The Alchemists: Three Central Bankers and a World on Fire

by Neil Irwin

  Offering more than just the appearance of activism, Hollande campaigned on a promise to raise taxes on the wealthy to cut budget deficits while maintaining social welfare benefits. In the end, he won, and then he began swiftly to deliver. Significantly for Europe as a whole, he was skeptical of Germany’s all-austerity-all-the-time model for how Europe ought to fix itself. Combined with the emergence of Monti in Italy, his election left Merkel an isolated advocate of an approach that had, to that point, been failing.

  It also marked a near-complete ejection of the national leaders who’d fought the earlier stages of the global crisis, with only Merkel still in place. In some countries (Britain, Spain, Portugal) voters ousted parties on the left in favor of those on the right, in others (France and arguably the United States in 2008) on the right in favor of those on the left. It was a matter of who was in power. It’s no coincidence that Merkel not only survived politically, but also received high approval ratings in mid-2012: Germany’s economy had been performing better than that of any other large Western nation. Voters elsewhere didn’t know exactly what they wanted in their elected leaders—they just knew they wanted something different from what they’d had.

  In this volatile political climate, voters in Greece seemed to want something very different. On May 6, the same day Hollande prevailed over Sarkozy, Greeks went to the polls to choose the parliament that would replace Papademos’s coalition government. The results stunned the world—or at least that portion of the world that hadn’t tracked the growing discontent on the streets of the Hellenic Republic.

  According to Greek opinion polls, voters overwhelmingly objected to the agreement with the troika to which their government had agreed. But they also by wide margins wanted to keep the euro. These were, practically speaking, irreconcilable views. If the nation rejected the bailout deal, it would rapidly run out of money to pay its bills—not just what it owed international creditors, but also salaries for government employees and payments to hospitals, the military, and so on. Unlike a nation with its own currency, Greece couldn’t simply print money to fund those obligations, inflationary consequences be damned. The decision to reject the troika’s demands would almost certainly have to be accompanied by a decision to convert to a new drachma or other uniquely Greek currency.

  The new currency would surely plummet in value against the euro, in expectation of high inflation. That would crush the savings of any Greeks who hadn’t already moved their euros to a Swiss or German bank or stashed them in cash somewhere in their homes. It would also make all Greeks’ paychecks lower in real terms, accomplishing in one fell swoop the reduction in wages that the ECB had so eagerly sought. And it would make Greek exports and tourism much more competitive, potentially laying the groundwork for a return to growth. Suddenly, the vacationer trying to decide whether to spend his or her holiday in Greece or Italy would see the former as a bargain.

  The invented word for a Greek exit from the eurozone, “Grexit,” became commonplace not just in newspaper headlines but also among high government officials discussing what to do next. The possibility of Greece leaving the eurozone had in just two years gone from something so unthinkable that European leaders were dismissive of any commentators who dared mention it to something openly discussed.

  Syriza, an alliance of communist and other far-left parties, won 17 percent of the vote in the May 6 Greek election. It had won 5 percent in the previous race. Golden Dawn, the country’s neo-Nazi party, went from 0.3 percent of the vote in the previous election to 7 percent. A large proportion of the Greek electorate had looked at the economic despair that the parties of the center had brought it and rejected them for the extremes. New Democracy didn’t win enough seats for a majority, even in a coalition formed with PASOK. After days of fruitless negotiations with smaller parties, no coalition came together and new elections were scheduled. In the next round on June 17, New Democracy and PASOK had just barely enough votes combined to form a new and fragile coalition. The center had held, but by a thread.

  • • •

  In July 2012, Draghi used an unusual metaphor to describe the work that lay ahead in fixing the eurozone’s deep structural problems. “The euro is like a bumblebee,” he said. “This is a mystery of nature because it shouldn’t fly but instead it does. So the euro was a bumblebee that flew very well for several years. And now—and I think people ask ‘how come?’—probably there was something in the atmosphere, in the air, that made the bumblebee fly. Now something must have changed in the air, and we know what after the financial crisis. The bumblebee would have to graduate to a real bee. And that’s what it’s doing.”

  In that same speech, Draghi pledged that “the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” But could the bank accomplish this so far impossible task before the economic schisms of the summer of 2012 transformed into the bloody political schisms of the old Europe? Six decades of European integration had been all about ridding the continent of political extremism and intolerance, the forces that had led to the twentieth century’s great upheavals. That had been the ultimate ideal of postwar Europe, the animating force behind the European Union and the euro, the “life compass” of Jean-Claude Trichet, the crowning achievement of a generation of prime ministers and presidents.

  One Monday evening in late May 2012, on the rooftop terrace of the Grand Bretagne hotel in Athens, tourists speaking a variety of languages—German, Finnish, English—laughed, photographed themselves with the Parthenon lit in the distance, and enjoyed €14 gin and tonics. Drumbeats sounded in the distance, and almost simultaneously police in white helmets and riot gear streamed out of the parliament building, forming a series of defensive lines. A crowd of perhaps five hundred made its way around Syntagma Square, several people waving giant Greek flags, others waving lit flares and ominously evoking villagers charging a castle.

  They were from Golden Dawn, the neo-Nazi party, the bartender explained, as the demonstrators shouted a series of chants in Greek and then went on their way. “They come through every few nights.” The night had offered two contrasting Europes: one lively, cosmopolitan, and content, the other austere, insular, and full of fury.

  The work of central bankers often seems a dry and technical affair. But Draghi’s job was really about something bigger than bond markets and bailouts. His task, five years after the crisis first began, was to try to rid the Aegean twilight of angry extremists. It was to bring back a world of economic possibility that would again suppress the ugliest instincts that lurk in the hearts of men.

  TWENTY

  Governor Zhou’s Chinese Medicine

  Amid purple neon lights, the sixty-two-year-old man with a round face and graying hair stepped up to address the crowd, on a stage that could have been set for a rock concert rather than a speech by a central banker. Everything was big and splashy: A chandelier the size of an elephant hung from the ceiling; the event’s sponsors included BMW and the Boston Consulting Group. It could have easily been in Las Vegas or Dubai.

  But this was Beijing, at the base of the city’s tallest skyscraper, the China World Trade Center Tower III. When Zhou Xiaochuan, the governor of the People’s Bank of China, spoke at the Caixin Summit economic conference on that November day, he couldn’t have contrasted more with the usual image of Chinese leaders, who typically make public appearances against a red backdrop of faded solemnity. When Zhou walked onstage, he was also setting foot into the new China, a world of big buildings, big money, and, if Zhou does his job well enough, a big imprint on the financial life of people across the globe.

  The rise of a great world power almost always goes hand in hand with its rise as global financial powerhouse. And behind the scenes of every great financial power is an effective central bank. London was the financial capital of the world during Britain’s reign as a nineteenth-century imperial power, which was made possible in no small part by the Bank of England. New York sup
planted London as the world’s financial capital after World War I as the United States emerged as the great global power of the twentieth century. It’s no coincidence that the Federal Reserve System was created in 1914.

  China’s ascent is perhaps the most remarkable economic trend of the last generation. The nation produced $330 worth of goods and services per person in 1991, adjusted for inflation. In 2011, that figure had reached $5,430. Behind those numbers are hundreds of millions of people who can now feed themselves reliably, endure less backbreaking work, and enjoy more of the comforts of the modern age than their parents’ generation could have dreamed of. China passed Japan to become the world’s second largest economy in 2010, and with a population four times that of the United States’, will almost certainly become the world’s largest within a generation.

  But whether Shanghai can become a great center of global commerce on the order of New York or London—and if so, what this twenty-first-century financial capital will look like—is very much in question. The tasks for Zhou and his successors at the People’s Bank of China aren’t easy ones. They must wrest power and influence away from the nation’s political leaders to build a financial system that takes full advantage of all the lessons learned by Western central bankers over the centuries. Yet they must ensure that the system they build suits a Chinese culture and economy that are quite different from those of the United States and Western Europe.

  That Friday in 2010, on that neon-lit stage in Beijing, Zhou offered a fitting metaphor for the differences between Chinese and Western economic policy. “A drug from Western medicine, which is based on theory and clinical trials, usually contains one ingredient and has a quick effect, while a prescription of Chinese medicine includes various ingredients that work together to treat a disease,” he said. “A Chinese doctor will adjust the composition of the treatment according to the patient’s condition, removing herbs, adding new ones and adjusting the dosage of some ingredients. Overall, the adjustment is based on the feedback from the patient.

  “Chinese medicine probably is not as comprehensive or logical as Western medicine,” he added. “Some drugs with large side effects may be removed, or reduced through trial and error. This is learning through experience, with endless adjustments.” In other words, Chinese economic policy is forever a work in progress, an effort to use a wide range of tools in concert to maintain good health—or, more literally, a prosperous and peaceful nation. The global crisis that erupted in 2007 in the United States and spread to Europe repeatedly threatened China’s booming economy, endangering the “harmonious society” that has been the foremost goal of current Chinese leadership.

  In a narrow sense, Zhou’s job was to make the Chinese renminbi as central to global commerce at the U.S. dollar. But his greater challenge was to shape an economy more resilient, a prosperity more durable than those of the crisis-stricken nations of the Western world. And he had to do it all without the authority that central bankers in the more advanced industrial nations have.

  But then nobody ever said that taking center stage would be easy.

  • • •

  The chairman of the Federal Reserve is easily among the half dozen most powerful U.S. public officials, and arguably number two behind the president. The president of the European Central Bank at times seems like the most powerful person in all of Europe. But the governor of the People’s Bank of China is, by most accounts, not even among the couple dozen most powerful Chinese officials. This fact is often lost on Westerners. Forbes listed Zhou as number fifteen on its list of the “World’s Most Powerful People,” and Foreign Policy placed him number four on a list of global thinkers, one spot below Barack Obama and one above Ben Bernanke, rankings that make China experts scoff. To understand why, one must know how the People’s Bank of China differs from central banks in the West.

  Created in 1948, the PBOC in its early decades wasn’t China’s central bank so much as its only bank, the state-owned financial institution responsible for making credit available to state-owned companies. Starting in 1983, as China was beginning its shift toward a hybrid economy of liberalized markets and state control, four different state-owned banks were spun off from the PBOC. In 1995, the institution was formally made the nation’s central bank in its modern form. Like its counterparts in most countries, the PBOC carries out a wide range of tasks for the Chinese government, including printing and circulating cash, executing the government’s interest rate and foreign exchange policies, and backstopping banks. The trillions of dollars in reserves that the Chinese government holds to guard itself against ups and downs of the global economy are held in accounts at the PBOC.

  But while the PBOC does many of the same jobs as central banks in the West, that doesn’t mean it has the same power. In the Chinese system, the concept of an independent central banker—the central-bank governor as an independent actor who can make whatever decisions he believes best for the nation—simply doesn’t exist. Zhou and his predecessors were technicians, functionaries charged with carrying out the policy directives that come down from higher up. The nine members of the Politburo Standing Committee, led by Chinese paramount leader Hu Jintao (until late 2012) and Xi Jinping (his successor), make the biggest decisions. Zhou had status as one of thirty-five members of the State Council, the administrative arm of the government. But his was only one voice, alongside those of officials representing many other interests—manufacturing, agriculture, the military, and so on. Zhou is said to have briefed the State Council on the condition of the economy every two weeks and make recommendations as to whether interest rates should be raised or lowered. But the decisions are authorized by a small, more exclusive group within the State Council and, ultimately, the Standing Committee.

  “I was in a museum one day when I realized it’s just like the imperial era, when the emperor received draft edicts from his advisers,” said one Chinese central banker, “If the emperor approved, he would stamp them with the imperial seal. Today, the PBOC sends guidance upwards. But nothing happens without that stamp from the top.”

  Even among people who devote their lives to studying Chinese policymaking—analysts, diplomats, academics—the details of how the central bank’s decisions actually get made are murky. It is presumed that Zhou and PBOC staffers have at least some say. “I think they’re part of the intellectual debate, but I don’t think they’re part of the power structure,” said an academic with deep relationships within the PBOC. As a U.S. official experienced in dealing with China matters put it, a Chinese diplomat to Washington can learn more about how decisions are made at the highest levels of the U.S. government by reading a few days’ worth of the New York Times and the Washington Post than a U.S. diplomat to Beijing can from years of assiduously cultivating government sources.

  This secrecy has created an atmosphere of fevered speculation and even distrust around the PBOC. In August 2010, there was a strange rumor circulating in Asian financial circles and redistributed by the political analysis firm Stratfor: The PBOC had suffered massive losses on its portfolio of U.S. Treasury bonds and Zhou had defected to the United States to escape punishment from Chinese authorities. One particularly implausible detail was that Fed vice chairman Donald Kohn had threatened to retaliate against any punishment of Zhou by disclosing the Swiss bank account holdings of some five thousand Chinese officials. China dealt with the rumor by shutting down Web sites repeating it and publishing indications of support of Zhou in state-run media. It was all nonsense, but the absence of the kind of transparency that’s standard in Western democracies means there are no reliable independent arbiters of fact. By contrast, when there was a rumor in financial markets that Alan Greenspan had been gravely injured in a car accident when he was Fed chair, his spokesman was able to shut it down by simply confirming to news services that Greenspan was sitting unhurt in his office.

  To understand the PBOC’s policies throughout the crisis, then, one has to understand the political syst
em and political culture in which it operates. Every government has a wide range of tools it can use to influence the economy—most significantly, taxing and spending, regulation, domestic monetary policy, and international currency policy. The major Western democracies have delegated those different tools to different arms at the state: Taxing and spending is the province of elected officials. Regulation is generally carried out by executive agencies. And monetary policy, experience has convinced the Western nations, is best left in the hands of independent technocrats who are largely separate from politics.

  The Chinese system essentially puts all these tools of state power over the economy in the same hands, at the highest levels, aiming to use them in concert to realize the government’s overarching goal. And that goal, more than anything, is self-preservation. Communist Party leadership in China has an implicit deal with the country’s 1.2 billion citizens: Leave us in power, and we will maintain rapid growth that will result in steadily rising standards of living.

  In the fall of 2008, when the world financial system was convulsing in the ugly aftermath of Lehman Brothers’ bankruptcy, the advantages of the Chinese method of making economic policy were evident. As the Western economies collapsed, so did demand for the clothing made in Zhejiang Province, the toys made in Wenzhou, the dishwashers made in Foshan. The implied deal between the Chinese government and its citizens was at risk of ripping apart. How many unemployed factory workers would it take for the masses to hit the streets to make their dissatisfaction known?

  On November 5, the government announced a new fiscal stimulus of ¥4 trillion, or about $587 billion—or about 12.5 percent of Chinese GDP that year. (The U.S. stimulus package enacted in February 2009 was not only much later coming, but also only 5 percent of that year’s GDP.) But more remarkable than the scale of China’s response was the way it deployed every tool of government power at once. Zhou’s PBOC, which just a few months earlier had been fretting about high inflation and an overheating real estate sector and trying to tighten the availability of credit in the economy, abruptly reversed course. It slashed the required ratio of reserves held by Chinese banks as well as the interest rate on deposits. Local governments were ordered to ramp up their spending on public infrastructure. The PBOC relaxed quotas that had held back bank lending, and so the four giant state-owned banks happily loaned money to those local governments and state-owned companies on a mass scale.