CENTRAL BANKING THROUGH THE AGES - REVIEW OF NEIL IRWIN'S "THE ALCHEMISTS"

Neil Irwin's The Alchemists: Inside the Secret World of Central Bankers (2013) is a history of central banking mainly in the West. There are many positives to this book: Irwin has done a lot of painstaking research to get his facts right and yet the book does not read like an academic tome. Indeed it is a very engrossing and fast-paced narrative and Irwin has the ability to capture the reader's attention (despite his obvious sympathies towards central bankers).




Central banking has always been a source of controversy as Irwin demonstrates. The first central bank was the Swedish Stockholms Banco established in 1656 and run by fraudster Johan Palmstruch. When, in 1660, there was a run on the bank, Palmstruch had an idea that foreshadowed Keynesian thinking centuries later - print paper money at will to meet demands.

Irwin writes:
"With [the unlimited printing of paper money], one understanding of money - as a physical object, its value rising and falling depending on the supply and demand for the metal it's made of - was replaced by another. Money was instead an idea, something unrelated to the actual value of the material on which it is printed. Instead, its value is set by the institution - specifically the central bank - that issues it. Like Palmstruch's printed paper, modern currency holds its value ultimately because of public confidence in the authority that stands behind it."

There were also controversies surrounding the birth of the Bank of England in 1694 and the US Federal Reserve Bank in 1914. The US got its Federal Reserve Bank (the Fed) after a century of trying. There had been two failed attempts before that due primarily to the distrust of the American public of big government. Indeed the distrust was so widespread that the birth of the Fed in 1914 was done wholly by stealth.

The German Reichsbank was created in 1876 and was responsible for the German hyperinflation in the 1920s when the bank printed money recklessly to pay the vast reparations that were imposed on Germany after its defeat in World War I.

Referring to the hyperinflation, Irwin writes:
"Year-to-year price increases weren't just high; they were exponential. At the end of 1920, a dollar would have bought you 73 marks. At the end of 1921, 192 marks. At the end of 1922, 7,589. In November 1923, that same dollar would have bought you 4.2 trillion marks."

More than half of The Alchemists is about recent developments - the 2008 Great Recession - which originated in the US and its after-effects such as the crisis in Europe. Irwin covers the events from 2008 (when the subprime crisis emerged) to 2012 (when QE infinity was announced). Irwin manages to make it all interesting.

One of the negatives of this book is that Irwin stands much in awe of the central banks and the enormous power they wield in shaping the destinies of nations. I think a reality check is warranted. The right perspective to take is that the central bankers are just a bunch of bumbling bureaucrats who have no inkling of how the real world works, and who have, by their actions, painted themselves into a corner while favouring the debtors over savers.

One important incident that Irwin leaves out of the book is the near collapse of the giant US hedge fund Long Term Capital Management (LTCM) in 1998 following Russia's default on its debt payments. Alarmed that the collapse of LTCM would have worldwide repercussions, the Fed arranged for its bailout by Wall Street banks. LTCM was an early example of an institution that was "too big to fail". This bailout of LTCM augmented by the accommodative policies of the Fed under Alan Greenspan emboldened Wall Street banks to take on even higher risks, confident that they will not be allowed to fail. This oversight of the Fed resulted in extreme financial engineering and high leverage by Wall Street banks that directly resulted in the 2008 crisis. Now it was the turn of the Wall Street banks to be bailed out by the Fed. If there is another economic collapse in the near future, given the state of the Fed's balance sheet, who will bail out the Fed?

Central banks, since 2008, have been kicking the can down the road by their artificial stimulus policies, postponing the inevitable. Now many central banks such as those of Japan, Sweden and the European Union, have embarked on negative interest rates with still no improvement in their economy. It must be remarked that negative interest rates are unnatural and are being tried for the first time in 5000 years.

It bears repetition that central banks have corrupted the very essence of money - making it a fiction, an illusion that is backed by nothing but the confidence of its users. Where will this end? With the collapse of paper money? I look forward to an age where there is a return to commodity backed money rather than this confidence-backed money - a return to senses in a way.