by Neil Irwin
The ECB launched a bold intervention, aiming directly at the financial markets. Under Draghi, the central bank had become, if anything, even more creative and interventionist than anyone could have predicted in August 2007, when Jean-Claude Trichet received his vacation-interrupting telephone call about BNP Paribas. Trichet was by now ensconced in a gigantic office suite at the Banque de France overlooking the Jardin du Palais Royal, giving occasional speeches, influencing world events from the sidelines, and enjoying his time at Saint-Malo undisturbed.
The Federal Reserve, the first of the major central banks to cut interest rates to counter the wider economic damage of the financial crisis in 2007, again went a step further than any of its counterparts in easing monetary policy in 2012. The quiet, cerebral professor from Dillon, South Carolina, had become a savvy Washington power broker. Whether Bernanke’s policies would succeed in getting the U.S. economy back on track was an open question, but his academic training told him that cheaper money was the best way to do so, and he made it happen.
The men who guided the world’s leading central banks through the megacrisis had different assumptions, challenges, and approaches to leadership. But their common legacy is this: As ugly as the global economy looked five years after the onset of crisis, no war had broken out among the great global powers. Europe remained united. There had been no confidence-shattering hyperinflation or, outside of perhaps Greece and Spain, economic depression. None of this was a certainty. Peace and prosperity are never as deeply entrenched as they may seem at times when things are going well. Rather, they require people like Bernanke, King, and Trichet to safeguard them, often by doing things that are wildly unpopular. It may seem like damning by faint praise, but a catastrophe averted is no small thing.
The central bankers’ judgments were far from perfect, and their mistakes—allowing the collapse of Lehman Brothers, endorsing early fiscal austerity in Britain, moving with such hesitation and delay in the face of the eurozone crisis—will do lasting economic damage. Each will be leaving his institution a very different place from the one he inherited, more deeply entrenched in the vagaries of politics, more thoroughly intertwined in the workings of high finance, with so many Rubicons crossed that there can be no hope of going back. No one can say that the Fed will never bail out an investment bank, or that the Bank of England will never try to preach to Parliament about how to manage its books, or that the ECB will never prop up government finances.
Adam Posen, on his final day as a member of the Bank of England’s Monetary Policy Committee, responded to Michael Woodford’s Jackson Hole paper with a stirring rebuttal of the idea that central banks should let precedent or politics stop them from doing what they need to do to keep their economies healthy. “It is . . . quite literally a prehistoric argument in monetary terms to assert that central banks are engaged in experimental, unprecedented, or somehow scandalous and dangerous policy maneuvers today—we should stop giving such trumped-up rhetoric any credence,” said Posen. “The idea that there are somehow pristine, virgin central banks, expected by the public to be like a vestal priesthood, that will be tainted forever by intervening in a given financial market, is . . . a truly primitive and antirational way of thinking about both economics and the beliefs of the general public.”
Ben Bernanke, Mervyn King, and Jean-Claude Trichet learned from the failures of Rudolf von Havenstein and Montagu Norman, of Arthur Burns and Masaru Hayami. Their successors will learn from their failures. Democratic societies entrust central bankers with vast power because some things are so important yet so technically complex that we can’t really put them to a vote. We’re wrong to expect perfection. But we must demand progress. The story of central banking is also the story of civilization: discovering in fits and starts how to manage a just and prosperous society, forever taking small steps toward a better world.
In 1660s Sweden, Johan Palmstruch’s Stockholms Banco introduced the first banknotes, shown here, bringing paper money to Europe. The Palmstruch bank collapsed and was replaced by what would become the Swedish Riksbank, the nation’s central bank to this day.
Walter Bagehot, editor of The Economist in the mid-nineteenth century, wrote about the Bank of England’s efforts to combat the financial panic that followed the collapse of Overend, Gurney & Co. in 1866. His lessons add up to Bagehot’s dictum, an idea that modern central bankers followed during the crisis that began in 2007.
The central bankers of the 1930s, including Hjalmar Schacht (left), president of the German Reichsbank, and Montagu Norman, governor of the Bank of England, were unable to contain the great financial crisis of their generation, setting the stage for years of economic depression and, eventually, a global war. Their failures haunted their modern successors.
Arthur Burns, chairman of the Federal Reserve in the 1970s, lacked the willpower—or the independence from the Nixon administration—to take the painful steps needed to contain the burgeoning inflation of that era. Inflation approached 9 percent in his final year in office.
Paul Volcker, chairman of the Fed starting in 1979, aggressively tightened the money supply to stop inflation—causing a deep recession in the short term but laying the groundwork for a generation of prosperity known as the Great Moderation.
European leaders spent the second half of the twentieth century building bonds of unification among their nations, aiming to prevent the kinds of conflicts the continent had experienced in the first half of the century. Here, in February 1992, they gathered in Maastricht, the Netherlands, and agreed to use a common currency. The European Central Bank would be created in 1998 to manage what would become the euro, the most visible symbol of European integration.
By 2007, when the first tremors of panic were felt, the leading Western central banks were led by Mervyn King (left), governor of the Bank of England; Ben Bernanke (center), chairman of the U.S. Federal Reserve; and Jean-Claude Trichet (right), president of the ECB. Their partnership would shape the course of the global economy.
The world’s central bankers met regularly at the Bank for International Settlements in Basel, Switzerland, where they had long discussions about economics and bank regulation and shared intimate dinners in the evenings over great food and wine. Between the meetings in Basel, on the sidelines of global economic summits, and economic conferences such as one each August in Jackson Hole, Wyoming, one central banker remarked that he seemed to see the other central bankers more often than his wife.
When Ben S. Bernanke joined the Federal Reserve Board of Governors in 2002 after a long career in academia, he was very much the professor; he envisioned only a brief foray into government service. Four years later, he became one of the most powerful men in the world as chairman of the Fed.
Bernanke led the Federal Open Market Committee, which sets monetary policy for the United States, through a controversial decision to cut interest rates and push money into the flailing U.S. economy through “quantitative easing,” or buying bonds using newly created money.
The series of financial bailouts during the crisis exposed Bernanke and the Fed to vociferous criticism from the left and right, and the Fed’s long-standing powers and independence came into doubt in Congress in its aftermath. Shown here are Bernanke (seated) and Treasury Secretary Tim Geithner (standing) at a House Financial Services hearing in 2009 about the AIG bailout.
Bernanke (left), Fed governor Kevin Warsh (center), and vice chairman Don Kohn (right)—here at a coffee break from the annual Kansas City Fed economic symposium in Jackson Hole—formed the inner circle in a series of extraordinary interventions to try to keep the global financial system from coming unglued in 2008.
Despite criticism from all sides during the bailouts, the Fed kept its powers to regulate banks and the independence to set monetary policy. It had support from President Obama, who was in turn influenced by his treasury secretary and former New York Fed president Timothy Geithner, and crucial help from banking lobbyists an
d presidents of regional Fed banks across the United States, including Tom Hoenig of the Kansas City Fed, pictured here.
Bernanke’s stewardship of the economy and crisis management was enough for Obama to nominate him to a second four-year term in 2009—though the Senate confirmation was a closer call than anyone had expected.
Over the course of the crisis, Bernanke and Mervyn King shared a particular bond—a background as academic economists—and had even shared an office suite as young faculty at MIT. King created the modern Bank of England, first as its chief economist in the 1990s and as governor starting in 2003.
King (right) sometimes clashed with Alistair Darling (left), the chancellor of the exchequer until 2010. They are pictured here in Porto, Portugal, at an international summit on September 14, 2007, the day Britain experienced its first bank run since Overend, Gurney—this time on Northern Rock.
Darling wrote that he was blindsided by King’s comments at the 2009 Mansion House dinner, arguing for the Bank of England to be given greater authority over the banking system. But by the 2010 dinner, pictured here, King was on better terms with the new chancellor, George Osborne (seated).
Leading central bankers and finance ministers traveled to Iqaluit, Canada, in February 2010 for a G-7 summit. In the Arctic, they developed consensus that after extensive intervention to support economic growth, including fiscal and monetary stimulus, it was time to begin planning an exit. As it would turn out, some of the greatest challenges were yet to come, and the turn to austerity was premature.
Mervyn King took advantage of the demonstration of dog sledding, though the banker’s interest in native culture went just so far; only the Canadian officials partook of raw seal meat in Iqaluit.
Jean-Claude Trichet, shown here at the Jackson Hole conference, had made a career helping build a unified Europe through a common currency. The veteran French civil servant was the second president of the ECB, the most vivid testament to European unity, starting in 2003. But by 2010, the economic fallout from the 2008 crisis had left the finances of Greece, and soon other European nations, in such precarious straits as to risk an unraveling of the union.
Now, Jean-Claude, it is your turn,” Bernanke (right) told Trichet (center) in a private meeting in Frankfurt as the eurozone crisis became more severe.
The ECB’s governing council usually met at its headquarters in Frankfurt to set monetary policy for the seventeen-nation eurozone, but in May 2010, as the debt crisis that began in Greece was rapidly spreading to Ireland, Portugal, and Spain, they met instead in Lisbon, shown here. At a dinner later that night, they broached for the first time the possibility of using ECB resources to buy bonds of countries that were under attack from markets.
Axel Weber (left), the president of the powerful German Bundesbank, was initially open to bond purchases in that late-night meeting, but by the next day he had changed his mind. He would become the most vocal opponent of the proposal, seeing it as a form of printing money to subsidize profligate governments. He resigned from the Bundesbank in early 2011, after his differences on this question with most others on the ECB governing council made the idea of his succeeding Trichet in the presidency untenable.
The ECB intervention succeeded in easing the sense of crisis in the summer of 2010. But that October, French president Nicolas Sarkozy and German chancellor Angela Merkel went for a walk on the beach at a summit in Deauville, France, where they sketched out a plan to push for private owners of Greek debt to take losses on their holdings. That led to a resumption of the crisis and its spread to Ireland and later Portugal and Spain.
Under Trichet (right), the ECB became part of the “troika,” the group of international institutions that negotiated with the Greek government, and later those in Ireland and Portugal, over the spending cuts and reforms they would need to undertake as a condition of aid. It put the central bank in the uncomfortable position of dictating to democratically elected leaders what policies to enact. In 2011, Lucas Papademos (left), the former vice president of the ECB, even became the prime minister of Greece.
In October 2011, days before Trichet’s term as ECB president was set to end, an event was held in Frankfurt to honor him. But afterward, instead of remaining in the opera house for a symphony performance, Trichet (left), IMF chief Christine Lagarde (center), and Merkel (right), among others, retreated to a conference room to try to hammer out a new accord to repair Europe.
With no German candidate in line for the job, Trichet’s replacement was Mario Draghi (right), the top Italian central banker and a savvy economist and market maven. But the question was whether “Super Mario” would be able to succeed where Trichet had failed at using the ECB as a force to preserve the eurozone without undermining the institution’s credibility—and the support of the German government.
Jens Weidmann replaced Axel Weber as the head of the Bundesbank. He continued Weber’s stance of deep skepticism toward any bond buying by the ECB, even as Draghi pushed to defend the eurozone.
With a subtle diplomatic touch and strong background as an economist, Draghi (pictured here at his first news conference in November 2011) guided the ECB governing council to a series of interest rate cuts to try to combat an economic downturn on the continent. He would later announce the Long-term Refinancing Operation, a massive effort to flood European banks with cash, and in September 2012, an unlimited, overarching backstop to try to stand in the way of a eurozone collapse. A united Europe was preserved, at least for the time being.
Zhou Xiaochuan, the governor of the People’s Bank of China, was a force for modernization and markets in the ascendant economy of China during this era, but he lacked the independence and power to act on his own accord held by the Western central bankers. As such, the Chinese central bank was not part of the joint efforts repeatedly launched by the other industrialized nations.
ACKNOWLEDGMENTS
Almost any book is the work of many people, and that is true of this one—which covers events that happened in nearly every corner of the world and in a span of 350 years—more than most. Howard Yoon of the Ross-Yoon Agency played a crucial role in refining the concept for this book; I also owe a great debt to his colleagues Gail Ross and Anna Sproul. Leonard Roberge, a terrific freelance editor, provided essential help in shaping this narrative and removed more unintelligible sentences and clunky metaphors than I prefer to admit. Scott Moyers and Mally Anderson at The Penguin Press were marvelous partners in shaping the book you hold in your hands. I also owe a great debt to Ann Godoff for taking a chance on a first-time author with an ambitious idea.
Lea Yu, a talented Beijing-based journalist, made major reporting contributions from China toward Chapter 20. The primary researchers on the book were, at various times, Anna Rose Bianco, Amanda Ruth Reynolds, and Jeniece Howe. Others who contributed research, translation, or other assistance were Athena Korlira and Elinda Labropoulou in Greece; Alessandra Pugliese in Italy; Catarina Nilsson in Sweden; and Caroline Huot in France.
I am greatly indebted to a number of people who read chapters and offered me advice; their work helped make the book more accurate in its factual details and smarter in its analytical conclusions. They include Liaquat Ahamed and Nicholas Lardy, along with several others who prefer not to be named, but know who they are. Final fact-checking was done by Lisa Bonos, Ylan Q. Mui, and Nathan Willis. Of course mistakes and weaknesses that remain are solely the fault of the author.
Many of the world’s central bankers are represented by first-rate communications staff. They have a sometimes unpleasant job, being the public representatives of organizations that are inherently secretive, but many do their job with wisdom, good humor, and a genuine desire to help the public understand their institutions. I cannot list them all here, but will single out four to whom I owe a particular debt. Michelle Smith at the Federal Reserve Board has been among the closest advisers to a treasury secretary and two Fed chairmen for good reason; working wi
th her is one of the great pleasures of the Fed beat. Diane Raley of the Kansas City Fed plays a crucial role in making the Jackson Hole Economic Symposium perhaps the hottest ticket in the world of economic policy. Regina Schüller and Eszter Miltenyi of the European Central Bank extended great kindness to this American in Frankfurt. These and other central bank public affairs staff around the world (and their bosses) will dislike parts of what is written here, but it is more accurate and thorough thanks to their assistance.
The Washington Post, my professional home since 2000, made this project possible in many ways: first, by teaching me to write and report, and then by putting me on the economics beat that, starting in 2007, gave me a front-row seat to one of the great stories of our age. I am particularly indebted to former executive editor Marcus Brauchli and financial editor Greg Schneider for allowing me to take an extended leave to report and write this book, and to chairman Don Graham and publisher Katharine Weymouth for their stewardship of one of the world’s great journalistic entities. The financial desk at the Post has a long history of collegiality and warmth, and I have been lucky to make it my professional home. Steven Pearlstein has been a wise and generous mentor, and one could not hope for better colleagues than those who were friends and collaborators during the years of covering the crisis and its aftermath: Binyamin Appelbaum, Lisa Bonos, David Cho, Brady Dennis, Dina ElBoghdady, Zachary A. Goldfarb, Michael A. Fletcher, Kelly Johnson, Lori Montgomery, Steven Mufson, Ylan Q. Mui, Maralee Schwartz, Michael Shepard, Alan Sipress, Sandy Sugawara, Nancy Trejos, and Jia Lynn Yang. Since returning from book leave, I have worked with the superb Wonkblog team: Ezra Klein, Suzy Khimm, Sarah Kliff, Dylan Matthews, and Brad Plumer. Post colleagues who offered particular advice on reporting parts of this book include Anthony Faiola, Keith Richburg, and Howard Schneider. During a long stay in London for reporting, Michael Bogdan and Elizabeth Holt-Bogdan, Cassandra Vinograd and Adam Cohen, and Todd Rothman provided great company. And I could not have written this book without important assistance from Lauren Fish, Toan Luong, and Mary Pat Strasser.
