A Review of The End of Alchemy
By Scott Hunter
Endineering and Physics Major
Reviewed January 23, 2017
The End of Alchemy, written by Mervyn King, the Governor of the Bank of England, is an analysis of the 2007-9 economic recession and provides critical thoughts on the current stagnation of the world economy. In The End of Alchemy, King discusses the reasons he believes teh 2008 banking crisis occurred and offers ways that these underlying issues could be resolved. The major reform King champions is a reform of central bank lending.
This book addresses economic freedom indirectly, focusing on the tie between the banking sector and government. King supports the economic freedom of banks and business to make loans because he encourages deregulation, but not completely. He also calls for reform of current money and fiscal policy so that it is more efficient. With his reforms implemented, the practice King deems alchemy, or banks selling increasingly risky loans to each other on future profits without enough equity to absorb losses from them, should stop. King explained very well why the banking system needed to change, and I agree that it does need modification, but I think that the methods offered needed some additional policy in place to prevent banks from overextending themselves. King's major idea of making central banks into a Pawnbroker For All Seasons (PFAS) instead of a Lender of Last Resort (LOLR) would do a good job of eliminating bank runs, and his comment on needing to regulate the leverage ratio a bank can have could be effective in preventing banks from overextending themselves. The leverage regulation is a reform which would actually deregulate to free up banks to make loans of a variety of risks without having to estimate the risk of each loan, and without limiting the number loans a bank could have of a specific risk value. I think that this is a great general solution, but I am curious to see if this would completely solve the problem in practice. The point of the simple solution is that it frees up banks to make loans while giving them a safety net which allows failure, but I wonder if it would be too free, where banks would try to beat the system by changing the proportion of risky assets to safe assets.
Another way economic freedom was discussed was in exploring the relationship of central banks to nations. Mervyn King's view was that money is tied to national boundaries. He uses countries using the euro as an example to show that countries using a common currency are chained to each other. They lose control over inflation targets and their own central banks. Further, each country in such a union is subject to the financial decisions of the union, and so loses sovereignty over their own economy. I absolutely agree. It could be possible for such a union to exist, and other countries exist which have adopted other currencies as their own, but they lose the power to control the economy by printing money and deciding exchange rates, and are at the mercy of the fluctuations of the adopted currency. This is okay for emerging economies, King asserts that an essential part of a successful capitalist economy is stability, and this would limit the stability of an established nation. King makes good, logical points. I think that though a single currency would be simpler, different currencies varying by country provide enough freedom for a country to control its own economy.
These economic freedoms which King addressed are primarily for central banks. First, King is saying that central banks should be unchained from having to bail out banks because independent banks are too essential to fail. By becoming a PFAS, this would maintain the necessary confidence in banks during an economic downturn to prevent bank runs while allowing appropriate competition, where a bank that takes on too many risks can be penalized. He also calls for reform and deregulation of banking laws, which he hopes would free up banks to lend as well as give them incentive to make good ones. Second, with regard to currency and inflation targeting, King is in support of central banks having the power to control inflation through their government. If they are part of a greater monetary union, then they and their government lose the freedom to choose their own inflation targets and thus regulation of prices and wages. Both of these freedoms are for an overseeing organization, and are not returning total freedom back to the people directly, but I would say they promote market stability and confidence in banks so that individuals are free to make economic choices using a stable medium, and allow the people of a democratic nation to decide how to run their economy through their elected leaders.
I think King's explanation of the events behind the 2008 crisis was both thorough and clear. The insight King offered about reforming systems that caused the crisis were well-supported by history and current thought, but also leaves room for expansion and development. These ideas, though challenging for someone new to the field, are worthy of consideration, and should be considered quickly, to resolve the present hurting economy.