Tuesday, May 24, 2016

My Amazon Review of Mervyn King's "The End of Alchemy: Money, Banking and the Future of the Global Economy"

Fixing the Banks

Mervyn King, the former governor of The Bank of England, has written a very readable book on the interaction of money and banking on the global economy. He offers his insights as a practical banker and a serious economist for the way forward from the financial crisis of 2007-09 that we are still reeling from.

Although he discusses a host of topics relating to how people make decisions in practice compared to how economic theory suggests they behave, the problems of the fixed exchange rate regime within the European Union, and the difficulties of making policy within a framework of competing nations; I will focus on two issues that he raised.

The first is his suggested reform for the banking system. His reform is a modified “Chicago Plan” of the 1930s which called for 100% reserves. Under that regime bank deposits would be matched with cash and short term government securities. Hence no risk and no potential for bank runs. In contrast the current system is based on fractional reserves where banks hold a small portion of their deposits in reserves and lend out the balance. This process is King’s alchemy where short   maturity deposits are transformed into long term assets. In the jargon of economists this process is called “maturity transformation.” 

This system is inherently unstable because the cash is not there to pay off depositors if they want all of their money at once. To deal with this contradiction the central bank acts as a lender of last resort to meet the demands of anxious depositors. This gives rise to the issue of “too big to fail.” King’s compromise is to turn the central bank into a “pawnbroker for all seasons.” Under his proposed system banks must hold sufficient reserves, liquid assets and discounted long term assets to meet all deposit and short term borrowing liabilities. The discounted assets would be valued at a “normal times” value with an appropriate “hair-cut”  to allow for risk and those asset could be pawned at the central bank should the need arise. Any lending above this threshold would have to be funded by additional equity and long term liabilities. Thus depositors would feel secure that their money be there when they needed it.

All this is fine and good, except there would be very little incentive for banks to make risky loans. Why is that bad? It is bad because new businesses, new ideas and new construction have to be funded if the economy is going to achieve the growth that most of us desire. To undertake King’s reforms we would need new institutions to undertake those risks. King is silent on this question.

The other issue that King raises that I would like to discuss is that the universal answer to all financial crises is to throw central bank money at it. We have been doing this for nine years. The problem that King rightly raises is that if the problem is structural rather than liquidity, throwing money at the crisis will delay solving the structural imbalances. To King’s mind central bankers in this environment may set interest rates too high to permit growth, but too low to allow for a structural adjustment.

The issue in the West is that savings are too low, while in the East consumption is too low. For example in order for the U.S. to cure its chronic trade deficit the savings rate has to rise and consumption has to fall, while China’s huge trade surplus has to be cured by higher consumption and lower savings. Politically asking people to reduce consumption is a hard sell so the easy way out is to keep interest rates low that works to keep consumption up.

All told Mervyn King has written an important book that will play a significant role in the ongoing debates over banking reform and monetary policy. He also offers a well done primer on current thinking on monetary policy that is accessible to the lay reader.

For the full Amazon URL see:

Sunday, May 22, 2016

Reversals of Fortune

With the polls now indicating a tight race between Hillary Clinton and Donald Trump, a far cry from the blowout predicted for Clinton two months ago, the focus will now turn to the July conventions. Where in early April it appeared that the Republicans were on the road to suicide, it now appears that the Democratic Convention will be far more raucous. To the chagrin of the Clinton's, it now appears that Bernie is a bitter-ender. After all Bernie Sanders, despite his Jewish background, is really a member of The Church of Our Lady of Perpetual Outrage. Simply put, Bernie is looking for a fight. My guess as the Republicans line up for Trump, the Democrats will make their Nevada convention look like a dress rehearsal for the real thing.

The other reversal of fortune is that while the Obama Administration was busy in taking Andrew Jackson, the founder of the Democratic Party, off the $20 bill a new Jacksonian was on the rise in the person Donald Trump. Recall that Jackson was the richest man in Tennessee, believed in democracy for white Americans only, supported the "tariff of abominations," removed the Cherokee Nation from Georgia and Tennessee and though his foreign policy was isolationist he believed that when attacked the U.S. should use the full might of its military to defeat the attacker. This sounds awfully like The Donald.

I know it is early and there will be more reversals, but we are living in an extraordinary political year where the two leading candidates are disliked by a majority of voters, myself included. To mix metaphors batten down the hatches and fasten your seat belts!

Wednesday, May 11, 2016

My Amazon Review of Marc Wortman's "1941:Fighting the Shadow War: A Divided America in a World at War"

Prelude to War

America’s entry into the Second World War has been told many times before, perhaps best in recent years by Michael Fullilove and Susan Dunn. Thus historian Marc Wortman faced a difficult task to add value. He partially succeeds and he does it with the writing style of a novelist making the book easy to read. Where he is most interesting is in presenting the very active American role in the famous sinking of the German battleship Bismarck and his very lengthy discussion of Phillip Johnson who would become a world famous architect, as a very active Nazi sympathizer who was almost indicted for treason. He also covers the role of the young Nelson Rockefeller as a state department official organizing our efforts to counter Nazi influence in Latin America.

He leaves out Dean Acheson’s role in coming up with the legal analysis that enabled FDR’s bases for destroyers deal and the role of American communists in their shifting from being pro-war to anti-war and back to pro-war as they cleaved to the party line coming out of Moscow.

As a result if a reader is not familiar with the history, Wortman’s book would be a good start in learning how Roosevelt with starts and stops moved the Nation to face the reality of the Nazi menace. 

For the full Amazon URL see: