The Alchemists: Three Central Bankers and a World on Fire
Page 1
THE PENGUIN PRESS
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Copyright © Neil Irwin, 2013
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Photograph credits appear here.
ISBN 978-1-101-60580-6
To my parents, Co and Nancy Irwin
Contents
Title Page
Copyright
Dedication
Time Line
Introduction: Opening the Spigot
Part I:
RISE OF THE ALCHEMISTS, 1656–2006
ONE. Johan Palmstruch and the Birth of Central Banking
TWO. Lombard Street, Rule Britannia, and Bagehot’s Dictum
THREE. The First Name Club
FOUR. Madness, Nightmare, Desperation, Chaos: When Central Banking Goes Wrong, in Two Acts
FIVE. The Anguish of Arthur Burns
SIX. Spinning the Roulette Wheel in Maastricht
SEVEN. Masaru Hayami, Tomato Ketchup, and the Agony of ZIRP
EIGHT. The Jackson Hole Consensus and the Great Moderation
Part II:
PANIC, 2007–2008
NINE. The Committee of Three
TEN. Over by Christmas
ELEVEN. A Wall of Money
Part III:
AFTERMATH, 2009–2010
TWELVE. The Battle for the Fed
THIRTEEN. The New Greek Odyssey
FOURTEEN. The King’s Speech
FIFTEEN. The Perilous Maiden Voyage of the QE2
Part IV:
THE SECOND WAVE, 2011–2012
SIXTEEN. The Chopper, the Troika, and the Deauville Debacle
SEVENTEEN. The President of Europe
EIGHTEEN. Escape Velocity
NINETEEN. Super Mario World
TWENTY. Governor Zhou’s Chinese Medicine
AFTERWORD: Back to Jackson
Photographs
Acknowledgments
A Note on Sources
Notes
Image Credits
Index
Time Line
November 30, 1656—Johan Palmstruch’s Stockholms Banco is chartered by Swedish king Karl X Gustav.
1661—Stockholms Banco issues the first paper banknotes in Europe.
September 17, 1668—After Stockholms Banco collapses, the Swedish Riksbank is created. It remains the country’s central bank until this day.
July 27, 1694—King William III charters the Bank of England.
May 10, 1866—British bank Overend, Gurney & Co. fails, sparking a panic in the London money markets. The Bank of England floods the banking system with liquidity, acting as lender of last resort.
Fall, 1907—A banking panic in New York sparks a global economic downturn, crystallizing the need for a central bank in the United States.
December 23, 1913—The Federal Reserve Act passes, setting up a central bank for the United States, albeit one with a complicated structure of twelve powerful regional branches.
1923—The German Reichsbank, led by Rudolf von Havenstein, prints massive amounts of money, resulting in hyperinflation. Price increases of thousands of percent per month destabilize the war-ravaged nation and spark uprisings by the Nazis and other insurgent groups.
November 16, 1923—Hjalmar Schacht introduces a new and more stable German currency, the rentenmark. Its value is set at one rentenmark per trillion reichsmarks.
October 29, 1929—The U.S. stock market crashes on “Black Tuesday.”
May 11, 1931—Credit-Anstalt, a leading Austrian bank, fails, prompting a ripple effect of withdrawals and more bank failures in Germany and elsewhere in Europe.
July 9, 1931—Hans Luther, head of the German Reichsbank, travels to European capitals and then to meet fellow central bankers in Basel, looking in vain for international relief from the growing banking crisis.
September 21, 1931—Britain leaves the gold standard, facing economic collapse should it try to maintain the peg of the pound to the price of gold.
July 22, 1944—Global economic leaders finish a conference in Bretton Woods, New Hampshire, where they agree to a world economic order for the post–World War II globe.
August 15, 1971—With the United States struggling to maintain the peg of the dollar to gold as mandated by the Bretton Woods system, President Richard Nixon suspends the gold window. His advisers include Federal Reserve chairman Arthur Burns and Treasury official Paul Volcker.
1978—In Arthur Burns’s final year as Federal Reserve chair, inflation reaches 9 percent.
October 6, 1979—In an unscheduled Saturday meeting of Fed policymakers, new chairman Paul Volcker engineers an interest rate hike and a new strategy to tighten the money supply, aiming to bring down inflation. These rate hikes lead to a deep recession, but eventually end the inflation that took root under Burns.
December 10, 1991—European leaders agree to the Maastricht Treaty, pledging to create a common currency.
June 1, 1998—The European Central Bank is created to administer the euro.
March 19, 2001—Suffering economic stagnation in the wake of a real estate and banking system collapse, the Bank of Japan begins a program of buying assets, known as quantitative easing.
July 1, 2003—Mervyn King takes office as 119th governor of the Bank of England.
November 1, 2003—Jean-Claude Trichet takes office as second president of the European Central Bank.
February 1, 2006—Ben Bernanke takes office as the fourteenth chairman of the Board of Governors of the Federal Reserve System.
2007
August 9—BNP Paribas announces it is unable to value mortgage-related assets on the books of three funds it manages, sparking a freeze-up in money markets and a €95 billion intervention by the ECB.
September 14—The Bank of England intervenes to aid Northern Rock, a British bank on the verge of failure.
December 12—The Federal Reserve, Bank of England, ECB, and central banks of Canada and Switzerland announce “liquidity swap lines” to provide up to $24 billion to help ease a freeze-up of the banking system. The first joint international effort of the global central banks during the crisis, it is a tool to channel dollars from the Fed to European banks that are facing shortages of dollars.
2008
March 14—The Fed rescues investment bank Bear Stearns by putting up $30 billion toward its acquisition by J.P. Morgan. It is the first bailout by the Fed in the crisis.
September 15—Lehman Brothers files for bankruptcy.
September 16—The Fed rescues insurer AIG with an $85 billion emergency loan.
September 18—The Fed, ECB, and central banks of Britain, Canada, Japan, and Switzerland expand swap lines by $180 billion, a move that enables the global central banks to lend dollars into their domestic banking systems.
Septem
ber 24—Fed swap lines are extended to the central banks of Australia, Sweden, Denmark, and Norway.
September 29—Swap lines are expanded by another $330 billion.
September 30—The Irish government announces it is guaranteeing the liabilities of the nation’s major banks, sparking a run on banks in European nations without such guarantees.
October 7—The Fed announces the “Commercial Paper Funding Facility” to backstop the multitrillion-dollar market for short-term corporate lending.
October 8—In the first ever globally coordinated monetary policy action, the central banks of the United States, eurozone, Britain, Canada, Sweden, and Switzerland announce that they are all cutting interest rates.
October 29—Fed swap lines are extended to the central banks of Brazil, Mexico, South Korea, and Singapore.
November 6—Bank of England cuts target interest rate by 150 basis points.
December 16—The Fed cuts its target interest rate to near zero and says it expects conditions will warrant “exceptionally low” rates for “some time.”
2009
March 5—The Bank of England slashes its target interest rate to 0.5 percent and announces £75 billion of bond purchases, or quantitative easing.
March 9—Global stock markets reach their lowest levels in over a decade, with the Standard & Poor’s 500 off 57 percent from its 2007 peak.
March 18—The Fed expands its own quantitative easing, to a total of $1.75 trillion in purchases of a variety of securities.
March 24—Bernanke and Timothy Geithner, the treasury secretary and former New York Fed chief, are pilloried in a House committee hearing for bailing out AIG.
May 13—The ECB cuts its main interest rate to a record low 1 percent.
June 17—Mervyn King delivers the annual Mansion House speech in London, blindsiding Chancellor Alistair Darling with criticism of British bank regulation.
August 6—King is outvoted on the Bank of England’s monetary policy committee, favoring a larger expansion of quantitative easing than the majority.
August 25—President Barack Obama announces that he is reappointing Bernanke to a second term as Fed chair.
October 4—The socialist PASOK party prevails in Greek elections, bringing Prime Minister George Papandreou to power. His government encounters massive deficits.
2010
January 28—The Senate confirms Bernanke for a second term as Fed chair by the narrowest margin in history.
February 7—Finance ministers and central bankers of the Group of Seven leading industrialized powers meet in the Iqaluit, Canada. In the frigid Arctic air, a consensus emerges toward austerity and tighter money.
February 11—European leaders hold an emergency summit on Greece and pledge to aid the cash-strapped nation.
April 23—Papandreou asks for a €45 billion bailout from European nations and the IMF.
May 2—European leaders agree to a €110 billion Greek aid package, which markets quickly decide is inadequate.
May 5—Protests of Greek austerity measures turn violent in Athens, as three people die in a firebombed bank.
May 6—The ECB holds a monetary policy meeting in Lisbon and makes no change to interest rate policies. Markets decline as Trichet suggests no move toward ECB aid for Greece. U.S. markets experience what becomes known as the Flash Crash, plummeting briefly. That evening, ECB governing council members discuss the possibility of buying bonds to ease pressure on Greece and other nations facing high borrowing costs. British elections are held, resulting in a swing in power toward the conservatives but no outright majority, necessitating negotiations to form a coalition with the Liberal Democrats.
May 7—Axel Weber, president of the German Bundesbank, sends an e-mail to colleagues retracting his open-mindedness of the night before to ECB bond purchases. Trichet travels to Brussels to impress upon European government heads the urgency of a eurozone rescue fund, implicitly dangling the possibility that if they act, the ECB could take action as well.
May 9—Eurozone finance ministers negotiate in Brussels to create a €750 billion rescue fund, known as the European Financial Stability Facility, as ECB officials in Basel, Frankfurt, and elsewhere agree to begin buying bonds to allay pressure from the bond markets. Weber votes against the move and holds a secret conference call of the Bundesbank board to consider whether to comply with the ECB’s directive. The Fed reopens swap lines with the ECB and other international central banks.
May 11—A crucial amendment to the Dodd-Frank Act aiming to increase transparency at the Fed—but maintain independence of monetary policy—passes the Senate. David Cameron becomes British prime minister after successfully forming a coalition with the Liberal Democrats.
May 12—An amendment to keep the Fed in place as regulator of large and small banks passes the Senate.
July 21—Obama signs the Dodd-Frank Act into law, increasing the powers of the Fed.
August 27—Bernanke gives a speech at the Jackson Hole economic symposium, raising the possibility of a new round of quantitative easing to address a slowdown in the U.S. economy.
October 18—In Deauville, France, German chancellor Angela Merkel and French president Nicolas Sarkozy walk on a seaside promenade and agree that private creditors must take losses in future bailouts. Trichet is stridently opposed to this approach, which causes a new wave of disruption in financial markets.
October 23—Finance ministers and central bankers of the Group of 20 major world powers meet in Gyeongju, South Korea, where Bernanke explains the Fed’s expected new policy of quantitative easing to skeptical international policymakers.
November 3—The Fed announces it will buy $600 billion in Treasury bonds in a second round of quantitative easing that will be widely known as QE2. It draws intensive criticism from American conservatives and the German, Chinese, and Brazilian governments.
November 21—Ireland, under post-Deauville pressure from bond markets, requests a bailout.
2011
February 11—Axel Weber resigns from the Bundesbank. His opposition to ECB bond purchases makes his possible ascent to the presidency of the central bank untenable.
April 6—Portugal requests a bailout, becoming the third European country to do so.
April 8—The ECB elects to hike interest rates, the first of two quarter-point increases, seeing a risk of inflation even as much of the continent falls into depression.
May 6—Trichet leaves a secret meeting of European officials in Luxembourg where the possibility of Greece leaving the eurozone is to be discussed, angry that the existence of the meeting has leaked to the press.
May 11—Merkel indicates that she supports Mario Draghi, Italy’s top central banker, to replace Trichet as ECB president when Trichet’s term is to end.
May 14—Dominique Strauss-Kahn, the managing director of the IMF, is arrested in New York for sexual assault against a hotel maid. He had been a crucial voice in negotiations over Greek aid to take into account the damage that rapid austerity could cause to the Greek economy.
May 17—European finance ministers instigate talks over Greek bondholders taking losses, against Trichet’s vociferous objections.
June 16—Mervyn King and new chancellor George Osborne deliver a coordinated message at the Mansion House Dinner in London, announcing plans to bring down budget deficits and to shift far greater control over the financial system to the Bank of England.
June 30—Papandreou narrowly clings to power in Greece as he wins passage of a €78 billion package of austerity measures. Violence continues in the streets as the Greek economy falls into depression.
July 21—After lengthy negotiations, a group representing banks and other Greek bondholders agrees to take a loss.
August 5—With borrowing costs spiking for the Italian and Spanish governments amid a loss of confidence in European resolve, Trichet sends lette
rs to the Italian and Spanish finance ministers outlining the steps they must take to receive help from the ECB.
August 7—The ECB resumes buying bonds, now including those from Spain and Italy.
September 9—Jürgen Stark, a German member of the ECB executive board, resigns, joining Weber as the second German to leave in protest of bond buying by the central bank.
September 21—Responding to another wave of weakness in the U.S. economy, the Fed announces its Maturity Extension Program, known as Operation Twist, aimed at replacing $400 billion in shorter-term bonds the Fed owned with a comparable amount of longer-term bonds, achieving some of the effects of new QE with less political blowback.
October 6—Concerned about the ripple effects of the eurozone crisis on the British economy, the Bank of England policy committee unanimously agrees to an additional £75 billion of quantitative easing.
October 19—At a farewell celebration for Trichet at the Frankfurt opera house, key players including Trichet, Draghi, Merkel, Sarkozy, and IMF chief Christine Lagarde meet to plot a path forward, amid worries that neither Papandreou nor Italian prime minister Silvio Berlusconi have the credibility to continue leading their nations.
October 27—European leaders, in yet another summit, negotiate for Greek bondholders to take further losses and extend a new aid package to Greece.
October 31—Papandreou calls for a referendum on the Greek bailout agreement, creating a situation in which a no vote would mean his nation’s leaving the eurozone.
November 1—Draghi takes office as the third president of the European Central Bank.
November 3—The ECB cuts its interest rate target a quarter percent at Draghi’s first policy meeting as president, and follows suit the next month, reversing the Trichet rate hikes from the spring of 2011 and reacting to a rapidly deteriorating European economy.
November 4—At the Group of 20 summit in Cannes, Merkel, Sarkozy, and other heads of state pressure Papandreou and Berlusconi to fulfill their obligations or stand down.
November 6—Papandreou steps down, to be replaced as prime minister by Lucas Papademos, a former ECB vice president.