Central Bankers Are Losing Faith In Their Own Alchemy

Tyler Durden's picture

Submitted by David Gordon via The Mises Institute,

Mervyn King is the British Ben Bernanke. An eminent academic economist, who now teaches both at New York University and the London School of Economics, King was from 2003 to 2013 Governor of the Bank of England. In short, he is a very big deal. Remarkably, in The End of Alchemy he frequently sounds like Murray Rothbard.

King identifies a basic problem in the banking system that has again and again led to financial crisis. “The idea that paper money could replace intrinsically valuable gold and precious metals, and that banks could take secure short-term deposits and transform them into long-term risky investments came into its own with the Industrial Revolution in the eighteenth century. It was both revolutionary and immensely seductive. It was in fact financial alchemy — the creation of extraordinary financial powers that defy reality and common sense. Pursuit of this monetary elixir has brought a series of economic disasters — from hyperinflation to banking collapses.”

How exactly is this alchemy supposed to work? “People believed in alchemy because, so it was argued, depositors would never all choose to withdraw their money at the same time. If depositors’ requirements to make payments or obtain liquidity were, when averaged over a large number of depositors, a predictable flow, then deposits could provide a reliable source of long-term funding. But if a sizable group of depositors were to withdraw funds at the same time, the bank would be forced either to demand immediate repayment of the loans it had made, … or to default on the claims of depositors.” Readers of Rothbard’s What Has Government Done to Our Money? will recognize a familiar theme.

Many have sought to salvage the alchemy of banking by resorting to a central bank. By acting as a lender of last resort, a central bank can bail out banks in need of funds to satisfy anxious depositors and thus avert the danger of a bank run. The alchemy of transforming deposits into investments can now proceed.

Though he was one of the world’s leading central bankers, King finds fault with this “solution.” A local bank can be rescued by getting money from the central bank, but the process generates new problems. Thomas Hankey, a nineteenth-century Governor of the Bank of England, pointed out some of these in response to Walter Bagehot, the classic defender of the central bank as the lender of last resort:

[i]f banks came to rely on the Bank of England to bail them out when in difficulty, then they would take excessive risks and abandon “sound principles of banking.” They would run down their liquid assets, relying instead on cheap central bank insurance — and that is exactly what happened before the recent [2008] crisis. The provision of insurance without a proper charge is an incentive to take excessive risks — in modern jargon, it creates “moral hazard.”

Given the dangers of financial alchemy, what should we do about it? Again, King strikes a Rothbardian note. He writes with great sympathy for one hundred percent reserve banking.

Even though the degree of alchemy of the banking system was much less fifty or more years ago than it is today, it is interesting that many of the most distinguished  economists of the first half of the twentieth century believed in forcing banks to hold sufficient liquid assets to back 100 percent of their deposits. They recommended ending the system of “fractional reserve banking,” under which banks create deposits to finance risky lending and so have insufficient safe cash reserves to back their deposits.

Like Rothbard, King calls attention to the insights of the nineteenth-century Jacksonian William Leggett. King cites an article of 1834 in which Leggett said:

Let the [current] law be repealed; let a law be substituted, requiring simply that any person entering into banking business shall be required to lodge with some officer designated in the law, real estate, or other approved security, to the full amount of the notes which he might desire to issue.

King may to an extent resemble Rothbard; but unfortunately he is not Rothbard; and alert readers will have caught an important difference between King’s idea of one hundred percent reserve banking and Rothbard’s. King’s notion, unlike Rothbard’s, still allows banks to expand the money supply. The “liquid assets” need not be identical with the deposits: they need only be easily convertible into money should the need arise to do so.

King’s own plan to “end the alchemy” allows for substantial monetary expansion. He calls his idea the “pawnbroker for all seasons (PFAS)” approach. This is a form of “liquidity” insurance. Banks would have to put up in advance as collateral with the central bank some of their assets. This would act as a “form of mandatory insurance so that in the event of a crisis a central bank would be free to lend on terms already agreed.” So long as the insurance had been paid, though, the central bank would still bail the bank out in a crisis by giving it more money. Contrast this with the plan suggested in the quotation from Leggett, in which if a bank could not redeem its notes, depositors could proceed directly against the bank’s assets. This allows no monetary expansion; and Rothbard’s plan is of course more restrictive still.

Having come so close to Rothbard, why does King shrink from the final step? Why does he still allow room for monetary expansion? He fears deflation.

Sharp changes in the balance between the demand for and supply of liquidity can cause havoc in the economy. The key advantage of man-made money is that its supply can be increased or decreased rapidly in response to a sudden change in demand. Such an ability is a virtue, not a vice, of paper or electronic money. … The ability to expand the supply of money in times of crisis is essential to avoid a depression.

But if the demand for liquidity suddenly increases, when the monetary stock is constant, cannot falling prices for goods satisfy the demand? King, here following Keynes, is skeptical. “Wage and price flexibility does help to coordinate plans when all the markets relevant to future decisions exist. But in practice they do not, and in those circumstances cuts in wages and prices may lower incomes without stimulating current demand.” Prices may keep falling indefinitely.

Other possibilities of coordination failure also trouble King, and underlying them is an important argument. Following Frank Knight, he distinguishes between risk and uncertainty.

Risk concerns events, like your house catching fire, where it is possible to define precisely the nature of that future outcome and to assign a probability to the occurrence of the event based on past experience. … Uncertainty, by contrast, concerns events where it is not possible to define, or even imagine, all possible future outcomes, and to which probabilities cannot therefore be assigned.

We live in a world of radical uncertainty, and thus we cannot be sure that relying on market prices to adjust to changes in the demand to hold money suffices to avert catastrophe. It is for this reason that resort to monetary expansion sometimes is needed.

This argument moves altogether too fast. It does not follow from the fact that Knightian uncertainty prevails widely that one must take seriously the possibility that prices and wages would fall indefinitely. In a situation of uncertainty, we cannot, by hypothesis, calculate probabilities; but this does not require that we take outlandish possibilities as likely occurrences that must be averted by the government. Some reason needs to be given for supposing that prices will continue to fall indefinitely. Why would entrepreneurs not be able to correct the situation, without resorting to monetary expansion? We are not faced with a dichotomy between exact mathematical calculation, in the style of an Arrow-Debreu equilibrium, and blind groping in the dark.

King himself acknowledges that in the American depression of 1920 to 1921, no resort to the government was needed.

The striking fact is that throughout the episode there was no active stabilization policy by the government or central bank, and prices moved in a violent fashion. It was, in the words of James Grant, the Wall Street financial journalist and writer, “the depression that cured itself.”

It is encouraging that King cites the Austrian economist James Grant, but he draws from his work an insufficient message. “The key lesson from the experience of 1920–21 is that it is a mistake to think of all recessions as having similar causes and requiring similar remedies.” In view of the manifold invidious consequences, fully acknowledged by King, of government intervention, should we not rather emphasize the need to rely on the unhampered market? King nevertheless merits praise for coming close, in his own way, to many Austrian insights.

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Destroy the FED, and go back to a value based currency regulated by the amount of gold or silver held in reserve. 

Make fractional reserve banking a capital crime.

Make the FED eat all of their phoney ponzi paper debt printed illegally out of thin air.

They had no legal standing to mint money in the USA, created fake money, fake debt, and real slavery for tax payers out of thin air.

Like magic, just say " Abracadabra, Presto ! ", aaannndddd - it disappears forever.  

Fuck the FED, and fuck the banks.  

J S Bach's picture

As evil as these people are, they are not stupid nor naive as to their monetary machinations.  They know EXACTLY what they're doing.  It's in the protocols and it's all part of a greater plan to confiscate as much wealth and enslave as many people as possible.  Their incredibly chutzpahtic hubris along with their very small numbers dooms them in the end.  Our greatest weapon at this point is education.  The more people who know the history and workings of the fractional reserve fiat currency scam, the quicker their inevitable downfall.  Spread the word as best you can wherever you can.

Herd Redirection Committee's picture

No shit its alchemy.

Any one ever hear of 'turning lead into gold'?  It is a reference to fiat currency, in those days lead on paper, paper money, that has been 'turned into gold', bank deposits.  Fractional reserve banking.  Which you then combine with usury, and voila, modern banking/alchemy.


bilbert's picture

+ 1,000 for "chutzpahtic hubris"

Nice turn of phrase, JS!

Dark Daze's picture
Dark Daze (not verified) SILVERGEDDON Dec 29, 2016 6:28 PM

Yes, and two of the main beneficiaries of the crime of wealth confiscation that occured in 2008/09 were, tada JPM and GS. They absolutely destoyed the heart of the nation and they want to strut around like cocks on the walk.

Snípéir_Ag_Obair's picture



Rivero thinks Iraq was about the mathematically-dying petrodollar... because spending 3 trillion rather than killing or bribing one guy was the best approach.

Rivero needs to look a little deeper into the Bush Admin and (((who))) most of all pushed for war.

(((they))) were not concerned with the petrodollar system nor helping China get cheaper oil.


Snípéir_Ag_Obair's picture

book called 'the babylonian woe' is worth a read, sure its online...

Its all black magick...

End the fucking Fed, and issue government currency backed by gold and silver. period.

Trump needs to read about Andy Jackson.

angryyoungman's picture

Bitchez be jealous of our petrodollar

Madcow's picture

it all works so long as they can deliver a return to real economic growth.

it all falls apart instantly if they cannot. 


For a better understanding of the central bankers' conundrum, here is Woody Allen:



barysenter's picture

Fly bankers! FLY!!!

hooligan2009's picture


“The idea that paper money could replace intrinsically valuable gold and precious metals, and that banks could take secure short-term deposits and transform them into long-term risky investments came into its own with the Industrial Revolution in the eighteenth century.

needs to be restated as this:

“The idea that paper money could replace labor and that banks could take secure short-term deposits and transform them into the supply of fungible long term supplies of labor came into its own with the Industrial Revolution in the eighteenth century.

the link between the value of work/effort and fiat money is missing

central banks think they can create the value/effort of work by prinitng money - this is (absurdly) false.

Lonesome Crow's picture

“The idea that paper money could replace labor and that banks could take secure short-term deposits and transform them into the supply of fungible long term supplies of labor came into its own with the Industrial Revolution in the eighteenth century.

the link between the value of work/effort and fiat money is missing

central banks think they can create the value/effort of work by prinitng money - this is (absurdly) false."

That needs to be corrected as this:

"The contradictory idea created by attaching the adjective 'paper' to word 'money' destroys the concept of money by renaming it to something that it is not, just as the adjective 'human' attached the word 'action' destroys the concept of action."

"Ditto when any other adjective is attached to it such as 'fiat' money, or 'animal' action."

"That thieves know they can steal value by exchanging the misrepresentation of value is quite true."

Lonesome Crow's picture

Again and as always, Austrians aid their adversaries by accepting their false premise.

Do intellectually continent people really believe that what they claim to understand is that what motivates central bankers is that they EVER had faith in their lies? Or are they motivated by something else?

Dark Daze's picture
Dark Daze (not verified) Dec 29, 2016 6:23 PM

So, simply have two systems simulatneously. Have hard money notes and investments that yield low rates, assuming a stable economy, and have a pure fiat system for lending and development, with higher rates of course, and all the applicable risks.

Cassandra.Hermes's picture

Market Cap to GDP 1.35% and almost 0 interest rates, they should!

THE DORK OF CORK's picture


Total Mises Bollox.

The Merve like all the rest is a merchant of scarcity and not abundance.

Gold is their last refuge.

Bureau of compliance's picture

Print or Die! Ink or Sink! Squid Squad Must Die!~   https://www.youtube.com/watch?v=5FV6wYr-aBc

Yen Cross's picture

   "Mervyn King is the British Ben Bernanke."  I've never read a quote that was more TRUE!

Let it Go's picture

Efforts to justify the most recent market melt-up following the election of Donald Trump are sometimes difficult to comprehend if you are one of those already skeptical of this market. A read of the pdf file of the 2009 bestselling book titled, "This Time Is Different" did little to convince me that this time is different.

It chronicles eight centuries of financial follies in which financial meltdowns have typically followed real-estate bubbles, rising indebtedness, and gaping deficits. More on why many of us see a strong similarity between what is happening today and prior financial meltdowns that have resulted in crisis can be found below.


hedgiex's picture

Wake us up when KING and all the IYIs have decided that they shall feed on the troughs of Umpires and not Players in economies and markets. There can be extreme disequilibira not imagined or forecasted but happened and identified through lagging indicators that require damage controls. A whole army of parasitical meddlers experimenting with their doctrines of neo-Keynesian, Austrain, etc have no skins in the game. Like witch doctors, they chant their voodoo for unchanging seasons (their conflicting, damaging and miniscule equilibria). You need a few battle tested warriors and can dispense with the rest of the pretentious "masters of the universe".




Peter Pan's picture

The current masters of the system will prefer to hold onto power even if they find themselves sinking. Before this is over, there will be violent gyrations, boundaries of nations will change and there will be far fewer of us around by the time the dust has settled.