The Alchemists: Three Central Bankers and a World on Fire (39 page)

On that first day of QE2, the offers were piling up: The dealers were ready to sell $29.039 billion in bonds to the Fed. The traders watched as a computer program sorted the incoming offers to find the ones that offered taxpayers the best deal. After all, a bond maturing in October 2014 should have a different price from one maturing in January 2016, so their job is to ensure that they buy the ones in which dealers are offering the best relative price.

With one minute to go, the traders’ computers begin flashing red. They watch CNBC and monitor the Bloomberg feed to make sure there is no major market-moving news; in that event, they might delay the end of the auction in order to give the bidders time to adjust their offers accordingly. When the clock expires, the Fed’s computer sorts through all the offers to choose the ones that offer the best deals. On November 12, 2010, of the $29 billion being offered on twenty-four different individual securities being offered, the best prices were being offered for sixteen different securities, such as $141 million for a Treasury bond scheduled to mature on February 15, 2015, that when originally issued offered a 4 percent yield.

The traders had bought billons in bonds, which were now owned by the Federal Reserve Bank of New York. The sellers—the banks and their clients—had billions of newly created dollars sitting in their accounts, money that they could lend out or spend to their heart’s content. The traders would repeat the practice 139 times over the ensuing eight months, until an extra $600 billion was floating around the world economy. Those dollars would, if Bernanke and Dudley were right, create more lending and investment—or, if the hawks were right, higher prices and bubbles.

•   •   •

A
s the opposition to QE2 escalated in the days after the decision, Bernanke’s Fed was under siege from all sides—from American conservatives, foreign powers, some of his own colleagues, and financial commentators whose views weren’t too different from those of the animated talking bears. The tradition of keeping quiet and communicating through formal written statements had ill prepared the Fed for a commensurate response. On the afternoon of the decision, Bernanke’s calendar listed two hours of “
Calls w/media
”—but those were apparently all off the record. Even the efforts to push back were hardly smashing successes.

Bernanke wrote an op-ed for the
Washington Post
that was published the next day, and in December he sat for another of his rare television interviews, again with CBS’s
60 Minutes
. “
One myth that’s out there
is that what we’re doing is printing money,” Bernanke told anchor Scott Pelley. “We’re not printing money. The amount of currency in circulation is not changing. The money supply is not changing in any significant way.”

Bernanke was being too clever, taking advantage first of the fact that QE2 increased the amount of money in the economy through electronic means, not by literally printing cash. But of course, a hundred dollars in a bank account is just as much money as a hundred-dollar bill in someone’s pocket. His second point, about the money supply, was an extremely subtle one: The Fed’s purchases would increase “monetary base” or “high-powered money,” increasing the number of dollars circulating through the economy only if the banks and individuals with extra dollars in their accounts lent out or spent the cash. This too was disingenuous—the whole action was premised on the hope that they would do just that.

Comedy Central’s
The Daily Show with Jon Stewart
was the first to point out the contradiction between Bernanke then and what he’d said on the same show, with the same host, twenty-one months earlier. In March 2009, describing the Fed’s earlier round of asset purchases, Bernanke had said that “to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed. So it’s much more akin to printing money than it is to borrowing.”

“You’ve been printing money?” Pelley asked in 2009.

“Well, effectively,” said Bernanke then.

Stewart joked that the Fed wasn’t printing money—it was “imagineering” it.

Whatever you call it, by some important measures, QE2 worked. In terms of economic growth and job creation, the next year was stubbornly sluggish. But after a summer in which economic data was pointing to a possible new recession and very low inflation, financial markets responded as quantitative easing shifted from a distant possibility in early August to a certainty in early November. Inflation expectations moved upward from 1.2 percent in August 2010 to right at about 2 percent in early 2011, roughly what the Fed was aiming for. By early 2011, the odds of the U.S. economy slipping into deflation were minuscule, bolstering Bernanke’s theory that a central bank need never allow falling prices.

Yet Bernanke and his colleagues were confronting a new variety of criticism. For generations, central bankers had steeled themselves against politicians who argued that money was too tight, interest rates too high. That’s what it traditionally meant to be independent—to have the courage to raise interest rates when the economy was overheating and inflation was a threat.

But now, up was down, dark was light, and politicians—at least on the right—were clamoring for tighter money at a time of mass unemployment. The Bernanke committee management strategy, of pushing the action through over the course of three months, three FOMC meetings, and a series of speeches, may have been the best way to get a sprawling group with a wide range of views to come together. But it also served to make the action feel like a giant step toward easy money. Similarly, the decision to announce a single gigantic number surely played a role in the blowback. After the U.S. government had enacted a $700 billion financial bailout and a nearly $800 billion, deficit-financed tax-and-spend package in the recent past, the $600 billion in bond purchases sounded to many critics like more of the same—even though the action likely reduced the budget deficit, because the Fed returns the interest earned on the bonds to the Treasury.

The Federal Reserve, as the Dodd-Frank debate had shown all too well, exists at the pleasure of Congress. To have one of the nation’s two major political parties engaged in all-out assault on the idea of “printing money” left many on the FOMC who voted for more easing in the form of QE2 wary of doing so again. The chairman now had a clearer idea of why the Bank of Japan had seemed so timid a decade earlier, when he was urging it toward activism.

“
I’m a little bit more sympathetic to central bankers now
than I was ten years ago,” Bernanke said in a press conference in June 2011, a weary smile on his face.

THE SECOND WAVE, 2011–2012

The Chopper, the Troika, and the Deauville Debacle

T
he Irish press called him “the Chopper.” At 8:45 the morning of Thursday, November 18, 2010, Ajai Chopra departed the Merrion Hotel in Dublin and walked the fifteen minutes to the Central Bank of Ireland for a day of meetings, trailed by photographers. The deputy director of the International Monetary Fund’s European division had suddenly become one of the most famous men in Ireland—and here was a chance to capture an image of the man “
ready to rip up the books
and offer the country billions” walking past street beggars hoping for some spare change. The symbolic resonance couldn’t be beat.

Ireland had been one of Europe’s great economic success stories of the previous two decades, emerging from relative poverty to become arguably the eurozone’s most dynamic economy. Its free labor markets and low corporate taxes made it a popular destination for international firms looking for a European outpost. Its government was efficient and generally free of corruption, and its public finances before the crisis were impeccable. But when Irish officials decided on September 30, 2008, to give government guarantees to their banks, the nation’s financial situation fell apart with remarkable speed. “What’s the difference between Iceland and Ireland?” asked a joke that went around in 2009, referring to the tiny Nordic nation whose banking system had imploded the year before. The answer: “One letter and six months.”

But while in many ways the joke proved all too prescient, it was the differences between the two nations that had the Chopper in town. First, Iceland had its own currency, which collapsed 58 percent against the dollar in 2008, setting the stage for an economic rebound as exporters became more competitive. That country’s unemployment rate peaked at about 8 percent. Ireland’s unemployment rate rose to 14.8 percent in November 2010. Second, Iceland’s banking system was small enough that its institutions could fail without endangering the entire European or world banking systems. Ireland’s couldn’t—at least that was a widespread view among European officials.

“
I’m not used to a situation where I’m so recognizable
,” Chopra said in an interview on RTÉ television. “People have come up to me, calling me by my first name as well, but they’ve done it in a very polite and very gracious way, and they’ve always wished me the best. And I think this pluck of the Irish is coming out in this crisis.”

So were the representatives of various international bodies offering bailout loans in exchange for strict concessions from the government. Klaus Masuch, a German economist with a reputation as a tough negotiator and a proclivity for short-sleeved dress shirts, was in Dublin for the European Central Bank. István Székely, a Cambridge-educated Hungarian who had worked for his nation’s central bank and the IMF, was there on behalf of the European Commission’s Directorate-General for Economic and Financial Affairs. Reporters stationed themselves outside the Central Bank of Ireland and shouted, “IMF? EU? ECB?” at people exiting because, as the
Irish Independent
dryly noted, “
nobody was really sure what the international officials looked like
.”

Black humor notwithstanding, the Irish seemed to deal with the coming era of austerity—and even their loss of economic sovereignty—with greater acceptance than the Greeks had. In the Mediterranean nation that spring, protestors had staged a nationwide strike, tried to storm parliament, and firebombed a bank, leaving three dead. By contrast, there was no significant violence in the streets of Ireland, although the chief executive of the low-cost airline Ryanair upstaged the prime minister by showing up at an event to celebrate the opening of a new terminal at Dublin’s airport with a coffin covered by an Irish flag. He announced that the terminal amounted to a “
nice welcoming lounge
” for IMF officials. It probably helped that the Irish were fast losing confidence in their own elected officials.
As the
Independent
headlined a letter to the editor
, “Better Chopra than our hopeless lot.”

“
I guess older people will be upset
or feel a sense of national humiliation,” said Niamh Norton, a college student quoted by the
Observer
. “But the truth is that it’s the big countries of the world that dictate what’s going on. . . . Ireland is a small country.”

•   •   •

T
he cast of international officials may have been a little different, but the small-country script being staged in Ireland had been well rehearsed in Greece a few months earlier. Brought together on the fly in the spring of 2010 and by fall the most powerful partnership in Greek politics, the team of Masuch, Danish economist Poul Thomsen, and Belgian fiscal policy expert Servaas Deroose represented, respectively, the ECB, the IMF, and the European Commission. This was the “troika,” suddenly responsible for the economic future of some eleven million Greek citizens.

Over room-service sandwiches and sometimes a Mythos beer in an Athens hotel suite, they talked about what they’d learned that day. Where was the Greek government following through on its promises? Where was it not? How might they steer their discussions tomorrow to have more of the former than the latter? Downstairs in a conference space, their staffers—forty, fifty, or more people—divided into teams, ate catered food, and discussed among themselves their own conclusions and plans for the next day.

In quarterly missions, usually lasting two weeks or so (although a few stretched out to more than a month), the representatives of the troika interrogated midlevel staff at all sorts of government agencies—the tax collectors, the energy regulators, the bank supervisors—to try to figure out whether Greece was living up to the agreements its leaders had made in exchange for the international bailout received in May. The meetings, most of them conducted in English, tended to be civil affairs, with the Greek officials understanding that all present were there to do a job. Some of their interlocutors even seemed pleased to finally have the outside pressure needed to enact reforms they had long sought.

There was more animosity outside the corridors of power, where the citizenry saw the visitors as the reason wages and pensions were being slashed. The faces of Masuch, Thomsen, and Deroose (and later Matthias Mors, who took over as the European Commission’s representative), each relatively anonymous at his respective organization, were splashed on newspaper front pages. The men had to travel with a police escort and eventually had to change hotels. At first they’d stayed at the Grand Bretagne. But when sometimes violent protests erupted in the square it overlooks, they moved to the Hilton a few blocks away.

The three officials tried to work out disagreements among themselves—for example, how hard to press on cutting wages for government workers as opposed to encouraging longer-term privatization projects. Ironically, while the IMF became a more visible target of populist ire on the streets of Athens, the organization was more worried than other troika members about the economic impact of immediate austerity. That reflected both the fund’s experiences in Asia in the 1990s and Latin America in the 2000s—and the fact that it was led by Dominique Strauss-Kahn, a man of the left who embraced Anglo-American-style Keynesian economics more than many continental Europeans. The ECB and the EC were the greater enthusiasts for steep and immediate spending cuts. Still, the three men—and their bosses in Washington, Frankfurt, and Brussels—managed to keep their disagreements confined to the suite in the Hilton and present a united front.

“It seemed they were very well coordinated with each other so as not to create friction points that were evident to us,” said one Greek official who worked across the negotiating table. “I have heard there were disagreements, but they were never able to undermine the collectivity of the troika.”

It remains the fact, though, that this was the situation in which Greece found itself in 2010: As the price of a bailout, its central bank was part of a team that was giving instructions to elected leaders on what to do about pensions, taxes, and privatization of state-owned industries.

Democracy had been born in Greece. And democracy, it was said, had died there.

Issues of national sovereignty aside, things were moving in the right direction. The series of interventions hatched over the weekend of May 9, 2010, had succeeded. European institutions—both the governments and the ECB—had shown the resolve necessary to keep the Greek crisis from spiraling out of control. Sure, the European stability fund was more an idea than a reality, but so long as the GIPSI governments carried out what they’d promised, an investor could feel assured that no eurozone nation would be allowed to default on its debts. And the ECB’s interventions in the bond market proved surprisingly effective. After an initial burst of purchases of Greek, Irish, and Portuguese debt in May and June, markets were functioning well enough that the buys were allowed to taper off.
By the last week of August
, the ECB’s total bond holdings under the securities-market program added up to only €61 billion.

It was a victory for Jean-Claude Trichet’s approach to crisis management. He was a big believer that even small interventions by a central bank, if made at just the right time and in the right way, could cause a significant shift in market sentiment. The start of bond purchases punished those who were betting on a eurozone collapse in the spring and made anyone thinking of selling off bonds wary of betting against the ECB and its limitless balance sheet. Markets eased pressure on the GIPSI countries. Spanish ten-year borrowing costs, for example, fell from 4.9 percent in June to 4 percent at the start of September.

The government of Greek prime minister George Papandreou was even having some success—with prodding from the troika—meeting its ambitious goals of cutting pensions and raising taxes. Finance Minister George Papaconstantinou even approached the Institute of International Finance, an association of giant global banks that are among the major buyers of government debt, to arrange a “non-deal road show”—an occasion for him to go to major financial centers and meet with investors to persuade them of Greece’s commitment to repairing its finances, in hopes that they might eventually resume buying its bonds.

The actions of May had bought Europe some time to address its economy’s underlying problems. Yet by the fall of 2010, none of its structural defects had been fixed. Greeks were still paid more than their levels of productivity would suggest was sustainable, and German and French banks were still sitting on piles of debt issued by governments with shaky finances. The continent’s bank regulators conducted a coordinated “stress test” of their various banking systems to examine potential weaknesses and announced its encouraging results on July 23: Most banks could survive losses totaling hundreds of billions of euros. But the test assumed that the debt of all eurozone countries would be fully repaid, which amounts to begging the question.

There were also early signs of cracks in that sense of common resolve, as the governments of Europe went about figuring out the details of the stability fund they had agreed to. Then came perhaps history’s most consequential stroll on the beach.

•   •   •

G
erman chancellor Angela Merkel was grappling with competing pressures. Her ability to resolve them would, more than any other factor, determine the future of Europe.

On the one hand, her countrymen were aghast that they were being asked to bail out the Greeks. The very day the bailout package was being negotiated, May 9, her coalition lost massively in regional elections in North Rhine–Westphalia, in part due to discontent over the push to aid Greece, and she would face seemingly constant challenges in Germany’s constitutional court as to the legality of the bailout measures to which she had committed the nation. On the other hand, the most powerful woman on the continent was also very much a European, determined to realize the vision of a united continent that her political mentor, Helmut Kohl, had set. “
Ladies and gentlemen, let’s not talk around it
,” she said in a speech in Aachen on May 13. “The crisis over the future of the euro is not just any crisis. . . . This test is an existential one. It must be passed. Failing it, the consequences would be incalculable for Europe and beyond. But succeeding, then Europe will be stronger than before.”

In the fall of 2010, it was antibailout fervor toward which Merkel was most attentive. Even some within her own government were starting to pose some fair but uncomfortable questions: Why were German taxpayers being asked to aid Greece—what about the people who’d lent the nation all that money in the first place? And wasn’t Greece effectively bankrupt? When a company goes bankrupt, its investors lose some of their money. Yet the banks and pension funds that had bought Greek bonds were, under the plan being pursued, not to receive a euro less than they were owed. Why, German politicians asked, shouldn’t they suffer the same losses any other unwise investor would? Ironically, this put the questioners in common cause with many Greek politicians, who’d have been more than happy to see their debt burden actually reduced, rather than just restructured.

If that was the mentality in Berlin, the sense in Frankfurt, both at the Eurotower and the Bundesbank, was quite the opposite. European central bankers saw grave risk in forcing losses upon Greek creditors. As Trichet and other ECB officials saw it, if Greek bondholders were forced to take haircuts, it could inspire a dangerous and unpredictable chain reaction. Investors would judge the debt of all the at-risk eurozone nations as riskier and likely dump Irish, Portuguese, Spanish, and Italian bonds. Even France could find itself in the line of fire. German and French banks, major holders of Greek bonds, could find themselves undercapitalized and require a new bailout.

And those were just the knowable effects. Government bonds are the bedrock of the financial system. As with the Lehman Brothers failure, a Greek default could have rippling second-order effects that would be very hard to predict. It was one thing for a nation to stiff bondholders when it had its own currency, as Argentina did in 2001 and Russia did in 1998. But to do so as a member of a shared currency union could cause all manner of unforeseen problems. Bailing out not just the Greek government but also Greek creditors was, in the ECB’s view, a small price to pay to prevent them.