Nicolette Dammacco: The end of alchemy

bUnlike most graduates, I’m lucky to have a career lined up even before I’ve actually graduated. And even luckier for me, I was able to sit in on a brunch discussion with Lord Mervyn King (the former governor of the Bank of England) through this job that awaits me.

I felt out of place in a room filled with Manhattan socialites, economists, established journalists and bankers, but I’m glad I was able to experience this completely different world.

In a location I’m not even allowed to disclose, I stared in wonder how these people seemed to comprehend all of what was going on in the world, arguing what should and what will actually be done, and who holds responsibility. Though so many thoughtful points were touched upon, I want to tell you about Lord King’s “The End of Alchemy.”

 

aWhat the author means by “alchemy” is the idea of changing something that isn’t very valuable into something that is. He is talking about paper and electronic money. There isn’t any inherent value on these items, save for the trust people place in them.

The banking system pretends that all the money that people put in the bank is “highly liquid”— that you can take it out whenever you want, when actually it’s backed by investments that are far from liquid and aren’t physically in the bank waiting for each individual dollar to be taken out.

“How much money does a bank need to finance itself through equity, in order to persuade other people that it’s safe to lend to the bank?” Before the 2008 crisis the answer was hardly any, because banks were able to get a lot of money from other places with little equity but right after the crisis the answer to that question changed to “a lot” because people believed banks weren’t safe any more.  The “innocence” of the banking system was lost. The future was unknown and people were tempted to run from the banks — not just people but financial institutions, as well, such as hedge funds. All that mistrust gave us a crash.

The apparent answer, for the Bank of England at least, is that they could and should have prevented earlier banking collapses by providing temporary financial support until the crisis had passed. However, it is not enough to respond to the crisis by throwing money at the system to douse the fire. First, we must ensure that all deposits are backed by either actual cash or a guaranteed claim on assets at the bank. Second, we need to ensure that the provision of “up front” cash insurance is mandatory and paid for, upfront. Third, we need to design a system which enforces a tax on the degree of “alchemy” in our financial system – private financial agents should deal with the costs of alchemy.

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