The 'Alchemists' Who Control The Purse Strings Of The Economy

Transcript

TERRY GROSS, HOST:

This is FRESH AIR. I'm Terry Gross. As the U.S. economy struggles to recover from the financial crash, and Europe is buffeted by a series of banking crises, attention has focused on the presidents and prime ministers who have tried to cope with it all. But our guest, journalist Neil Irwin, says there's an elite group of policymakers who can make enormously important decisions on their own, often deliberating in secret and in many ways unaccountable to voters.

They're central bankers: men and women who control the money supply in their national economies. In the U.S., the Federal Reserve Bank pumped hundreds of billions of dollars into the economy in recent years, prompting some in Congress to seek limits on the Fed's power.

Irwin's book is both about the efforts of central bankers in recent years to contain crises but also about the past blunders of central bankers whose decisions have sometimes had ruinous consequences. Neil Irwin is a Washington Post columnist and economics editor of Wonkblog, the Post's site for policy news and analysis. His book is called "The Alchemists: Three Central Bankers and a World on Fire." He spoke with FRESH AIR contributor Dave Davies.

DAVE DAVIES, HOST:

Well, Neal Irwin, welcome to FRESH AIR. You call your book "The Alchemists." Why?

NEIL IRWIN: You know, hundreds of years ago, alchemists were these people who dreamed of turning routine materials into gold or silver and creating wealth where there was none. Some of them were kind of charlatans and cranks; some of them were some of the leading scientists of the day.

It was once said that Sir Isaac Newton was not the first of the modern scientists but was rather the last of the alchemists. But it turns out, around the time Sir Isaac Newton lived, mankind was discovering something else, which is you don't really need some crazy potion or invention to create money and create value where there is none. If you have a central banker, and you have a printing press, and you have the authority of the state imbued in both, you can create money from thin air.

And the truth is, that's how modern economies have worked ever since, ever since this was first sort of figured out in 17th century Sweden. And so the central bankers of today, they're really the inheritors of this long tradition, of having the power that is granted to them by the state, by the government, to create money and control the supply of money in the economy.

DAVIES: There is this magical quality to money. I mean, you know, once economies diversified, and barter didn't work, I mean, we couldn't be, you know, just trading one good for another, people used precious metals because they were small and transportable as stores of value.

But when did governments fix onto the idea that they could not just establish a currency but could actually consciously increase the amount of money in circulation or in some cases withdraw some in response to a crisis? When did they figure this out?

IRWIN: You know, it's been an evolution. I tell the story, it's kind of fascinating. I had not heard it before I started working on this book and researching it. In 1660s Sweden a man with a kind of checkered pass was granted a charter by the crown to create what would become the first central bank. And he was the man named Johan Palmstruch. He was the first to create paper bank notes in Europe.

So paper money had its start at this time 350 years ago. You know, what's remarkable is that, you know, we've learned a lot since then, and there's a lot that we've learned about how you can control the banking system, how you can regulate banks, how you can, if you're a central banker, kind of turn the dial of the money supply.

And when there's too little growth, when prices are falling, when it's, you know, a situation where the economy is contracting, that's when you want to turn the dial one direction and pump more money into the economy. When it's the other, when it's the reverse, when the economy is overheating, when you have inflation, when prices are rising too quickly, that's when you want to turn the dial the other direction and pull it back.

The idea that this is a dial over which people have control and governments have control is something that has only really developed in the last 100 years as we've moved beyond the gold standard and toward this world of fiat money, where, you know, one thing you learn the more monetary history you study is money is an idea. It's not a physical object.

It's an idea of what is this value, what is the store value. What is money worth? Why does money have value? Because people will take it as compensation for other things.

DAVIES: One of the most interesting parts of the book, I think, is your description of a number of events in the '20s and '30s where governments and central banks made unwise and ill-informed decisions that had terrible consequences, many in Europe, and of course none worse than the reaction to the financial panic in the United States following the stock market crash. Explain what the Fed did in reaction to the financial crisis in the United States and why it didn't work.

IRWIN: So the Great Depression, there's no reason there should've been a Great Depression. More so than any other traumatic events in world history, you can blame the Great Depression on the central bankers and the failures they made. You know, this started as a pretty routine drop in the stock market, a stock market panic in the United States in 1929. There's no reason that had to become a global panic that led to massive unemployment in Germany and Britain and Austria and France and ultimately would lead to the rise of the Nazis and to World War II.

You know, this was the ultimate failure of central banks to understand their role, to understand their powers and to understand how to use them to try to keep mankind on a better course. So what happened narrowly is the stock market collapsed, there was a panic through global financial markets, and so in the United States there were a wave of bank failures, but there was no mechanism for trying to stop those banks from fail.

It was kind of accepted this is a capitalist system, there's no deposit insurance. If your bank makes bad bets and goes under, well, you just lost your savings. Sorry, but that's how it is. So you had a wave of bank failures. What that amounts to is a contracting of credit.

So as banks fail, suddenly there's less money circulating through this financial system. And when there's less money, prices tend to fall. So what happens is deflation sets in, companies cut jobs, so unemployment rises, and this forms a vicious cycle. The worse the economy gets, the more banks fail; the more banks fail, the worse the economy gets.

What you want to see happen is the central bank step in and prevent that vicious cycle from setting in. The Federal Reserve didn't have either the capacity or the will to do that. There were some people within the Fed system in the early 1930s who wanted to act more aggressively, particularly at the New York Fed, but they were really overruled by a sense that this is purging the rottenness from the system, this is what we have to do to get out of - to let the market do its work.

And so as a result we had this huge contraction of the money supply in the United States. You had this wave of bank collapses, and you had massive unemployment that led to some very bad places.

DAVIES: Right, so if the central bank should have, instead of that, pumped money into the economy, lowered interest rates, assured banks, made credit easier, that would have allowed the economy perhaps to right itself. Let's talk about a couple of fundamentals. When we talk about a central bank like the Fed, putting more money into the economy, we're not talking about the government making welfare payments. We're not talking about dropping $20 bills from helicopters.

How does that happen? How does the central bank create money and then put it into the system?

IRWIN: Right, so the basic divide of powers is the central bank controls the supply of money in the economy. It's up to the fiscal authorities, it's up to Congress and the president to decide what to do with money. So the Federal Reserve or any other central bank, they can pump money into or out of the economy, but then in general usually just don't spend it. They don't spend it to buy things.

Or - so the way they do that is through financial markets. So they go in - and I've actually been in the room at the New York Fed where they do this, they'll - you know, it's a pretty normal conference room down in Lower Manhattan where the New York Fed is located.

And you have a few people at a computer, and they say all right, today our plan is to buy $2 billion worth of Treasury bonds to create $2 billion in new money. So they go on, and they essentially take bids from different - they're called primary dealers. It's all the major banks. And the major banks say OK, we have some bonds for sale, we'll sell you these many at this price.

And the Fed clicks a few buttons, and what happens is they buy those bonds. So what happens is $2 billion is created from thin air through that tapping on the keyboard. Two billion dollars is now on the balance sheets of those banks. Meanwhile, $2 billion in bonds is on the balance sheet of the New York Fed.

So what suddenly just happened and this thing that's pretty unexceptional, you're in a kind of boring little conference room like you would see in any office in America, is these kind of mid-level people sitting there typing at a computer have just created $2 billion from thin air and used it to buy these bonds and push it out into the financial system.

DAVIES: Right. Now, they don't hand the $2 billion to somebody for nothing. What they do is, as you said, they buy these financial assets which are held by private parties. But in doing so they inject more money into the system, and that tends to give them - give people who get the money more ability to invest and provide for more stimulated economic activity.

IRWIN: Right, and that's what we've seen the Federal Reserve and many of the other central banks do over and over these last few years. It's - you know, if you went back a few years, the way central banks handled the money supply was by adjusting interest rates. Well, a lot of the - you know, in the United States, in Britain, in Japan, they've had zero interest rates now for four, five, six years.

So they're having to find other ways to try and pump money into the economy, and that's where this strategy of buying bonds comes in. So, you know, the idea is that buying Treasury bonds, it's neutral. You're not - if you're the Federal Reserve, you're not trying to pick winners and losers in the economy. You're not trying to say I'm going to favor the auto industry over the housing industry, or I'm going to favor manufacturing over the service sector.

What you're trying to do is change the baseline amount of money in the economy and change the interest rates that apply across sectors and across industries. Now, it doesn't always work that way in practice. They've been buying some housing, some mortgage-backed securities, things like that. But as a goal anyway, the central bank isn't trying to pick winners and losers; they're trying to be neutral and determine what kind of supply of money is the one that's going to result in low inflation and help the job market get back on track.

DAVIES: Now, in the book you talk about how, you know, the United States suffered from inflation in the 1970s, and Paul Volker, who was the head of the Fed at the time, worked hard to bring that down, to hike interest rates in some cases, and that the United States just kind of licked inflation and had a long period of relatively stable, low-inflation economic growth.

And you talk about a gathering in 2005 at Jackson Hole, Wyoming, one of these places when central bankers sit down with the finest wines in deluxe accommodations and talk about the economy. And you referred to, in effect, a consensus, a Jackson Hole consensus about managing the economy through central banks. What was the consensus? What did they agree upon?

IRWIN: So think about the world we saw in 2005. If you looked around, we'd seen in most of the world 25 straight years of pretty solid growth, very low inflation, no real financial panics or crises, at least that affected the major Western powers. You know, there were some problems here and there. Japan had been mired in a long slump, and you know, there had been a series of emerging market crises in the late 1990s.

But if you're a policymaker in the United States or Western Europe or Britain, you're feeling pretty good about yourself. You feel like, you know, you've mastered a lot of the problems that have whipsawed economies for centuries. You know, the consensus of how you manage that economy - as I call it, the Jackson Hole consensus - is this sense of a kind of common understanding of what you do.

And there's different parts of it. One is that, you know, financial markets are basically efficient. And yeah, financial markets might have bubbles here and there, but those are - you know, the problems that result from that are things that we as a powerful central bank we can easily contain.

You know, it's easy to call it hubris, and it certainly was, but it's also based on something, which was the sense that from the early '80s to the mid-2000s you do have this track record of success in kind of managing a global economy that seemed to be in one kind of long straight path toward prosperity.

Now, as we learned and as some people at the time seemed to understand, there were some real significant imbalances building beneath the surface throughout this period, and that's what got us in huge trouble.

DAVIES: We're speaking with journalist Neil Irwin. He is a columnist for the Washington Post and economics editor of its Wonkblog. His new book is called "The Alchemists: Three Central Bankers and a World on Fire." We'll talk more after a short break. This is FRESH AIR.

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DAVIES: This is FRESH AIR, and our guest is journalist Neil Irwin. He has a new book about central bankers called "The Alchemists."

Well, when the financial crisis erupted in 2007 and 2008, it was clear that a lot of the assumptions that a lot of central bankers and the economists had relied upon had been wrong. You know, mortgages were defaulting around the country. Securities that were based on them were plunging in value. And big financial institutions were threatened.

Ben Bernanke, who was and is the chairman of the Federal Reserve, felt it was critical to intervene directly and aggressively to prevent financial collapse. Now, what did that mean in policy terms?

IRWIN: Well, they started very early at the Federal Reserve cutting interest rates. They saw, you know, the U.S. housing market had peaked in 2006, and by late 2007 was almost in freefall. But it's a lot bigger than that. You know, what was happening is the U.S. housing market was underneath this much broader set of securities that really formed the bedrock of the global financial system.

So there were all these, you know, U.S. mortgages, subprime but also other kind of risky U.S. mortgages, were packaged into mortgage-backed securities, some of which were rated triple-A. So they're considered the safest of the safe. European banks in particular invested heavily in these seemingly super-safe securities.

So as it became obvious that these were not as valuable as it had seemed, that there were going to be huge losses on these mortgage securities, suddenly there's these ripple effects across the globe. So you have European banks who have nothing to do with, you know, the housing market in Florida but have these mortgages on their books as a super-safe asset, they're looking at these huge losses.

They're not sure how much money they've lost. It's very uncertain. And so you have a freeze-up in the European banking system because of problems in the U.S. subprime mortgage market. It's a study in how the global financial system has become deeply interconnected in ways that aren't always easily understood or easy to track.

So what Ben Bernanke says at the Fed back in 2007 and early 2008, is, look, this hopefully won't be that big a deal, but it could be the big one, and we need to try and get ahead of the problem and do what we can to step in as the lender of last resort, as the guardian of the U.S. economy and try to combat this thing.

So you see a series of actions to try and pump money into the financial system, to try and lower interest rates to help the economy and to create novel programs to deal with the specific problems they were facing, which is a crisis in the European banking system. So early on you see this - these efforts to pump hundreds of billions of dollars into even European banks through the ECB.

So what happens is the Fed says to the European Central Bank, OK, we'll do a swap line. We'll give you dollars, you give us euros. You can then led out dollars to your banks because that's what they need right now, and then we'll unwind the thing after 90 days or whatever.

DAVIES: Now, when Bear Stearns was collapsing, Bernanke saw it was - you know, he saw that it was important to prevent a collapse of the financial system. Did the Fed have the power to loan Bear Stearns money? Was that clear?

IRWIN: It's not at all clear. I mean to use Paul Volker, the former Fed chairman's, line, it was clearly the very outer edges of their authority. What happened is Bear Stearns was an investment bank. It had - you know, it relied on short-term funding.

So every night it had to go into the capital markets and roll over its debt to make sure it could open for business the next day. And as doubts arose about its solidity, about its safety, suddenly those investors in what's called the tri-party repo market, they weren't there one night. That happened in March of 2008.

And so overnight there was this set of decisions: What do we do? And JP Morgan was willing to buy Bear Stearns, but they needed the Fed to guarantee some of the assets they would be taking on to do it. So what we had is overnight, at something like 4:00 or 5:00 in the morning, you have the Fed agreeing to essentially guarantee $30 billion of private assets in a way that, you know, it was using this emergency lending authority that, speaking of things we didn't understand, I don't know how many people understood that the Fed had that emergency lending authority.

But their lawyers knew exactly what it was in the Federal Reserve Act. And so we all woke up on a Friday morning and found out that the Fed had essentially bailed out an investment bank. And that was a pretty transformative event in the history of the relationship between the central bank and Wall Street.

DAVIES: Now, so was the Fed essentially using its ability to create money - again, with keystrokes of a computer, simply create accounts, and then buy, you know, financial assets, including, you know, this - you know, some of these mortgage-backed instruments that were pretty shaky?

IRWIN: Yeah, look, they took on some risk with the bailouts of both Bear Stearns and AIG. In the fall of 2008, you know, it was a remarkable effort. You know, the Ben Bernanke mentality was this is the big one, this is a - this could be a devastating crisis. We are going to use whatever powers we have, whatever tools we can find, to try and create a wall of money that will contain this economic collapse, this financial collapse.

And, you know, he would send emails to his staff with the subject line blue sky. He wanted them to think about what they might do, what's an idea out of the clear blue sky that would maybe help solve this financial crisis. And that involved a lot of things. It involved buying mortgage-backed securities. It involved a program that was meant to use Fed money to pump into markets for credit card-backed securities and auto loans and all kinds of private lending.

You know, this was really a case of the Federal Reserve, which has this bottomless capacity to create money, using that money to create a kind of wall of protection around the global financial system.

DAVIES: You know what I never quite understood was - there was this very controversial program that had to be approved by Congress, the Troubled Asset Program, the TARP program, right, in which taxpayers were, you know, paid to buy a lot of these financially weak assets so as to preserve the integrity of the financial system.

And if in fact the Fed could simply create as much money as it wanted and do this stuff on its own, why then would you have the Congress, you know, do this, which requires political will, which is a part of the federal budget, which has to be covered by taxpayers or added to the national debt - why not have the Fed, which has the power to create money, simply carry the load itself?

IRWIN: Well, you know, the Fed is under pretty significant limits on what it can do with that money it creates. And that's good. I mean, this is an unelected body of people. They're economists who, you know, get together eight times a year and debate what to do with the money supply. They're not elected officials. They don't have the authority that Congress has to spend money however it wants.

They have very clear limits on what they can do. And they can lend money to - that's secured. So they can either buy government bonds, which is how they might increase the money supply; they can buy assets that are in emergency situations that are considered safe, so that was their rationale with AIG. Yes, it was an $80 billion bailout of AIG, but that loan, that $80 billion loan, was guaranteed by other assets at the company, and therefore it was viewed as not risky.

You know, even that's a kind of questionable legal interpretation, but they went with it and it seemed to have worked out OK. You know, what was happening in that week of September 14, 2008, the Federal Reserve was reaching the outer limits of its legal authority. And with Lehman Brothers, this was a different situation from Bear Stearns.

With Bear Stearns there were assets that were reasonably safe that they could lend that money against. Lehman was insolvent. There was a gap between what the company was worth and what it needed to open for business the next day. And the Fed lawyers concluded we just can't make essentially an equity injection. We can't essentially buy stock of this company that's very risky, and we just can't do it.

So what was happening in that week of September 14, 2008 was with the Fed at the outer limits of what they could do, if there was going to be a new wave of bank rescues, Congress was going to have to approve it and give the Treasury secretary the authority to make it work.

GROSS: Neil Irwin will continue his interview with FRESH AIR contributor Dave Davies in the second half of the show. Irwin is the author of the new book "The Alchemists." I'm Terry Gross, and this is FRESH AIR.

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GROSS: This FRESH AIR. I'm Terry Gross. Let's get back to the interview that FRESH AIR contributor Dave Davies recorded with Neil Irwin, author of the new book "The Alchemists," about the elite group of finance policymakers known as central bankers. They control the money supply in their national economies and can make enormously important decisions on their own, often in secret. In the U.S., the central bank is the Federal Reserve. Irwin is a Washington Post columnist and economics editor of Wonkblog, the Post site for policy news and analysis. When they left off, they were talking about the Fed's actions during the financial crisis of 2008.

DAVIES: After the financial system stabilized, Congress began looking at financial reform legislation. And there was an awful lot of anger at the Federal Reserve - not just from, you know, some hard-line conservatives like Ron Paul, but from even from Christopher Dodd, the Democrat from Connecticut. Why were they angry at the Fed? What did they want to do?

IRWIN: Yeah. If you get to 2009, it seems like the one thing that everyone in Congress could agree with, left, right, center, is that the Federal Reserve had really exceeded the bounds of its power and was really an institution they wanted to clip its wings and let the Fed know who's boss. So you saw that in what would become the Dodd-Frank Act. So Christopher Dodd, the senator from Connecticut, he saw a strategy for coming up with a financial reform that could be bipartisan, and using the Fed, using this antagonism toward the central bank that had so outstripped its normal authorities during the crisis, as a tool for finding consensus. And so he wanted to tell the Fed, you know what? You're not going to regulate banks anymore. We think you did a crummy job overseeing banks before the crisis. We think that's part of the reason we got into this panic to begin with, so we're going to not let you do that anymore.

At the same time you have this impulse from both the left and the right on reducing their independence. So Ron Paul calls it audit the Fed. I think people within the Fed would say well, it's not an audit. We already have auditors who check our books and all that sort of thing. This is about Congress overseeing our monetary policy decisions that are supposed to be independent.

But that was a strong push from both conservatives, like Ron Paul and also Bernie Sanders, the socialist from Vermont. So you have both the left/right coalition trying to go after the Fed on its kind of independence and disclosure transparency grounds. And, you know, what we see, this is not unusual in history. I mean often when times turn bad, people want somebody to blame, and often the someone to blame is the most powerful institution that has control over the financial system, which in this case, in this country is the Federal Reserve system.

DAVIES: Right. but it's also the case that the Fed, you know, operated with very different rules than most other government agencies. I mean, the identity of banks that got large amounts of money weren't public at the time. You know, minutes of critical meetings weren't made available, aren't made available until is it, went five years after they occur. So we're really looking at an agency of unelected people who operate in a lot of cases in the dark.

IRWIN: Yeah. And that's very troubling. You know, it's the reality of how the system has evolved and it's very much the case that we as a society have decided, you know what? There are some decisions that it's better off be made by technocrats, by experts who can act quietly, who can act behind the scenes and move quickly and move on a scale commiserate with the problems. That's not to say it really fits with most of our democratic principles. You know, the Fed meets eight times a year to discuss interest rate policy. We only find out exactly what they said at those meetings five years later; we get transcripts. That's not exactly a model transparency.

You know, it is true that Ben Bernanke goes before Capitol Hill and answers questions over and over. And it's true that, you know, if you know how to read their minutes and their different documents they put out you can glean a lot about what they're up to. But it's very much a secretive institution. And so if you are an advocate of transparency and democracy and kind of a free flow of information, it's definitely the case that the Federal Reserve system and other central banks, for that matter, are not really what you want to see.

DAVIES: Is that because the decisions they make if they are debated publicly will influence financial markets in ways that are counterproductive?

IRWIN: Potentially, that's part of it. You know, it's, you know, it's funny. There has been a revolution in thinking among the central bankers over the last generation. It used to be many of them thought that saying nothing was actually - enhanced their power and having a bit of a mystique and a bit of a kind of powerful man behind the curtain, puppet master sort of reputation and view in the world was helpful. I think that's really evolved in the last 20, 30 years. Now all of the major central banks, their governor, their head person, gives a press conference. Ben Bernanke does it four times a year. Mario Draghi of the European Central Bank, the Bank of England, they do it once a month.

They've concluded that, you know, sometimes if you tell people what you're trying to do and what your goals are it can actually help get better policy, rather than hurt. So we've seen that from the Fed. They've released projections of what they think the economy is going to do and they talk a lot about what they think the future course of policy is going to be. So, look, the Fed is a more transparent institution then it was 10, 20, 30 years ago. That said, it's still the case that you have these guys who get together and in private in a secret, dark room and - I don't think it's actually that dark - but they get together in the secret, private room and decide what they're going to do, and they're making decisions on behalf of all Americans and using what are ultimately taxpayer resources to do it.

DAVIES: So when Congress was drawing up to the financial regulation - the Dodd-Frank bill, you know, Ben Bernanke got involved in trying to protect the Fed's interests. What, if anything, changed for the Federal Reserve in Dodd-Frank?

IRWIN: Well, you know, what's amazing is - so the Dodd-Frank negotiations and that path toward the national reform law, it started with the going after the Fed was the one thing everyone could agree on. They need to have their wings clipped, we need to go after them. As it evolved, it actually became the case that the Fed ended up with more power over the financial system than it began with. So what we have now is the Fed not only oversees the major banks, which they have for a very long time, they now also can potentially oversee any company, any financial company that poses risks to the system.

So in the future you would imagine AIG, which was basically unregulated, more or less, when the crisis happened, in the future you would imagine the Fed coming in and saying, you know, this company AIG is so big and so systemic, we need to have windows into what they're doing and we're going to regulate them, even though they're not a bank. So that's one example of a number of areas where the Fed has walked out of this with really more authority and more oversight than they ever had before. That also creates a lot of responsibility. You know, if we get into another crisis situation, it's entirely on them. Right now, you know, with the 2008 crisis, they can say quite reasonably, look, we didn't regulate AIG. We didn't even know it was creating all these huge risks. How can you blame us? In the future that's not their excuse.

DAVIES: Do you feel like they're on top of the game? I mean do they know what these big banks are up to and what kind of risks they're taking?

IRWIN: You know, it's funny. They have a lot of powers and they have some very smart people in their bank regulatory departments. But the banks are even more complicated than you can imagine. We just saw this with the JPMorgan case of the London Whale a few months ago. You know, here's JPMorgan the, you know, the biggest U.S. bank, had this trading operation that ultimately lost billions of dollars. You know, the Fed, we just got a report on this from the congressional investigation, the Fed was clearly asking questions and trying to get their head around what this was, but certainly didn't act with enough vigor to stop it from happening. You know, this is always a tension, right? So you want a financial system that's vibrant, that has innovation, that has banks developing new ways to get money from savers to borrowers, to make a vibrant successful competitive economy. But you also don't want financial collapses, you also don't want the kind of deep recession and bailouts that we saw these last several years. Figuring out how to regulate the financial system in banks to get to that happy medium, it's no easy task compared and I don't envy any of the people trying to make it work.

DAVIES: We're speaking with journalist Neil Irwin. He is a columnist for The Washington Post and economics editor of its Wonkblog. His new book is called "The Alchemist: Three Central Bankers and a World on Fire."

We'll talk more after a short break. This is FRESH AIR.

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DAVIES: We're speaking with Neil Irwin. He is a financial writer. He writes, he's a columnist for The Washington Post and is the economics editor of its Wonkblog. His new book is called "The Alchemist: Three Central Bankers and a World on Fire."

You write a lot about a series of financial crises in Europe. I mean, there was Greece and Ireland and Portugal and the response of central bankers there. And, you know, it's different there because you have, you know, the European Union with a common currency - the euro. But these are all nation states with their own political structures and fiscal policies. How did that alter the role? How did that affect the role that central bankers in Europe played in dealing with these kinds of financial crises?

IRWIN: You know, in Europe you have a very unusual situation, as you say. It's so 17 sovereign nations, they each have their own parliament, their own prime minister or president or chancellor or whatever they might have. You have one central bank that is trying to set monetary policy for the entirety of the eurozone and is acting independently from politics. This creates an unusual situation during the crisis because what happens is ECB's find itself in some unusual position of essentially telling democratically-elected governments what it's going to take for them to get help from the central bank. So when Greece gets in real trouble they need a bailout package. The ECB becomes part of what they call the troika. It's along with the IMF and the European Commission. The ECB is there on the ground having these negotiations with the Greek prime minister and finance minister and political officials in Greece over how you're going to reform your labor market, how you're going to cut your budget and your pension system and how you're going to improve your tax collection. You know, that a...

DAVIES: You know, you mentioned the IMF. That's the International Monetary Fund, which is a big player in all their stuff too. Yeah. Go ahead.

IRWIN: Yeah. You know, we talk about the kind of ways that the Federal Reserve is a little bit anti-democratic. That's even more true when you have a central bank that's in Frankfurt and full of these appointed officials essentially dictating to democracies in Greece and Portugal and Spain and Ireland what you need to do to get our assistance. And so it really is a troubling kind of inversion of the usual power relationship between the central banks and the governments.

DAVIES: Right. and one of the dilemmas that the central bankers faced was, do you make the investors, the bondholders, you know, who hold some of these financial assets pay, take losses? But if you do that does that not undermine confidence in banks everywhere? I mean, it's a real dilemma for them, isn't it?

IRWIN: It is. And this is the case where Jean-Claude Trichet, the former president of the European Central Bank, was very much on the side of, no, you must not make bondholders bear brunt of the Greek problem. In contrast to say the German chancellor, Angela Merkel, she, you know, if you're a German politician you're saying, well, for goodness sakes, you know, the people who bought Greek bonds, whether it's a bank or an individual or a pension fund, they were taking the risks that Greece would not be able to pay their debts. Of course, they should pay part of the burden of this loss of confidence in Greek government. Why should we, the German taxpayer, pay to bail out Greece and not the people who had lent them money in the first place? So this is an area where you had a clear divide between but the ECB wanted and what the politicians wanted. The ECB lost on that. You know, we've seen, it's called private sector involvement. It means, in practical terms, bondholders, those who lent money to Greece and other countries, taking a loss.

DAVIES: You know, you see a lot of anger at the central bankers in Europe, in Greece and some other places where they feel that conditions of austerity are being imposed, which means, you know, losses of income, loss of employment, you know, loss of government services, while a lot of the people who they feel made the gambles and created the problems are made whole, in effect, even rewarded. Do they have a point?

IRWIN: They do. You know, a number of the economies in Europe are in what you can only call a depression. Greece, Spain, 25 percent employment - pardon me, 25 percent unemployment, youth unemployment even higher than that. You know, even the core European countries are not doing great. If you're in Italy or France or even Germany, your economy is not quite a strong as you would like it to be. You know, this is a human tragedy in peripheral Europe, and this is an area where having that common currency has come at some real cost. So normally what would happen, when a country like Greece finds itself but able to pay its debts, is it would - it would experience a run on its currency and the value of its currency would plummet, it would default on its debts, and that would be very difficult and very wrenching and not much fun for anybody, but it would also sew the seeds of the next expansion. So if you're Greece, suddenly your currency would depreciate by 50 percent, and that would make you much more competitive as a tourist destination, your exports would be more competitive. And so you would actually have the seeds of the future growth sewn by that depreciation, even as wrenching and it's painful as it would be.

But instead what we've had is an economic collapse in Greece while they're still using the euro, so there's been no depreciation. So they're having to try and do that depreciation by having internal deflation. They're trying to have wages fall rather than just it happens automatically because the currency collapses. So what you have is a combination of a very difficult economic situation in Greece and some of the other European countries without being obvious path forward to get out of it and return to growth.

DAVIES: You know, you see the anger in the United States, too, here at the bailouts, which ended up protecting and rewarding a lot of wealthy investors who gambled and, you know, manipulated investors and devised these, you know, exotic derivatives. And it raises the question, I mean, is there any way that we can craft a financial system in which people are free to be innovative and if they want to aggressively bet on markets with their own resources, but have a system that separates that activity from the financial infrastructure that allows the rest of the economy to function, so that when they're gambling, you know, they're not gambling the entire system?

IRWIN: I hope so. Look, it's very hard to figure that out. And, you know, if you ask Paul Volcker, the former Fed chair, you know, he would argue that the last financial innovation that really benefited mankind was the ATM machine.

(LAUGHTER)

IRWIN: That it's, that a lot of the work that Wall Street does is not actually creating any real useful product for the economy. I think that overstates it, to be honest. Look, if you're a big complicated multi-trillion dollar economy, you know, finance is going to be complicated. Just as, you know, I don't know how to make a 737 jet. Making a jumbo jet is a really hard thing to do that no individual knows how to do. Well, why would we expect the financial system to be any less complex than some of the industries we have like those that are making jets?

The question is exactly what you described: Can we find a way to make sure the kind of risk-taking, speculative type of activity, that that is - there's a high wall between that and the things that benefit from this government safety net, whether it's the Federal Reserve's lender of last resort facilities, whether it's, you know, bailouts in an extreme situation, whether it's deposit insurance like we have for bank deposits.

Keeping those two sides of the world separate is, I think, the fundamental challenge facing financial regulators and creating a system that really works for the U.S. economy and doesn't leave us vulnerable to these kinds of ups and downs like we've seen.

DAVIES: A lot of countries, including the United States, used to be on the gold standard, and sometimes you hear critics of the Federal Reserve argue for a return to the gold standard, or some, you know, some equivalent with a precious metal. What would that mean, in modern terms?

IRWIN: You know, it's funny. There's a lot of conversation around the gold standard, and that's only picked up since the crisis, as people have become more uncertain about the future of the dollar and all the different interventions and forms of money printing that the Fed has been doing.

I'm not sure how - that there's really a case for a gold standard being workable in the modern era. You know, when you link your currency to gold, what happens is you're essentially saying: We're going to make the value of our money dependent on what happens with this market for this yellow metal people find in the ground.

And if there's suddenly a big mining advance and there's a lot of supply, well, then we're going to have some serious inflation and prices are going to rise. If there's a bout of economic growth and the supply of gold doesn't increase, well, suddenly, we're going to have deflation and a recession because money supply can't keep up with a growing economy.

So it's really linking your future, your economic future to one metal and one thing that - to one commodity. You know, what most societies, most modern societies have concluded is what you instead want to do is say: We're going to let our value of money be decided by this group of economists who are kind of sober-minded and serious people.

We're going to put them in a room a few times a year and have them adjust the value of that currency, the value of that money, to try and keep inflation low, say 2 percent. That's what the Federal Reserve does. That's what the European Central Band does. That's what the Bank of England does. That's increasingly what the Bank of Japan does.

And it's not really tied to what's happening with mining technology or discovery of gold reserves. The value of the currency is determined by what will enable the entire basket of products and goods and services people buy to rise at a very slow, gradual pace? You know, certainly, there's plenty to criticize in how the central banks have handle their responsibilities the last few years, but I don't think that anything has happened to make somebody want to reject that thesis and that theory of how money - how the money supply should be managed, and rejected for something like gold, which is party of why the Great Depression became as severe as it was.

DAVIES: The adherence to the gold standard deepened the Great Depression?

IRWIN: It did. Part of what happened is - part of the reason the Federal Reserve, for example, couldn't pump money into the economy to counteract the impact of bank failures and the recession is that it was committed to maintaining the gold standard, which meant that if it eased policy too much, suddenly, America wouldn't have had enough gold to meet demand for it and would've been in real trouble.

Once you're off the gold standard, then you can set your money supply based on what's necessary and what's best for your economy. As long as you're committed to gold, you're kind of beholden to whatever the price of gold is.

DAVIES: Neil Irwin, it's been really interesting. Thanks so much for spending some time with us.

IRWIN: Thanks for having me.

GROSS: Neil Irwin spoke with FRESH AIR contributor Dave Davies. Irwin's new book about central bankers is called "The Alchemists." You can read an excerpt on our website, freshair.npr.org. Coming up, we listen back to an interview with David Kuo, who worked in President Bush's office of Faith-Based and Community Initiatives and left disillusioned. He died Friday. This is FRESH AIR. Transcript provided by NPR, Copyright NPR.