they hand the bonds over to another bank for collateral. Now, that exchange became complicated. The problem wasn’t just that the securities were worth less than they’d been before--banks can deal with losses. It’s just that now no one knew exactly how much less--and whether, if one bank had lent money to another in exchange for mortgage-backed securities, it would ever get paid back. From there the problem spread, becoming a crises in the U.S. by the time of the 2008 presidential election. No one had seen anything like it since the Great Depression of the 1930s. Back then the central bankers dealt with crises separately, and often at odds with one another, making the problem worse instead of better. The economy deteriorated so badly in Germany that it led to the rise of Adolph Hitler and the second World War.
Fortunately, the heads of the world’s three central banks charged with resolving the crises were well-studied in the history of money markets, dating back to the time Sweden printed its first paper thaler. They were well-versed in the multitude of short-sighted mistakes that had been committed down through the centuries. They knew, for example, the Great Depression was at its core a failure of central banking, and could have been averted had the principle players worked together. These current central bankers were determined to work together now. Even so, they had a rocky road ahead of them, and still do to this day. But they did prevent what many had feared at the time: a complete meltdown of the world’s economy, followed by a long recovery of one or two decades.
What they did in the fall of 2008 was build a wall money around the problem. They did it by lending to banks and investment firms and even individual businesses. They did it by swapping dollars and euros and pounds with each other and their counterparts in emerging nations. They did it by trying to influence their governments to bail out insolvent banks. With people in almost every country on earth hoarding their money, the central bankers created more of it, flooding the financial system, substituting their own bottomless resources for those of newly fearful world investors.
From May 2008 to March 2009, the global stock market fell in value by almost $27 trillion, a 47 percent drop, wiping out the wealth equivalent to the goods and services produced by every human on earth in half a year. If you look at a graph of the U.S. stock market, the period 1929 to 1931 tracks very closely with that of 2007 to 2009. So do measures of the economy more broadly, such as industrial production. But in the 1930s--and this is key--the decline continued for many years. In the recent episode, it leveled off in the spring and summer of 2009. While the U.S. economy has pretty much recovered since then, economic problems persist in the European Union, mainly from EU countries that are relatively new to democracy--Greece, Italy, Portugal and Spain. For these four countries, the lessons learned have come at a steep price, a price that Europe as a whole has been paying, and paying. The alternative is very likely the dissolution of the EU.
Additional sources: “The Most Powerful Idea in the World” by William Rosen, “On the Medieval Origins of the Modern State” by Joseph Strayer, and “Novus Ordo Seclorum” (new world order) by Forrest McDonald.