The Alchemists: Three Central Bankers and a World on Fire (3 page)

Indeed, on that chaotic Thursday, King left it to Deputy Governor Rachel Lomax to represent the bank in conference calls with his counterparts across the world. Later on, King would put himself as close to the front lines of the battle against panic as anyone. But on day one, his arrogance left him in the grandstands.

The leaders of the three major Western central banks were in different worlds—far apart physically, as was usually the case, but also disconnected in their analysis of the problem facing the world economy and what, if anything, they should do about it. To Trichet, the problem was a banking panic, a one-off moment of market uncertainty. To King, it was a necessary corrective to a long period of banking excess. To Bernanke, it was a more deeply intertwined set of risks to the banking system and the overall economy. He came to this view partly because the United States was ground zero for the housing downturn and bad mortgage lending that spurred Europe’s problems. But it was also a matter of Bernanke’s academic training. A leading scholar of the Great Depression, the chairman had theorized that the era was so troubled economically because of what he called the “financial accelerator”: Bank failures fueled economic weakness, which fueled even more bank failures, which in turn fueled further economic weakness. He was determined, if it became necessary, to use every tool at the Fed’s disposal to halt this vicious cycle.

It was sheer luck that the Federal Reserve had a chairman so well prepared for the moment. Bernanke’s academic training as a monetary economist, particularly as a scholar of the Depression, hadn’t come up in his interview with President George W. Bush in the summer of 2005, when the native of tiny Dillon, South Carolina, was being considered to replace legendary Fed chair Alan Greenspan. But that background would influence his every action from that August Thursday on. Bernanke seemed almost haunted by the fear that he would make the same mistakes central bankers did in the 1920s and ’30s, which left mass human misery in their wake.

Whatever their perceptions or prejudices, central bankers all have an awesome power: the ability to create and destroy money. Why is a piece of paper with Andrew Jackson’s face on it worth twenty dollars? Why can that piece of paper be exchanged for a hot meal or a couple of tickets to a movie? It’s only a slight exaggeration to answer, “Because Ben Bernanke says so.” The bill may have the U.S. treasury secretary’s signature on it, but at the top it reads, “Federal Reserve Note.” 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.

Over two continents, five years, thousands of conference calls, and trillions of dollars, euros, and pounds deployed to rescue the world financial system, central bankers would take the primary role in grappling with the global panic that began in earnest on August 9, 2007. They would act with a speed and on a scale that presidents and parliaments could never seem to muster. Over the next half decade, Jean-Claude Trichet, Ben Bernanke, and Mervyn King would create the world to come.

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E
ver since the first central banker set up shop in seventeenth-century Sweden, offering paper notes as a more convenient alternative to the forty-pound copper plates that had been the currency of what was then a great empire, money has been an abstract idea as much as a physical object. The alchemists of medieval times never did figure out a way to create gold from tin, but as it turned out, it didn’t matter. A central bank, imbued with power from the state and a printing press, had the same power. With that power, it creates the very underpinnings of modernity. As surely as electric utilities and sewer systems make modern cities possible, the flow of money enabled by the central banks makes a modern economy possible. By standing in the way of financial collapse, they’ve enabled the gigantic, long-term investments that permit us to light our homes, fly in jumbo jets, and place a phone call to nearly anyone on earth from nearly anywhere on earth.

In modern times, when the amount of money exchanged electronically dwarfs the volume of commerce that takes place with paper money, even the physical work of printing paper dollars and euros is something of a sideline for the central banks. The actual work of creating or destroying money in modern times is as banal as it is powerful: A handful of midlevel workers sit at computers on the ninth floor of the New York Fed building in lower Manhattan, or on Threadneedle Street in the City of London, or at the German Bundesbank in Frankfurt, and buy or sell securities with a stroke of their keyboards. They are carrying out orders of policy-setting committees led by their central bankers. When they buy bonds, it is with money that previously did not exist; when they sell, those dollars or pounds or euros cease to exist.

Frequently, words alone are enough. To the layperson, the phrase “additional policy accommodation may be warranted” might seem either insignificant or unintelligible. But it’s likely to inspire convulsive joy on the trading floors of Wall Street, London, and Hong Kong when spoken by the Bank of England governor or the ECB president or the Fed chairman: It’s the central banker’s way of saying he’ll soon be flooding the world with pounds or euros or dollars.

Within an instant of the phrase’s hitting financial newswires, the stock market will typically rally, making a retiree in Liverpool wealthier. The price of oil will usually bounce upward, making it more expensive for a truck driver in Stuttgart to ply his trade. And the cost of borrowing money will probably fall, making it cheaper for a young couple in St. Louis to buy a house. Sometimes it doesn’t even take a full sentence, but a single word. When in 2006 a CNBC journalist at a weekend social event asked Bernanke whether markets had interpreted him correctly a couple of days before, he replied, “No,” believing he was off the record. After she reported the conversation on Monday, the Dow Jones Industrial Average fell eighty-five points within minutes.

To a degree that’s rare among high public officials, central bankers feel connected to the long thread of history. The successes of their predecessors made the world as we know it. The Bank of England played a crucial, if often overlooked, role in creating the stable financial system that allowed Britain to rule vast swaths of the world in the nineteenth century. The creation of the Federal Reserve enabled New York to supplant London as the world’s financial capital in the years after World War I, enabling the rise of the United States as global superpower and setting the stage for a generation of prosperity that followed the Second World War. The (belated) achievement of the Fed and other world central banks in defeating the inflation of the 1970s laid the groundwork for a quarter century of stable prices and global prosperity—one that started crashing down on August 9, 2007.

They are also, of course, keenly aware of central banking’s past failures, of which the Great Depression is only one. The actions of Bernanke and Trichet and King on that day in 2007—and on many days that would follow—were shaped by their knowledge of, for example, the collapse of Overend & Gurney in 1866. The mighty British bank’s failure sparked a panic so great that the streets of the City of London were mobbed with depositors scrambling to take their money out of other financial institutions. Thanks to the recent invention of the electric telegraph, the panic soon spread to the countryside, and even to the far corners of the empire. Facing a freeze-up in the money markets, the Bank of England, as the writer and public intellectual Walter Bagehot famously wrote at the time, lent “to merchants, to minor bankers, to ‘this man and that man,’” and thus stopped the run—though not the destructive economic downturn of its aftermath. What the ECB did on August 9, 2007, was an updated, electronic version of that same strategy, and Trichet, Bernanke, and King often invoked Bagehot’s words as a model for their own crisis response almost 150 years later.

Bernanke and other Fed officials understood all too well the United States’ aversion to the type of centralized political control embodied by a central bank. The lack of a central bank in the nineteenth century had meant that banking panics were an almost constant feature of the American economy. Even farmers’ predictable need for cash each harvest season routinely brought the nation to the brink of financial shutdown. Yet the battle to establish the institution that Bernanke would one day lead was exceedingly bitter. The compromises needed to gain Congress’s support resulted in an unwieldy structure that would be a challenge to lead, especially as those old arguments against centralized power reemerged a century later.

The men who led the global economy in the crisis that began in 2007 had come of age in the 1970s, when central bankers were so fearful of an economic downturn—and the political authorities—that they allowed prices to escalate out of control. “I knew that I would be accepted in the future only if I suppressed my will and yielded completely—even though it was wrong at law and morally—to his authority,” wrote Fed chief Arthur Burns in his diary in 1971. “He”
in this case was Richard Nixon, who insisted that Burns keep interest rates low and the U.S. economy humming in the run-up to the 1972 election. Prices rose so fast that steakhouses had to use stickers to update their menus according to that week’s cost for beef. Central bankers have been vigilant about inflation ever since—for better and, especially in the 2000s, for worse, when some saw inflationary ghosts where there were none.

But no specters of the past loomed larger for Trichet, Bernanke, and King than the missteps taken by the central bankers of 1920s and ’30s. It was then that the Reichsbank of Germany printed money on a massive scale to fund the nation’s government, so much so that people needed wheelbarrows to carry cash to the grocery store and would buy bicycles or pianos to hold value that reichsmarks couldn’t. That hyperinflation led to the desperate circumstances that allowed the Nazis to gain support. What came next would enable their rise to power.

The Great Depression was at its core a failure of central banking. Just a few blocks away from the building in Basel, Switzerland, where the central bankers of the early twenty-first century drank good wine and plotted their response to the contemporary crisis, the central bankers of the early 1930s met in a hotel and found far less to agree upon. Blinkered by nationalistic distrust, a misguided commitment to keep their currencies tied to gold, and the lack of a common understanding of how economies work, they concluded that the global economic crisis of 1931 was beyond their ability to combat. Even the technological limits of communication in that era—transatlantic phone calls were accomplished with great difficulty, and jet travel wasn’t yet an option—stood in the way of men like the Reichsbank’s Hjalmar Schacht and the Bank of England’s Montagu Norman. Their shortcomings led millions of people into dire poverty and created a fertile environment for World War II.

The European currency union that Trichet led—and which in a later phase of the crisis he would take extraordinary steps to try to preserve—was itself a direct result of that conflict. Born in Lyon in 1942, during the German occupation of his homeland, the ECB president grew up in a country rebuilding after the devastations of occupation and war. Like other postwar leaders, he was so intent on creating a continent where armed conflict might never break out again that he made a unified Europe the mission of his lifetime. The euro was their crown jewel, the physical embodiment of that effort—and an accomplishment that the great global crisis of the twenty-first century would eventually threaten to destroy.

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T
he partnership between Trichet, Bernanke, and King was one between men of different backgrounds, temperaments, and intellectual proclivities—differences that would loom large in the events yet to unfold. Beginning that Thursday, the three men atop the central banks of the major Western powers could only look to each other to find ways to see beyond those differences.

When they took their respective jobs—in 2003 for Trichet and King, in 2006 for Bernanke—they joined a brotherhood of uncommon intimacy. The world’s top central bankers meet in person frequently—at an economic conference each summer in Jackson Hole, Wyoming, on the sidelines of countless global summits, and, most significantly, six times a year in Basel, where they take brief refuge from the politics, personal attacks, and hard choices that come with doing a job most people don’t quite seem to understand and more than a few regard as sinister.

They speak the same language, literally and figuratively: All speak good English and are deeply versed in the discourse of economics. Foreign ministers, finance ministers, and defense ministers may have cordial relations with their counterparts from other nations. Some may even become friends. But none of those leaders have the same sustained, intimate exposure as the central bankers to the personalities and thinking, idiosyncrasies and blind spots of their international colleagues. Central bankers understand more deeply than perhaps anyone else where other countries are coming from. They share a closeness unheard of elsewhere in international relations, knowing with great confidence that what is said at the table in Basel will stay there.

There were some older connections between the leaders of the ECB, the Fed, and the Bank of England, too: King and Bernanke had shared an office suite as young faculty members at MIT; Trichet and King had met when King was a student at Cambridge and Trichet, a young civil servant, had gone abroad to study the British tax system. But the panic that began that August day in 2007 would test their bonds as well as their ability to come together to guide the global economy toward prosperity.

Mankind had given them incredible power. Now was the time to show that they had learned history’s lessons. As the consequences of a generation of bad lending and rising debt started to unfold, this committee of three knew better than anyone just how high the price of failure could be.