Money out of thin air

Central banker's remarkable power.

Photograph by Farzin Ghayour; Getty

Photograph by Farzin Ghayour; Getty

In The Alchemists, Neil Irwin uses the financial crisis to explore the birth of the central banker and his remarkable power to create money.

In 2007, as players in the financial industry slowly began to realize that all those AAA-rated securities may not be quite as AAA as they’d been led to believe, the world’s bankers felt the world shift beneath their feet. Later, one global bank executive described the terrifying novelty of the situation to Washington Post reporter Neil Irwin: “It was something none of us had experienced. It was as if your entire life you had turned the spigot and water came out. And now there was no water.” As the global financial crisis unfolded, three men—each unelected, secretive, speaking a specialized language and performing roles only hazily understood by the public—found themselves with remarkable power over the fate of millions. U.S. Federal Reserve chairman Ben Bernanke, Jean-Claude Trichet of the European Central Bank and Mervyn King of the Bank of England were the most powerful central bankers in the world. The trio are at the centre of Neil Irwin’s new book The Alchemists, which tells the story of the financial crisis from the point of view of the people who would, according to Irwin, “in a real sense create the world to come.”

As a quick draft of recent financial history, Irwin’s book is another addition to a growing genre that includes Michael Lewis’s The Big Short, Andrew Sorkin’s Too Big to Fail and, coming soon, former U.S. Treasury secretary Timothy Geithner’s inside account of the crisis. More than just a blow-by-blow account of meetings and summits from Iqaluit to South Korea, however, Irwin aims to tell a larger story of the history of central banking. In so doing, he attempts to explain just how these mysterious technocrats gained such awesome power, and to help us understand how they used it during these past few turbulent years.

It’s a tale that Irwin begins in an unlikely setting—17th-century Sweden. In 1656, King Karl X Gustav created the Stockholms Banco and put it in the hands of a Latvian-born entrepreneur who went by “Johan Palmstruch,” a name he had adopted after being jailed in Amsterdam for failing to pay his debts.

In 1644, a silver shortage forced Sweden to mint its 10-daler coin from copper. It was two feet long and weighed 20 pounds.

In 1644, a silver shortage forced Sweden to mint its 10-daler coin from copper. It was two feet long and weighed 20 pounds.

It wasn’t the most auspicious start, but Palmstruch turned out to be a financial innovator. Instead of forcing people to haul around the Swedish daler, then a cumbersome copper plate, the bank held the plates in its vaults and offered a paper note as a receipt. With so much copper currency simply lying around, the bank had another idea. Why not lend out the cash and make a return?

It was another of Palmstruch’s innovations that really changed the course of history. Even if Palmstruch didn’t have vast stores of copper currency in the bank, he reasoned, he could always print paper notes. These weren’t receipts tied to one particular account or person, but notes that could be traded from person to person and redeemed for copper by their holder. It marked the beginning of the modern idea of money—a currency supported not by the worth of its material but, ultimately, by “public confidence in the authority that issues it.”

For generations, pseudo-scientific alchemists had been trying to create gold from base metals. With a central bank, Irwin writes, you didn’t need magic to create wealth from thin air. “All it took to create wealth where there’d been none before was some paper, a printing press, and a central bank, imbued with the power from the state, to put it to work.”

Paper money was a massively popular innovation, used by traders from Venice to London, and was opening up new sources of credit to Swedish nobility. Palmstruch’s bank printed it as fast as it could. When people began trying to redeem their notes for copper, however, the bank quickly ran into trouble. While rumours spread that the bank wouldn’t be able to pay back depositors, people began trading their paper notes at a discount. Each note had less purchasing power than it had a month ago, a process we now know as inflation. The government ordered Palmstruch to cut back on loans, which reduced the amount of money in circulation, plunging the country into a deep economic downturn. In the end, Palmstruch was convicted of fraud and sentenced to be executed (though the sentence was eventually overturned).

“Over just a few short years, Sweden had experienced both the best and the worst of central banking,” Irwin notes—from a credit boom to a surge of inflation to a recession. “They had created the modern era of global finance, and all that is great and awful that would emerge from it.”

Four centuries later, the inheritors of Palmstruch’s mixed legacy found themselves dealing with the same basic questions and hoping to avoid the pitfalls that entrapped not just Palmstruch but so many other central bankers in the generations since. Irwin’s thesis, and the central tension of his book, is simple: “When central bankers fail, so do societies.”

Irwin based The Alchemists on interviews with bankers and policy-makers in 27 cities and 11 countries. It is dense and detailed, covering the process to select a new European Central Bank president and the collapse of Lehman Bros. with the same studiousness. But central bankers are, by design, not the most interesting people. The job demands steadiness and even a certain dullness, which means they don’t necessarily make the most compelling book subjects. Moreover, the fi ve years that have passed since the financial crisis does not off er an expansive view of history, and Irwin’s story feels artifi cially truncated. (One imagines the author desperately appending chapters on Cyprus as we speak.)

Still, by focusing on central bankers from around the world and linking them to their predecessors, Irwin is able to put the past half-decade of turbulent financial history into context as an interconnected global phenomenon with deep historical roots. He jumps from Ireland to Portugal to China, finding connections between the neo-Nazi punks on the streets of Greece and the actions of stuffy technocrats a continent away.

In the end, Irwin leaves his three central bank heroes with the most ambivalent of reckonings. The best the author can say is that under the stewardship of Bernanke, King and Trichet there have been no wars between the world’s biggest powers, no massive civil unrest. “It may seem like damning by faint praise,” he writes, “but a catastrophe averted is no small thing.”