Neil Irwin, The Alchemists: Three Central Bankers and a World on Fire (New York: Penguin, 2013), 400 pp., $29.95.

WORSHIPPING AND lionizing central bankers is an increasingly popular activity. This veneration holds appeal not only for investors but also for politicians and the media. Indeed, a strong codependence exists between politicians and central bankers. Without the political class, a central banker like Ben Bernanke is just a college professor. At the same time, politicians often find central bankers to be useful foils for political rhetoric around election time.

Although the growing power of central bankers since the 1970s is largely a political phenomenon, it has been scantly discussed in political discourse. Outside the grim ghettos of financial media, the issue of central-bank accountability is not a hot topic. The global bureaucracy of central bankers operates across national boundaries, exercising huge authority over both fiscal and monetary policy while avoiding explicit political responsibility. The Fed is all-powerful, for example, yet largely unaccountable.

In his classic 1995 book Confidence Game, Steven Solomon described how economic change in the 1980s and 1990s created a political vacuum in terms of policy mechanisms to address global currency and capital flows—and how that void was effectively filled by central bankers. Global capital mobility caused governments’ sovereign control over national savings and national monetary policy to slip away—or, more specifically, to be pooled. According to Solomon, George Shultz characterizes the new era as one in which

the “court of the allocation of world savings” every day judges the economic policies of governments, rewarding those it favored with investment and strong currencies and punishing others by withholding capital and weak currencies. . . . Capital was free to pursue its innate profit-expansive logic regardless of geographic boundary or political consequences. 

In his new book The Alchemists: Three Central Bankers and a World on Fire, Neil Irwin picks up the policy and personal narrative of this global central-bank priesthood. Like other journalists turned authors such as Solomon, William Greider and Martin Mayer, Irwin brings to the task his personal experience with the people at central banks. Irwin, who has covered the Fed and economic issues for the Washington Post for over a decade, is now a Post columnist and the economics editor of Wonkblog.

Irwin explains the evolution of the global fraternity of central bankers through the actions and deliberations of three key figures: Ben Bernanke, chairman of the U.S. Federal Reserve; Jean-Claude Trichet, president of the European Central Bank (ECB) from 2003 to 2011; and Mervyn King, governor of the Bank of England and chairman of its Monetary Policy Committee. He starts right off with a blunt assessment of the role of the central banker in Western democracies:

Central bankers uphold one end of a grand bargain that has evolved over the past 350 years. Democracies grant these secretive technocrats control over their nations’ economies; in exchange, they ask only for a stable currency and sustained prosperity (something that is easier said than achieved). Central bankers determine whether people can get jobs, whether their savings are secure, and, ultimately, whether their nation prospers or fails.

Regrettably, this is an accurate assessment of the political situation with respect to central bankers generally and the U.S. Federal Reserve System in particular. They have been given a very wide economic portfolio. But it wasn’t always thus. A little history provides a context for Irwin’s tale. In the 1970s and 1980s, the chief concern of central bankers and their political patrons was inflation, an economic concept well understood by Americans. Experience with soaring living costs, scarcity of jobs and price controls going back to World War I meant Americans generally supported efforts by the government to curb inflation, even if jobs were also a big concern. Even in colonial times, inflation and bad money had chastened the common man against paper currency issued by unscrupulous bankers. This was one reason why the United States did not have a central bank for eighty years prior to World War I. This sentiment was well articulated by President Andrew Jackson when he killed, through his veto, the reauthorization of the Second Bank of the United States:

Every monopoly and all exclusive privileges are granted at the expense of the public, which ought to receive a fair equivalent. The many millions which this act proposes to bestow on the stockholders of the existing bank must come directly or indirectly out of the earnings of the American people. It is due to them, therefore, if their Government sell monopolies and exclusive privileges, that they should at least exact for them as much as they are worth in open market. The value of the monopoly in this case may be correctly ascertained. The twenty-eight millions of stock would probably be at an advance of 50 per cent, and command in market at least $42,000,000, subject to the payment of the present bonus. The present value of the monopoly, therefore, is $17,000,000, and this the act proposes to sell for three millions, payable in fifteen annual installments of $200,000 each.

Chief among Jackson’s objections to the Second Bank of the United States was governance—namely, the role of private individuals as shareholders and a lack of accountability to the states. But in the eighty years following Jackson’s veto, much changed. By 1913 the concept of a central bank was greeted with a good bit of relief in the business community. The economy was in a miserable state, and many Americans were weary of periodic financial crises. The creation of the Fed in 1913 marked a new willingness on the part of Americans to tolerate management of the economy by the federal government in Washington.

THE U.S. economy surged early in the World War I period, but when the credit ran out, the exports to Europe stopped. The American economy once again fell into the doldrums. In those days, the Fed was constrained to back all of the paper money in circulation—that is, “Federal Reserve notes”—with 40 percent gold and 100 percent commercial paper. Because of such restrictions, monetary policy was not a significant factor in the 1920s economy, especially compared to today.

Such was the antipathy to inflation a century ago that the idea of artificially stimulating economic activity—which in our day goes by the name of “quantitative easing” and is the current policy of the Fed and other world central banks—would never have been considered. But government action in the form of war spending and debt issuance did have a big impact on the economy during World War I. O.P. Austin, chief statistician of the foreign-trade department of the National City Bank of New York (the predecessor of Citigroup), observed in 1917 that “world currency” had grown by 80 percent in the preceding five years and government debt by 140 percent, while population had grown by only 2.5 percent. He noted further that significant price increases soon followed this rise in spending and government debt issuance—instituted to support World War I—and that most of the inflation came via “uncovered paper.”

The U.S. economy slid into the Roaring Twenties, a decade of commodity deflation, rising urban unemployment, land speculation and financial shenanigans that would conclude with the crash of 1929. Through the Great Depression and World War II, central banks took a backseat to government agencies such as the Reconstruction Finance Corporation, which funded policy objectives through direct borrowing. The Fed kept interest rates artificially low until the outbreak of the Korean War, in part because creating jobs for returning soldiers was a national priority. Rapid domestic growth and job creation after the war made inflation the primary concern of Fed policy, but interest rates remained relatively low through the late 1960s. But by the early 1970s, the forces of inflation and unemployment once again rose to a level of national concern.

In 1971, Richard Nixon announced a cluster of momentous policy initiatives—the end of official sales of gold, effective devaluation of the dollar, and federal wage and price controls. This potent brew was crafted by a special working group that included Secretary of the Treasury John Connally, Under Secretary of the Treasury for Monetary Affairs Paul Volcker and others. It is fair to say that Nixon only vaguely understood what he was doing. While it is true that FDR actually closed the gold window decades earlier with his confiscation of domestic precious metals held by individuals, it was Nixon who loosed the Fed from “the surly bonds of earth” in a fiscal and monetary sense. Nixon unleashed domestic debt issuance and inflation by officially abandoning the limiting equivalence of the dollar and gold set at Bretton Woods. When FDR and Abraham Lincoln had taken similar actions in the past, it was on the eve of war. Nixon’s decision, by contrast, turned largely on personal political considerations.

After 1971, the dollar became a pure fiat currency, meaning its value was set by law or other governmental interventions. It is worth noting that after the vast monetary expansions during the Civil War and World War I, the U.S. government eventually returned to gold convertibility. There was no such intention with Nixon’s unilateral decision, which caused an international panic and forced other countries to follow suit and allow their currencies to “float” against the dollar. Thus did fiat money become commonplace around the globe. By the time of his reelection campaign in 1972, Nixon had seen the dollar lose a quarter of its purchasing power to inflation during his first term. The financial credibility of the U.S. government and the Federal Reserve System had reached a new low.

The late 1970s and the 1980s were difficult years for the United States as issues such as employment, inflation and trade competition with other nations came back to political prominence. For the first time since World War II, the poor economic outlook revived American fears of inflation or worse. Policy makers struggled for solutions. In 1978, Congress made long-run growth, low inflation and price stability the explicit goals of Fed policy through the Humphrey-Hawkins Act. In America, you understand, growth can simply be legislated. But the powerful demographic force of the post-WWII baby boom drove national priorities and inflation, forcing Fed chairman Paul Volcker to raise interest rates well into double digits in 1979 to cool the fires of inflation. Volcker’s bold political stroke set the stage for the economic expansion in the 1980s under Ronald Reagan.

By the early 1990s, the United States had lived through a real-estate boom and bust with the savings-and-loan crisis. Fed policy was increasingly focused on keeping interest rates low to spur consumer activity and jobs, with little concern about inflation. America turned inward in its search for jobs and growth, and naturally turned again to housing as a solution. Depression-era agencies such as Fannie Mae and the Federal Housing Administration “were repurposed by the Clinton administration to direct social policy through the housing and mortgage markets,” author and financial analyst Joshua Rosner told a subcommittee of the House Financial Services Committee this March. “In 1994, the [Clinton] Administration set about to ‘raise the [home] ownership rate by 0.5%–1.0% per year for the seven years, from 65% to 70% by the year 2000.’” The years of subprime boom and bust that followed under President George W. Bush were only made possible by Bill Clinton’s housing policies. In place of the military-industrial complex that propelled U.S. growth from the 1950s to the 1980s, the affordable-housing lobby used public policy to drive employment and growth from the 1990s onward. The 2007 subprime crash, like the crash of 1929, was merely the climax of more than a decade of housing-market speculation.

SINCE THE 2007 crisis, while Congress has hid its head in the sand with respect to fiscal issues, the Federal Open Market Committee (FOMC) effectively has managed both fiscal and monetary policy. By keeping rates artificially low compared to the true rate of inflation, the Fed subsidizes the U.S. Treasury’s debt load to the tune of hundreds of billions of dollars per year.

Meanwhile, Washington’s subsidy for the U.S. banking system amounts to hundreds of billions more annually, far more than the industry reports in profits. Subsidies for the banks range from federal deposit insurance to low interest rates maintained by the Fed to federal guarantees for mortgages and small-business loans. To pay for the subsidy of artificially low interest rates, individual, institutional and corporate savers pay a repressive tax levied by the central bank in the form of quantitative easing, where the Fed buys financial assets from commercial banks and other private institutions in order to inject more fiat money into the economy. Irwin, who falls into the camp of those who tend to lionize central bankers, likens the U.S. central bank’s low-interest-rate policy to a modern version of alchemy, but old-fashioned, nineteenth-century socialist redistribution from savers to debtors is perhaps a more accurate description of the policy direction of the Bernanke Fed.

Irwin uses seventeenth-century Sweden and a story familiar to students of economics to illustrate his dubious “alchemist” metaphor. A Swedish banker named Johan Palmstruch creates an early model of a modern central bank, Stockholms Banco. The bank uses various metals to back its activities, but one day it runs up against an age-old problem of money and banking—liquidity. Palmstruch quickly discovers the magic of issuing unbacked paper money to provide additional liquidity, but eventually the bank fails. He is tried for fraud and imprisoned.

“All it took to create wealth where there’d been none was some paper,” writes Irwin of the Swedish experience, “a printing press, and a central bank, imbued with the power from the state, to put it to work.” Sadly, with the rise of modern central banking, people who “create” such money are no longer thrown into prison. Even as recently as the 1920s, the business of finance was seen in classical—that is, negative—terms, but today investment banking and even central banking are considered acceptable by many parts of society.

Early in his book, Irwin uses a couple of additional examples of central banking as a backdrop for the rest of the volume. He covers the failure of the Overend, Gurney & Company bank in the 1860s in the United Kingdom, Jackson’s assault on the Second Bank of the United States, the hyperinflation of Weimar Germany and the secret meeting at Jekyll Island prior to the creation of the Federal Reserve System in 1913. Following this background, Irwin gets his readers to 1971 and Nixon’s decision to close the gold window.

In a chapter titled “The Anguish of Arthur Burns,” we learn of a fundamental reality of central banking—namely, its intimate relationship to politics despite pretensions of independence. Irwin draws on the diaries of former Fed chairman Burns to capture his distress over the decision to break the link between the dollar and gold. “The gold window may have to be closed tomorrow because we now have a government that seems incapable, not only of constructive leadership, but of any action at all,” wrote Burns, leaving some readers wondering, no doubt: What would he say about Washington today?

Burns was probably the last Fed chairman to recognize any limits on his actions in terms of monetary policy. Irwin, betraying his journalistic background, places much blame on Burns for his failure to control rising prices in the 1970s. This is probably an oversimplification. In fact, demographics, free trade and external shocks such as rising oil prices, which Irwin notes, probably did more to spur inflation than the specific actions taken or not taken by the FOMC.

Indeed, Burns’s contemporaries considered him a “tight money” Fed chairman. He operated in the poisonous political environment that swirled around Washington during the Nixon years, making concepts like central-bank “independence” ridiculous. Moreover, Volcker was a protégé of Burns, so drawing a great distinction between the two is not particularly useful. “To attribute the inflation of the first part of the 1970s solely to Burns’s leadership is wrong,” wrote Fed economist Robert Hetzel in 1998. “Monetary policy under Burns’s FOMC was never as expansionary as vocal congressmen urged and, through 1972, was less expansionary than the Nixon Administration desired.” He adds that the inflation of the 1970s “represented the failure of an experiment with activist economic policy that enjoyed widespread popular and professional support. Burns was part of a political, intellectual, and popular environment that expected government to control the economy.”

WHEN IRWIN recounts the transition from Burns to G. William Miller and then to Paul Volcker, he falls into the familiar trap of Volcker hero worship, crediting Volcker with leading the great struggle against inflation beginning in 1979. But as I noted in my 2010 book Inflated, although Volcker was nominated by a conservative Southern Democrat, Jimmy Carter, his Republican predecessor, Gerald Ford, took the battle against inflation every bit as seriously. Few commentators adequately note the irony of the Democrat Volcker engineering the 1971 decision by the Republican Nixon to devalue the dollar and then, eight years later, being asked by Carter to fix the inflation problem unleashed by that very action.

Volcker did break the back of inflation and, for a while at least, restored public confidence in the ability of Washington to manage the economy. William Silber, writing in Volcker: The Triumph of Persistence, notes that Volcker “earned his unparalleled credibility over the course of his professional career by approaching public service as a sacred trust.” But had not Volcker broken that trust by embracing a pure fiat currency? It can be argued that, while Volcker did defeat inflation in the late 1970s and early 1980s, his more significant action came in 1971, when he set the course for decades of American fiscal dissolution and the financial crises that followed.

Irwin notes that Volcker’s success in fighting inflation made it possible for his successor, Alan Greenspan, to keep interest rates low, again part of the collective (and false) Washington narrative that gives Bill Clinton and Robert Rubin credit for balancing the budget during the 1990s. In fact, swelling contributions to Social Security from aging baby boomers took enormous pressure off the Fed and the Treasury Department during this period. So great were the cash inflows to Social Security, we should recall, that officials warned about the disappearance of public Treasury bonds. The Fed’s purchases of Treasury and mortgage bonds today are on a scale with the positive cash inflows from the baby boomers of two decades ago, but the cash flow of Social Security is now negative.

While restoring public credibility to the Fed was certainly helpful to Alan Greenspan and his colleagues on the FOMC after Volcker left in 1987, the central bank was entering a period of relative calm. The neoliberal philosophy of free markets and deregulation was grafted on to Washington’s New Deal apparatus, fueling nominal growth along with mounting public deficits. Then came the great effort to promote home ownership, fostered by Bill Clinton, well-placed members of Congress such as Barney Frank of Massachusetts, and the government-sponsored enterprises Fannie Mae and Freddie Mac. That begat the wave of housing investment that would become the massive housing bubble of the last decade. Alan Greenspan became the high priest of the period of expansion known as the “great moderation,” but the wave Greenspan’s FOMC rode was demographic—a product of the famous baby-boom generation, which drove the U.S. economy, as well as cultural trends, for decades. It dominated American life, including consumer purchases, housing, saving, education and government spending.

Irwin is on target in describing the Fed’s famous 2005 Jackson Hole meeting and the procession of economists lionizing Greenspan as the greatest Fed chairman ever. Even monetary economist Allan Meltzer, among the great historians of the institution and a staunch conservative, genuflected before Greenspan. Yet even in 2005, the cracks were starting to appear in the U.S. banking system. Officials from the Fed and their colleagues in the economic profession congratulated themselves with supreme confidence that inflation, jobs and growth were all manageable via the right government policies. The U.S. federal debt grew unabated and excesses were visible in the housing market, but low unemployment and buoyant economies around the world blunted complaints.

Only when some of the major Wall Street firms started to implode in 2007 did Fed officials really begin to understand that the idea of global bureaucrats managing economies and avoiding serious financial corrections was an illusion. Irwin notes that officials at the Federal Reserve Bank of New York dismissed warnings about the housing sector as early as 2005—a policy of deliberate ignorance that has received far too little attention. The fact that serious economists could ignore the special demographic factors underlying the period of the “great moderation” remains a source of wonderment to this reviewer. The housing bust that began in 2007 was largely the result of a phenomenon that began six decades earlier, when World War II soldiers came marching home, started families and had lots of babies. As the baby boomers reached retirement, an inevitable decline in housing sales was the result.

THE BERNANKE Fed has been distinguished by greater openness and transparency than previous regimes, but this does not necessarily mean greater understanding on the part of the public about what central bankers do. By focusing on Trichet, Bernanke and King, Irwin has indeed placed our attention on the key policy makers in global finance over the past decade. The largest part of The Alchemists is devoted to telling the story of how these men navigated the crises that seemed to cascade across the U.S. economy and then Europe. Irwin is not particularly critical of Bernanke, former New York Fed president and later Treasury Secretary Timothy Geithner, or any of the other players in this financial and economic drama. The role of Geithner, for example, in the bailouts of American International Group and Citigroup is treated in generous and approving terms. Irwin essentially says a government rescue was the best course. “We came very, very close to a depression,” Bernanke warns. “The markets were in anaphylactic shock.” This sort of logic is used frequently by Fed officials to justify virtually all of their actions and omissions from 2007 onward.

Respectful references are made to Bernanke’s studies of the Great Depression, especially his conclusion that allowing large firms to fail is bad. But the only lesson learned by the former Princeton economics lecturer seems to be that bailouts and deficits are the best course. Five years after the crisis, the FOMC continues to subsidize the structural fiscal deficits enacted by Congress. Echoing the arguments of most Fed officials, the author bemoans the fact that Lehman Brothers was not somehow saved and that fiscal austerity has followed decades of libertine fiscal delusion in the industrial nations. Like the intellectually pugnacious Nobel laureate Paul Krugman and Bernanke himself, Irwin seems to suggest that printing money and issuing new debt were reasonable policy choices.

But the sad fact is that Lehman Brothers could not be sold and had to fail. And nations such as Britain that lack sufficient economic growth must restrain their spending. Compare the resolution of Lehman to the continued “anguish” of Bank of America over time and economic resources lost because of litigation over legacy mortgage-backed securities. Citigroup, likewise, wallows in Japan-like torpor under the weight of hundreds of billions of dollars’ worth of moribund assets. The litigation against Bank of America could still force a legal restructuring à la Lehman Brothers, depending upon how the courts decide key issues related to billions of dollars in claims.

Bernanke and his counterparts in Europe have worked tirelessly to keep under wraps situations such as Bank of America and many others like it in the EU, but this merely keeps those situations unresolved. King, for example, faces a UK banking system that has been crippled since 2007, and the final disposition of several large banks remains up in the air. The main players among the central bankers never actually seem to get around to dealing with real-world problems such as zombie banks, those economically deformed financial institutions whose net worth is less than zero but which continue to operate because they are shored up by governmental credit support. If there is a weakness in this thorough book it is that, while the author makes a number of useful observations as part of a largely journalistic narrative, he could have provided more critical analysis of the actions taken and not taken by his three main protagonists. I’d like to know more about what the author thinks of these events and issues.

The decision to build a wall of money, as Irwin accurately describes it, to meet the crisis was no doubt a practical choice. It also put Bernanke, Trichet and King, however, in the position of picking winners and losers, and ultimately making highly significant political decisions that once required democratic assent. The most recent 2013 Fed bank stress tests, for example, had one purpose: to present a convincing facade as to the health of zombie banks such as Citigroup and Bank of America. The central bankers’ support for rescues of countries such as Greece and their de facto embrace of the concept of “too big to fail” work against the public’s interest in terms of economic efficiency and long-term growth. Without restructuring, there is little chance for growth.

Irwin describes the clubby atmosphere at private meetings and dinners in which the central bankers foster an environment where bailouts are considered routine while tough questions are often avoided. A reader of this book could contrast the sharp rebukes of Mervyn King to the UK government over its runaway deficits with the accommodation of Bernanke’s FOMC and Trichet’s ECB toward their respective host governments. Using Irwin’s own criteria from his tough judgment of Arthur Burns, Bernanke has shown a lack of courage to face the necessity of restructuring the big banks and ending Washington’s fiscal dysfunction. King emerges in this book as the clear leader in force of advocacy and in courage.

Is there another Paul Volcker waiting in the wings, prepared to slap sense into spendthrift American politicians on federal spending? Perhaps, but was Volcker really so radical a departure from Burns? Or Greenspan after them? In terms of their willingness to bail out large banks, Volcker is the father of “too big to fail,” and Bernanke seems little different. The alchemists led by Bernanke, Trichet and King were right to buy time with the wall of money, but they erred by not using that precious time to restructure the economies of the United States and Europe. By following the philosophy of Volcker and Bernanke—that it is bad to allow big enterprises to fail—we have missed an opportunity to restore a more stable, sustainable path to the future. The rise of the alchemists among central bankers has given us less political accountability, less economic restructuring and renewal, and far fewer real possibilities for growth in the global economy. The reality remains that nobody can spin straw into gold, not even central bankers.

Christopher Whalen is a writer and investment banker who lives in New York City. He is the author of Inflated: How Money and Debt Built the American Dream.

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