While markets appeared to shrug off Sunday’s events quickly, a surprising number of people came out in support of Powell. Central bankers across the world rallied behind the Fed Chair, but even fervent critics of the notion of central bank independence, an ideological cornerstone of neoliberalism, made their case. “I’m seeing actual communists on my timeline backing this,” one Harvard student commented, “this might be the most unified the online left-of-center has ever been.”

Such a reaction is at odds with the widespread populist anxieties about technocratic overreach that marked the 2010s, when independent central banks, already far outside the purview of democratic control, were gradually expanding their originally narrow remits into highly political territory without further accountability or oversight. But now the renewed tension between Trump and the Fed has rekindled debates about the unelected power of monetary policy makers in democratic societies. In this context, it is worth recalling how central bank power evolved — and that formal “independence” may not be that important.

Half a century ago, central banks had a relatively limited role: they supported government policies and acted as a “lenders-of-last-resort” to banks. This changed drastically at the dawn of the neoliberal era in the late Seventies, when high inflation prompted a sea change in monetary policy. The subsequent decades saw the financial sector grow to envelop the world economy, greatly expanding the scope of central bank responsibilities and the importance of targeting inflation (a euphemism for preserving the value of financial assets). Full “operational independence” is a product of the Nineties, but even then central banks required cooperation from their respective states. And in the relative stability in the world before the financial crisis, this arrangement suited both.

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After 2008, two things happened that spelled the end of this compromise. Firstly, governments reneged on their end of the bargain and ceased cooperation by conducting long grinding austerity regimes, putting the onus of stimulating the economy on central bankers. Secondly, and most importantly, large parts of the financial sector not only grew and consolidated but became dependent on low interest rates and regular liquidity injections through central bank asset purchasing programs such as quantitative easing (QE). As a result, the central banks became “lonely stewards” of the economy: using elaborate means to fend off deflation while incurring blame for stagnant growth, increasingly forced to overstep their mandates while provoking political backlash for doing so.

Populist critiques of neoliberal technocracy flourished in the post-2008 era. But when it comes to central bank policies, most of the objections have been rather baseless. Across the new Right — from the AfD to Curtis Yarvin — there is a stubborn notion that central banks have debased currencies and created inflation, with some vague gestures towards the money supply and low interest rates. Some of these critiques are hard to take seriously, given how the same MAGA types stand firmly behind Trump as he hectors Powell to lower rates. The view on the populist Left, perhaps most competently expounded by Yanis Varoufakis, is that independence is a pretense and somehow both “an antidemocratic travesty”, placing political decisions beyond democratic accountability, and at the same time “entirely at the mercy” of governments wishing to impose deflationary policies.

Not only was inflation persistently low throughout the 2010s (frustratingly, given inflation would have rendered the repayment of large stocks of public debt cheaper in real terms), but QE and other unconventional monetary policies”, almost certainly didn’t inflate asset prices, even if they kept them from falling. The impact of these policies on bank lending and investment ultimately proved negligible. And while it is undeniable that low interest rates produced redistributive effects favoring the wealthy, in lieu of sufficient government stimulus programs, this was the price of preventing a new financial crisis and of the persistent decline in unemployment rates all the way to the pandemic. What is more, the “normalized” interest rates after the 2021-2023 inflation surge have hardly put a stop to runaway asset prices and epic financial grift.

What really happened during these years has little to do with the autonomy of central bank technocrats. In fact it was a grand failure of fiscal policy and permanently depressed investment, exacerbated by steady worsening of inequality and affordability crises on the back of asset price growth. The attendant economic stagnation bred the economic populist backlash that made the confrontation between elected leaders and technocrats inevitable.

This political dynamic seems to have led us to overstate the relevance of formal independence. If the last decades have shown anything it is that independence has always been a convenient political construct, not a subordination of sovereign decision-making. What matters is everything around it: accountability, transparency, operational quality (staff and research), coordination with the fiscal authorities, etc. It is tempting to think of central banks as the guardians of a room which contains the levers of the economy which can be yanked by politicians in the service of short-term electoral gain. There is, however, no strong established relationship between a central bank’s formal status and the soundness of its monetary policy choices, nor, as it happens, between monetary policy and inflation outcomes in general. Jerome Powell himself has conceded that over the last decades the Fed’s monetary policy was too restrictive on balance.

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The developmental miracles in East Asia provide another example of why independence is not the key variable. During their main growth periods, Japan, Korea, Taiwan and of course China all completely subjugated their central banks — while experiencing modest inflation and historically unprecedented and lasting growth. In all cases, it was domestic banks and the mobility of inbound capital that were strongly curtailed. It turns out that what mattered was boxing in finance. Those who departed from this arrangement, such as Japan in the Eighties, collapsed into financial turmoil. And the reason why Japan has maintained some of the highest living standards in the world is largely due to the innovative and now fully independent Bank of Japan supporting the government’s fiscal policy.

When it comes to autonomy from political influence, then, thinking about central banks may not be fundamentally different from thinking about other government agencies. The incompetence of a central bank no more invalidates the concept of statutory independence (with appropriate oversight) than the repeated fiscal policy failures of elected governments invalidate the concept of electoral democracy.

What matters is not independence but power. We tend to think about power in the context of competing strength. But the relationship between central banks, states and financial markets has shown that, in a crisis, strength can derive from weakness and vice versa. As political economist Cornelia Woll has argued, the apparent “weakness” of financial markets and states (their dependency on central banks) is their strength in that it allows them to force the central bankers’ hands.

Discussion of Powell’s clash with Trump misses the mark in another way too: the Federal Reserve is not just any central bank. To call it such is like calling Citizen Kane a film about a newspaper owner. As the sole issuer of dollar reserves, the Fed sits at the apex of a global economy in which the dollar is the main currency for trade invoicing and funding. Almost everyone transacts and borrows in a currency they neither earn nor issue. In times of crisis, they fully depend on dollar liquidity extended by the Fed to their respective central banks. During the financial upheavals of 2008, and particularly 2020, the so-called “dollar swap lines” were part of how the Fed averted total disaster.

This status quo greatly augments the power of the Fed, and, with it, the geopolitical leverage of the American government. This very much implies that Trump’s desire to replace Powell could be about more than accommodating the effects of his domestic policies. As economist Mona Ali has pointed out, the stakes of the Powell–Trump clash may be less about domestic rule-of-law versus presidential mobsterism than it is about executive control over the levers of global financial hegemony. Of course, it could be argued that US financial coercion isn’t what it used to be; the relatively ineffective sanctions regime directed against Russia over the last years showed as much. Then again, the beneficiaries of the standing and unlimited dollar credit lines from the Fed are America’s partners in Europe and Asia-Pacific, as well as Canada, Mexico and Brazil. Thus, there is a direct link between Trump’s desire to take over the Fed and his tendency to browbeat and coerce US allies, a tendency growing more pronounced in light of China’s apparent victory in the trade war.

American financial power, though, depends on a constant need for dollar assets: not just by the global monied elite but also by banks, firms and other entities that have dollar liabilities. The most obvious way to get dollar liquidity when you need it is to sell off your dollar assets: stocks, bonds, etc. Such runs on the dollar have become more frequent in Trump’s second term, as we saw after his Liberation Day in April (when he first announced his tariff system) and, a month later, after the US credit rating was downgraded. Over the last year, the United States has looked less like a hegemon and more like an emerging market, facing persistent capital flight and a dollar that is losing ground to virtually all major currencies. The primary purpose of the Fed’s swap lines is not charity but to de-risk the US financial system by preventing exactly such sell-offs of dollar assets and the spillover of financial risk from abroad.

The irony is that Trump risks undermining the very power he seeks. Perhaps because he misidentifies its source. Anyone who professes to care about unelected power, should be struck not just by the Fed’s untenable influence over the fate of billions, but by the fact that it is itself ultimately shaped by its deep structural dependence on the global financial system. In a pinch, the interests of banks win out over those of the public.

In view of all this, fears over central bank independence and technocratic overreach seem awfully misplaced. If discretionary economic policy-making is central to how we think of democracy and national sovereignty, then what raises concern is the aggrandizement of unaccountable power by an authoritarian executive and by international finance. These should be the focus of populist ire. Everything else is a distraction.

Imagine how useful it would be for a President to have the power to open the credit tap and ease economic conditions by lowering interest rates. Now imagine how useful it would be to have these powers if you were a President who had just kicked off a tariff war that was going to be very painful for consumers. Trump wants that power, but Powell doesn’t want to give it to him.

The current bout of financial chaos is particularly interesting (if you’re a social scientist) or disturbing (if you’re almost anyone) because it has been brought about intentionally by an elected official. This puts the Fed in unusual territory. The central bank is meant to be apolitical, not passing judgment on the choices of the elected branches. However, it is also, at least in one prominent view, meant to secure the stability of the financial system. What, then, is the central bank meant to do when the political branches are intentionally exploding the stability of the financial system?

To answer, we have to go back to the roots of the Fed, for ambiguity has been baked into the institution from the start. Founded in 1913 in response to a series of financial panics and charged with furnishing an “elastic currency” necessary to underpin a stable financial system, the central bank was a compromise on all fronts. It was decentralized with a centralized capstone body; it was privately owned but had public powers. The Federal Reserve System is made up of 12 reserve banks placed around the country with one capstone body located in Washington, D.C. Each reserve bank was, and still is, owned by the private banks in the region and is run by a board made up partly of local bankers and their appointees. The Board of Governors in D.C. is appointed by the President and confirmed by the Senate.

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Founded in this convoluted way, both endowed with the public power to govern the creation of money and established to underpin the efficiency and effectiveness of the private financial system, the Fed was born with a central tension that it has never resolved: is it an independent arm of the state acting in the public interest or a private organization seeking to advance the interests of the financial system?

In 1927, when the Fed’s charter was extended in perpetuity, one Senator from Iowa protested:

“I concede to the commercial interest the right to have their own competitive banking system with reserve banks and all under their own control; but I demand on behalf of the farms and the people who labor with hand or brain the same right under the law to organize a cooperative system with cooperative reserve and all under their own control.”

In other words, if the Fed serves Wall Street, what about the interests of farmers or teachers? One clear implication being, the central bank was not designed to act in the public interest broadly construed.

This tension inherent in the Fed’s formation, between its role as a public institution and its aim to support the financial system, later emerged as friction between the Fed’s role in domestic policy and its role in the international financial system. Not long after the Fed opened its doors, the central bank was thrust onto the international financial scene. With the First World War came financial disruption, not least with the effective abandonment of the international gold standard. As a consequence, the President of the New York Fed, Benjamin Strong, and the Governor of the Bank of England, Montagu Norman, struck up a friendship. After the war, the two men worked hard to re-establish the gold standard on the belief that it was required for a healthy capitalist economy. Later, in 1930, they collaborated in founding the Bank for International Settlements (BIS), an international body established to coordinate German reparation payments and to act as the central node in what would become a global system of financial governance. Put simply, Strong was more interested in coordinating Fed policy with Norman than with any US Treasury Secretary.

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The Fed’s ambiguous relationship to its international and domestic policy responsibilities would rear its head as the century progressed. In the Sixties, the Fed actively cultivated the birth of the Eurodollar market — the offshore currency that now acts effectively as an international currency. And only a decade later, it declared its intention, via the BIS, to informally backstop the Eurodollar market, which by then had effectively become too big to fail. Here was the monetary authority for the United States supporting the growth of an offshore market in its own currency. From the perspective of the Fed as a domestic policy institution this is hard to understand — it was promoting and supporting the expansion of an unregulated market in US dollars. From the perspective of the Fed as an international financial actor, however, it made more sense: Eurodollars had become a de facto international currency after the gold standard, and someone needed to backstop the market’s liquidity.

By the time the Great Financial Crisis arrived the Fed was comfortably established as the de facto central bank to the world, not least because of its role in backstopping the Eurodollar market. The Fed’s extension of international swap lines during the crisis and its high-profile bailouts of foreign banks, such as RBS (something that Andrew Jackson had worried about, and which motivated his veto of the second bank of the US), revealed how far the Fed was willing to go in its role of providing international financial support. But its justification was this: given the deep integration of the US financial sector with global finance (cultivated in part by the Fed itself), the Fed must seek the stability of the international financial system (or more precisely, some parts of it, just ask those nations which didn’t receive swap lines in the wake of 2008).

This sort of justification, and consequent action, stems from a particular understanding of the role of the central bank: that it has a public-spirited aim, dedicated to the stability of the domestic, and by proxy global, financial system. According to this view, a powerful international financial system is in the public interest.

This is quite different from the alternative view which sees the central bank as an independent agency of the state — like the EPA, the FTC, or the SEC — with the aim of executing monetary policy in the public interest. In this view, what is in the public interest, who is the public, and who gets to articulate its interests are all relevant questions. In other words, this alternative conception of the Fed puts it firmly in the context of domestic politics, and much less clearly in the position of backstopping international finance.

The tension at the heart of the Federal Reserve, then, is all about the public interest. What is it? Or more precisely, who gets to define it? One view of the Fed takes as given that the stability of the international financial system is in the interest of the American public. The other view sees defining the public interest as a matter of domestic politics.

With this historical context in hand, we can see today’s battle over the Fed in a new light. Trump’s actions, not least in their undermining of Fed independence, have begun to upset the global financial governance arrangement. For the first time since at least the Sixties we are seeing cracks in the dominant view that the central bank should seek to preserve the effectiveness and efficiency of the domestic financial system and thus underpin the functioning of the international financial system. But if Trump’s actions are pushing the Fed away from the previous consensus, what are they pushing the central bank towards?

There are reasonable arguments for changing the contemporary structures of the Federal Reserve, and in particular its relationship to the international financial system. An international financial system based on the creation of unregulated domestic currency doesn’t seem sensible, and there have been many proposals over the years to change it. Furthermore, the shifting of financial global powers has led some to believe it may change anyway, even if not by design. But what about making the Fed into an agency concerned with the pursuit of monetary policy in the public interest as articulated by domestic politics? Arguments in favor tend to emphasize that any such monetary policy will have to be rooted in the policies of the nation state. But they clearly point toward more congressional, not presidential, control of the central bank. If the President’s actions elsewhere (crypto in particular) are any guide, Trump will seek to use the state’s capacity to create money and regulate the private creation thereof to fill his own coffers at the expense of everyone else. This was precisely the worry of the American founders, who explicitly put the power to regulate the value of money in the hands of Congress, not the President, as they worried that in such a case, he might fancy himself a king.

And Trump undoubtedly does. The question is, will this wannabe King prevail in a battle with the global financial system? The stakes are unquestionably high. But what lurks behind this battle is that longstanding, deeper question: who should define the public interest? The current debate pits Trump, the wannabe King, against Powell, the sensible preserver of international financial stability. There is no voice here for domestic, democratic politics in articulating the public interest, and that may be the most worrying thing of all.

In one respect, the collapse of both Silicon Valley Bank and Credit Suisse were isolated, one-off events that have now been contained. Both were badly-run banks ripe for a fall: Credit Suisse because it had squandered investors’ faith; SVB because regulators had let problems fester for a long time. Quick and aggressive actions by both the Swiss and American authorities rapidly staved off crisis. Nevertheless, the runs on these banks are better seen as symptoms of an underlying disease that continues to fester.

Only yesterday, a spooked IMF correctly interpreted SVB and Credit Suisse’s fate as the sign of things to come: the edge of a coming economic storm whipped up by a decade of geopolitical fragmentation and cheap money. Now, the overdue attempt to reverse this course has slowed the global economy, possibly to the point of recession.

Unlike the 2008 crash, this does not follow an era of prosperity, but rather 15 years of monetary chaos. Before 2008, the West had experienced a long period that came to be called The Great Moderation. The neoliberal model, so widely adopted in the post-Cold War era, had substituted fiscal for monetary policy as the prime lever of economic management, diminishing the role of politicians in favour of central banks. Over three decades, a mix of steady growth, short and shallow recessions, rising wealth and tame inflation was lionised by economists as their profession’s triumph; the Nobel Laureate Robert Lucas declared in 2003 that “the central problem of depression-prevention has been solved”.

Yet ordinary people always saw there was something fishy in this triumphalism. The steady inflation underpinning it actually owed less to clever macroeconomic management than to the return of China and the deeper integration of developing countries into the world economy. Coinciding with this globalisation was the biggest migration in human history, as literally billions of people left their farms for the burgeoning cities of the developing world. This swelled the global labour pool by several orders of magnitude, luring a tide of investment away from the developed countries as firms sought cheap labour. In Western countries, profits boomed but the job market did not.

So when the crash happened in 2008, there was a moment when it seemed the model might come in for profound change. But cheap labour meant cheap money. With inflation kept low by repressed labour costs, central banks were free to flood the markets with money, inflating asset values and thereby creating a wealth effect that boosted demand sufficiently to bring the economy out of recession. Depression was averted, the economy was back on its feet, and the authorities celebrated their triumph.

However, a model in which the rich got richer and everyone else got by was obviously bad for social cohesion, and the decade which followed the crash produced an upsurge of protest, populism and anti-establishment politics on both Right and Left. This political revolt had its financial analogue in Bitcoin, which exploited cheap money policies to produce assets which, by having their supply fixed, could only rise in value. The grassroots financial innovation exposed the central bankers’ strategy as little more than old-fashioned currency debasement.

Not that any of this bothered central banks. For a start, political stability wasn’t in their mandates, so they looked on the wave of protests and violent rhetoric with equanimity. One would have thought that asset-price inflation might at least have come onto their radars since it was baking inflationary pressures into the economy. With the rising cost of assets falling heavily on workers who were trying to buy houses, or businesses that had to pay rising rents, anything which restored the bargaining power of labour would release that pent-up demand. But again, central bankers waved off these concerns.

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Unbeknown to them, however, the depressed condition of Western workers was about to change. Around the mid-decade, with the demographic transition underway across most of the developing world, the increase in the global labour supply peaked. The first signs of rising labour costs began showing up in the data of Western countries. The picture which resulted resembled that of the early Seventies, when years of steadily building inflationary pressures were sent into overdrive by the oil shocks. Similarly now, any kind of jump in prices would release the horses of inflation.

That happened during the pandemic. When lockdowns and shipping closures choked off supplies and radically altered people’s demand patterns — suddenly we wanted more takeaways but much less air travel — the resulting imbalances sent prices haywire. Rightly, central bankers assumed that since these effects would be transitory, they would sort themselves out in time. Wrongly, they inferred that meant inflation would settle back down of its own accord, and there was no fundamental need for them to change their monetary policy.

What they had failed to understand was that the altered conditions in labour markets meant that unlike previous inflations, this time workers were in a better position to bargain for pay increases. Across the developed economies, wages shook off their decades-long funk and began rising, and to cope employers had no choice but to raise prices. That wasn’t necessarily a problem for them: workers earning more could afford to keep buying in a cycle that was virtuous for many businesses and workers. But it put a floor under the inflation rate so that even when headline inflation did start coming back down, the underlying “core” inflation held up.

Once this became apparent, central banks had no option but to change tack. Having postponed it so long, by which point inflation was nearing double digits, they were forced to slam the brakes hard, with sharp interest rates and measures to take money out of markets. Following decades of more or less handing money over to fund managers, central banks were now asking for it back. That forced asset-holders to either liquidate some of their portfolios or cut their buying, knocking down asset prices. In the age of social media, word spread fast that some banks no longer had enough assets to redeem everyone’s deposits if they all turned up at the teller’s window. So began the runs which crashed SVB and Credit Suisse.

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Central banks now find themselves trapped in a stop-start course of withdrawing money with interest-rate rises, and putting it back at each sign of stress (the IMF even predicts that the West will soon return to rock-bottom interest rates). And this hair-of-the-dog treatment may soften the hangover but only prolong the addiction of the financial system to cheap money. Central bankers insist they have not changed course. The markets, currently acting as if the magic money-tree is back, don’t believe them. As a result, this tug-of-war will probably drag on, complicating both the battle on inflation and any efforts to fix the underlying problems in the economy.

There may yet be a silver lining to this tale of woe, though. Unlike in past crashes, when owners emerged largely intact and workers took the hit, this time, it looks like asset prices will remain under pressure while wages hold up. So far, the fall in real incomes has led everyone to take a plus ça change attitude. But there’s clear evidence that wages are catching up with inflation, and in some countries have already turned positive. Workers matter more now, and central banks will have to go back to the drawing board to factor this into their models. In particular, if core inflation remains sticky, they will have to keep interest rates higher for longer, which will squeeze profits and further depress asset prices. And this will force owners to do the heavy-lifting in the fight against inflation, quite a change from the last few decades.

But for now, central banks are muddling through, with Bitcoin arguably serving as the most reliable indicator of how utterly we have lost faith in them. After rising from its humble origins as a penny trade for computer nerds, at one point in the easy-money cycle it was worth over $60,000. When central banks indicated they were serious about inflation, it crashed. But lately, as they eased up in response to the mini-crisis, Bitcoin’s back on a tear, mocking the claims of central banks that they’re back in control. Where they could once wink at asset-owners and say they had their backs, throwing ever more money at them each time their assets fell in value, they’ll now have to start ghosting them. Unless and until central banks convince everyone they are more committed to bringing down inflation than to protecting asset-values, cryptocurrencies will continue to prosper.

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What we’re thus witnessing is the end of a historic era as much as an economic one. If neoliberalism set loose the bankers, egged on by central banks, the coming decades will likely see them finally reined back in. And, in that moment, there is the potential to rebalance the world economy, raising workers’ wages and forcing central banks to pay more attention to social conditions, not just those of the banks.

For now, we’re all keeping a close eye on the central banks for signs of backsliding. Use Bitcoin as an index of our lost faith in the financial system. The higher it rises, the more we are giving up on those we once regarded as sages. And if central bankers ever fall back into their worst habits, things could get ugly. The recessions of the 2010s helped stoke a global populist revolt. Another political crisis will probably follow any mismanagement ahead.

Such strong, withering analysis is, perhaps, unexpected from someone who has held senior roles at Wall Street finance houses such as Bear Stearns and Goldman Sachs. But Prins is no ordinary former banker.

The US author and journalist left the financial services industry in 2001. She did so, in her own words, “partly because life was too short”, and “partly out of disgust at how citizens everywhere had become collateral damage, and later hostages, to the banking system”.

Since then, Prins has chronicled the closed and often confusing world of high finance through the 2008 crisis and beyond. Her writing combines deep insider knowledge with on-the-ground reporting with sharp, searing prose. Alongside countless articles for New York Times, Forbes and Fortune, she has produced six books – including Collusion: how central bankers rigged the world, which has just been published.

Her main target in the new work is “quantitative easing” – described by Prins as “a conjuring trick” in which “a central bank manufactures electronic money, then injects it into private banks and financial markets”. Over the last decade, she tells me when we meet in London, “under the guise of QE, central bankers have massively overstepped their traditional mandates, directing the flow of epic sums of fabricated money, without any checks or balances, towards the private banking sector”.

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Since QE began, in the aftermath of the financial crisis, “the US Federal Reserve has produced a massive $4.5 trillion of conjured money, out of a worldwide QE total of around $21 trillion”, says Prins. The combination of ultra-low interest rates and vast monetary expansion, she explains, has caused “speculation to rage … much as a global casino would be abuzz if everyone gambled using everyone else’s money”.

Much of this new spending power, though, has remained “inside the system”, with banks shoring up their balance sheets. “So lending to ordinary firms and households has barely grown as a result of QE,” says Prins, “nor have wages or prosperity for most of the world’s population”. Instead, “the banks have gone on an asset-buying spree”, she explains, getting into her stride, “with the vast flow of QE cash from central banks to private banks ensuring endless opportunities for market manipulation and asset bubbles – driven by government support”.

Prins describes “the power grab we’ve seen by the US Federal Reserve, the European Central Bank, the Bank of Japan and other central banks”. Using QE, she argues, “these illusionists have altered the nature of the financial system and orchestrated a de facto heist that has enabled the most dominant banks and central bankers to run the world”.

She says all this looking me straight in the eye, with the deadpan delivery, supreme confidence and unflinching focus of the senior investment banker she was. But the words are those of an angry and committed activist – someone who is absolutely determined to do what she can to reform global finance, starting in her native country.

Nomi Prins deals in bold statements and fearless analysis. While often accused of hyperbole, her deep research, financial expertise and former ‘insider status’ means only a fool would dismiss her. She is just at home within academia as she is on the political front line – a regular on the university lecture circuit, Prins was also a member of Senator Bernie Sanders’ team of economic experts, advising on central bank reform. Yet, such is her reputation that she commands a place among those she chides – and is regularly consulted, formally and informally, by senior officials at the Fed, the ECB and other major central banks.

Surveying the history of the response to the 2008 financial crisis, Prins tells me that explicit bank bailouts were only a small part of the story. “First, there was the $700bn package agreed in Congress to save the US banks that caused the crisis,” she says. “But the real bailout was the trillions of dollars of QE produced by the Fed – a massive subsidy to banks and financial markets, that has created an enormous bubble, a subsidy agreed by unelected officials and barely debated or remarked upon.”

After initiating QE in late 2008, the Fed then “exported the idea – and that required the collusion of other major central banks”, Prins argues. She points out that even though the Fed and the Bank of England have currently stopped doing QE, new money amounting to hundreds of billions of dollars a month is still being pumped out by central banks elsewhere, not least the ECB and the Bank of Japan.

“When the asset bubble pops, the fragile financial system and the broader economic environment could be thrown into deep depression and turmoil,” she says. “That’s why the QE baton has been passed from the US to other nations, and why the central banks are so desperate to collude.”

I put to Prins the conventional wisdom: there was no alternative to QE, and without it, the global banking system would have collapsed in 2008, causing untold economic and political damage. While she accepts there was a need for immediate post-crisis action, she argues the time for emergency measures has now long since passed. “If financial markets so much as wobble, the world’s leading central banks, between them, do more QE,” she says. “The insiders maintain the status quo of subsidies to the financial system – but there is no world war, aliens are not invading our planet, this is totally unjustified.”

Prins says that QE has been “a massive deceit and a huge factor in driving inequality – a dedicated effort by institutions with the ability to create money, deciding that it doesn’t go to ordinary people”. While it was sold “as a massive trickle-down programme, helping the incomes of regular households, the benefits have been focused at the very top”.

Stock markets have benefitted, she acknowledges, “but a mere 10% of Americans own 85% of the market”. Prins also argues that low interest rates have harmed most Americans. “We need to normalise the rate environment, so ordinary people get some kind of return on their pensions and savings,” she says.

QE and low rates, says Prins, have also caused “a debt explosion” – as not only have governments taken on more borrowing but financial institutions have too, keen to boost the scale of their investments in QE-driven markets that look like a one-way bet. US government debt has soared from $9 trillion to over $20 trillion since the financial crisis, Prins observes. “And public and private debt combined amount to a staggering 225% of global GDP – much of it accumulated since the financial crisis,” she says.

“The next financial crisis will be sparked by a debt failure somewhere – then this QE bubble will pop very quickly,” Prins predicts. “And when the new crisis comes, rates are already low and we have little in the way of fiscal ammunition, so mitigation will be very tough – and it will be ordinary people who suffer the most”.

In response to the financial crisis, Prins maintains it would have been far cheaper and more effective for the state to intervene directly, providing explicit assistance to cash-strapped householders struggling to service the distressed mortgages at the heart of the crisis. “There was half a trillion dollars of sub-prime mortgages across the US in 2008,” she recalls. “You could have bought up these properties, or just temporarily covered the loans,” she says. “That would have cost much less than half a trillion, and would also have helped the banks by turning their junk assets into performing loans.”

Prins says the “banks and central banks together” instead concocted QE. “We’ve allowed a grotesque $21 trillion global subsidy which has seen the bankers not only avoid punishment for the huge mess they created, but then entrench their financial advantage even more.”

What we need, she says, is “better regulation” – in particular, a return to the “Glass-Steagall environment where investment banks can’t leverage their balance sheets by so much and rely on government support”. Since the Depression-era separation between risky investment banking and run-of-the-mill commercial banking was repealed by the Clinton administration in 1997, “a financial crisis was unavoidable”, she says. “As long as the deposits of ordinary people and companies can be used by investment bankers as fodder for reckless speculation, in the knowledge those deposits are backed by the state, the world is at risk.”

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By Liam Halligan

Prins is dismayed at how easily on-going QE, continuing years after the financial crisis, has been accepted by the political and media classes. “There is joint approval across the middle of the left-right spectrum,” she says. “The economics profession and almost all commentators don’t seem to care that this money is completely unaccountable and untracked – and has caused an enormous bubble.” The reason, she observes, is that contemplating the end of QE is too difficult. “The unwind will cause pain and could result in a meltdown, as the markets and the debt mountain collapse.”

In Collusion, Prins takes us on a whistle-stop tour of global finance, describing how the leaders of the Banco de México tried to navigate their country’s complicated relationship with the Fed and how Brazil has led the charge in challenging the dollar’s all-important “reserve currency status”. The book goes to China, where we learn how Beijing is using “dark money” to upend dollar-hegemony, helping to drive the country’s ascent as a global superpower.

We read how Europe’s response to the financial crisis has heightened tension between the ECB and Germany – fuelling intra-EU resentments that have fuelled populism and help explain Brexit. Prins describes how Japan “leverages the rivalry between the US and China”, while embarking on “the most ambitious money-conjuring scheme to date”.

Further reading

Capitalism's richest got richer from central bank responses to 2008's bust (as well as from the boom before it)

By Liam Halligan

But it is in the US where the bulk of the narrative is set and it is there the arguments Prins makes will be most keenly read. The Federal Reserve has just lifted interest rates by a quarter point, and signalled that two more increases are likely in 2018. As the world’s most important central bank continues the long, gradual march away from emergency measures, and with the ECB also committed soon to ending QE, the warnings in this important book about extent of today’s asset price bubbles, and the role central banks have played in causing them, are about to be severely tested.

“What we’ve witnessed, since 2008, is the unbridled ability of the so-called people at the top to implement socialism for the banks,” Prins tells me. “If anyone had said we are going to give $21 trillion to the global banking sector, it would never have happened – so we’ve had a backdoor process instead, under the pretense it would help ordinary people.”

Leaning forward for the first time, Prins ups the ante. “Well, real people don’t believe that – and they’ll believe it even less as and when we have another crash, a crash off the back of ten years of emergency measures that were supposed to fix the system.”

“The issue isn’t whether this money-conjuring game can continue,” she says as she prepares to leave. “The issue is that central banks have no plan B in the event of another crisis – and that’s going to create an even more massively negative view among ordinary people towards those who see themselves as elites.”

Listen to Liam Halligan’s interview with Nomi Prins here:

“I love this stuff,” said Stan Druckenmiller in September 2013. “This is fantastic for me and for every rich person.”

A legendary Wall Street investor and former right-hand man to George Soros, Druckenmiller was talking about Quantitative Easing (QE).

Speaking four and a half years ago, Druckenmiller was concerned that central bank money-printing had gone too far. By pumping up financial markets, while crushing the amount of interest that ordinary savers could earn, QE was disproportionally benefiting the already wealthy.

“Who owns assets – the rich, the billionaires. You think Warren Buffett hates this stuff? You think I hate this stuff?’ declared Druckenmiller. “This,” he continued, “is the biggest redistribution of wealth from the poor and the middle class to the rich ever”. Druckenmiller’s statement formed part of a radio documentary I made at the time.

The significant redistributive effects of QE have long been obvious to those with a passing knowledge of economics and – that rare, even endangered thing – an open mind. It’s only recently, though, as politics has become more polarised on both sides of the Atlantic, that QE’s unfair implications, and its role in fuelling popular discontent, have begun to be widely discussed.

I fully accept that, during the immediate aftermath of the 2008 financial crisis, “extraordinary measures” were necessary to avert disaster. Following the Lehman Brothers collapse, and the freezing of inter-bank markets, the global economy faced disaster. Had the world’s leading central banks not provided emergency liquidity, payment systems would have collapsed, sparking panic, instant economic torpor and serious civil unrest.

Since then, the Western world’s virtual printing presses have seen almost constant action. The Fed has expanded its balance sheet from $800bn to $4,400bn – implementing six times more QE than originally envisaged. The UK has implemented £435bn of QE – almost nine times the amount originally advertised.

The ECB, having initially hidden its QE activities behind a myriad of technicalities to avoid provoking German voters, has caught up – and fast. The balance sheet of the eurozone’s central bank now exceeds $5,000bn – significantly bigger than the Fed’s. Bigger – not only as a percentage of GDP – but in absolute terms, too. And the Bank of Japan is in a class of its own. After years of hyper-QE, its balance sheet now also outstrips that of the Fed, despite the Japanese economy being less than a third the size of America’s.

The QE we’ve seen since 2008 hasn’t been straight money printing. From ancient Rome to revolutionary France and Weimar Germany, that has always ended in tears. Instead, the Fed, the Bank of England and other members of the global central banking get-togethers have been creating electronic balances ex nihilo and using them to buy bonds. The initial idea was to absorb bad debts from fragile banks and other corporate investors – so as to shore up the financial system.

What QE became, however, was a way for central banks to buy endless government bonds. That’s allowed ‘advanced’ economies to keep government spending and borrowing high, while rigging bonds markets to keep interest rates historically low. This was supposed to maintain confidence and spark ‘trickle-down’ growth.

What we’ve seen since the Lehman collapse has instead been, across the Western world, the slowest, most hesitant economic recovery in recorded history – as well as a host of negative side-effects:

• Years of QE and ultra-low interest rates have hammered savers. With rates below inflation, real interest rates have been negative, meaning that the thrifty lose out. Rock-bottom annuity rates, resulting from the impact of QE on sovereign bond yields, have condemned countless retirees to lower pension incomes for the rest of their lives.
• The flip side of savers’ low interest-rate pain has been a massive wealth transfer to the bailed-out banks. Voters have had to watch the financiers, having wrecked the economy, get rich at everyone else’s expense all over again. That tears at the heart of the social fabric.
• The massive Western monetary expansion has generated deep distortions within both equity and bond markets AND which – as QE is withdrawn – could unwind in a rapid and explosive manner. While almost no-one wants to discuss this, it is an obvious high risk.
• Equity markets are particularly over-valued. The US Dow Jones Industrial Average closed at an all-time high on more than seventy times during 2017. Valuations are stretched on low trading volumes – a classic indication of crash territory.
• In the UK, in particular, but also the US, much of the QE money has ended up in real estate. This has pushed average house prices to historically high multiples. In Britain, the average home now amounts to eight-times average earnings.
• As such, home ownership is plunging, especially among the crucial family-forming 25-39-year old age group. These were the voters who, in the June 2017 general election, backed Jeremy Corbyn in droves. By juicing up the housing market, and pricing-out a generation of young adults, QE has changed the face of British politics
• Discontent with QE also helped fuel the emergence of the right-wing ‘Tea Party’ in the US – which, in turn, paved the way for President Trump’s populism.
• QE has also driven the populist fringes in Germany. Former Finance Minister, Wolfgang Schäuble blames QE for the electoral success of the right-wing nationalist party Alternative für Deutschland, while warning that the ECB’s QE policies will “ultimately end in disaster”.

Why hasn’t QE led to inflation? The answer is that it has – but the inflationary pressures have been channeled into stocks, bonds and property, prices that don’t feature in the price measures of retail consumers. It should be noted, also, that a large chunk of the funds created by central banks have, for now, remained out of circulation. That’s because banks and other corporate investors that sold bonds and other financial instruments to central banks, receiving QE cash, returned that cash back to central banks. Rather than using these funds to lend – part of the point of QE – commercial banks were required by regulators to set aside more ‘reserve capital’ with central banks – all to strengthen their balance sheets.

Much of this ‘lodged’ QE money, though, remains in existence, even if it is currently held by central banks on behalf of commercial banks. As the global economy picks up, and bank lending increases, part of that money could well re-enter circulation, driving the inflationary impact of QE to sectors beyond financial assets and real estate.

The Federal Reserve and Bank of England are no longer printing virtual money. The Fed – and to a much lesser extent its UK equivalent – have also begun to normalise monetary policy, by starting, albeit gingerly, to raise interest rates. The ECB and Bank of Japan, though, continue to boost their balance sheets using QE, creating the equivalent of tens of billions of dollars of virtual money each month – which helps to keep global stock markets high. So QE hasn’t ended, not by a long chalk and no-one really knows what will happen to global markets when it does.

In the meantime, negative real interest rates continue to penalise not only ordinary savers but institutional investors such as pension funds. Ongoing low bond yields mean such investors, to meet ongoing obligations, are forced to channel money into far riskier financial assets, potentially stoking another boom/bust cycle. Negative real rates are also squeezing banks’ margins, making them even less willing to lend – the exact opposite of what QE was supposed to achieve.

While QE and ultra-low rates were justified at the outset, then, immediately after the 2008 crisis, they’ve long been deeply counter-productive. These policies have lingered because, by making financiers even richer and letting governments keep borrowing, they have attracted powerful friends.

Influential voices, though, are now speaking out. Noted City grandee Sir Martin Jacomb says rock-bottom interest rates, by warping capital markets and abusing savers, are “causing great harm” to companies and households. The authoritative Bank for International Settlements judges that monetary policy is “overburdened”, posing “a potential threat to financial stability”. US investment guru Bill Gross says “central bankers are threatening the engine of the economy by keeping interest rates too low for too long”, concluding “this cannot end well”.

QE will go down in history as a policy that prevented disaster but, through reckless overuse, ended up doing considerable harm – not least in terms of further skewing the distribution of wealth. “I mean, maybe this trickle-down monetary policy that gives money to billionaires, and hopefully we go spend it, may end up working,” said Stan Druckenmillar back in 2013. “But it hasn’t worked for five years”.

Almost another five years on, these words still ring true.

Read more on the (un)accountability of the world's central bankers

Blame central bankers and their easy money for our troubled economic times

By Douglas Carswell

I listened with interest to the recent UnHerd interview with Niall Ferguson, conducted by my colleague Juliet Samuel. The interview dealt mainly with the causes of and fall out from the global financial crisis, ten years on.

I found myself nodding in agreement with Ferguson on most key questions. We are both, after all, broadly in favour of free markets, lean government and business-friendly tax rates.

Ferguson is right to argue that the financial collapse of a decade ago was caused less by under-regulation of banking sectors in the US, UK and beyond than by over-regulation. ‘The story that it was all the fault of deregulated markets is a fairy-tale,’ he argues.

Ferguson is similarly correct, unfortunately, when he warns that the Western world’s too-big-to-fail banks remain as dangerous as ever they were. ‘I don’t think that the financial system is significantly more stable that it was ten years ago, despite all the new regulation’, he says.

In one important respect, though, I felt Ferguson pulled his punches in this interview, as he has done in the past. For there is a banking sector regulation that is so effective that it removes the need for hundreds, even thousands of others. Moreover, it’s a regulation that is vital, as the historic record shows, when it comes to guarding against another financial crisis. Yet it remains absent in the policy armoury, in every part of the Western world – and, regrettably, Ferguson has consistently argued against it.

Among the world’s best-known and most prolific non-fiction authors, Ferguson specialises in economic history – in particular, the nexus between economics, finance and politics. He has – thanks to copious talent and a legendary work ethic – carved out a glittering career.

As well as academic posts at Harvard, Stanford and Oxford, Scottish-born Ferguson is also a leading columnist, TV presenter and public intellectual. On top of all that, he has somehow found time to become the authorised biographer of Henry Kissinger – surely the most important US diplomat of modern times.

When asked by UnHerd about the much-discussed ‘crisis of capitalism’, Ferguson reframes the question:

“Capitalism worldwide is doing pretty well and there is no coherent ideologically alternative. The real worry today is that socialism is making a comeback, even though we thought we had killed it off in around 1989.”

While capitalism has its faults, it has indeed lifted billions of people out of poverty over recent decades, not least since the fall of the Berlin Wall. In 1990, almost two-fifths of the global population lived in extreme poverty. Today, that figure is down to 10% of a far more populous world – as capitalism, in various guises, has spread across China, the former Soviet economies and much of the developing world.

The problem is, of course, that here in the Western world, the slow growth of incomes over the last ten years, coupled with inflated out-of-reach property prices, has led to widespread disillusion. ‘Within the developed countries, there is still a very significant social and political hangover from the financial crisis of 2008,’ Ferguson says. ‘And for younger voters, in particular, whose economic education began just a decade ago, it is pretty easy to blame that hangover on capitalism’.

Former US Treasury Secretary Larry Summers has argued that since the financial crisis, the Western world has suffering from ‘secular stagnation’ – in other words, an endemic lack of demand. Ferguson isn’t convinced by such neo-Keynesian thinking, and the related calls for endless policy stimulus:

‘I remain sceptical of the secular stagnation thesis,’ he says, ‘the claim we are in some kind of permanent low-growth, low interest rate, low-inflation plateau’.

Growth will pick up, Ferguson argues, if Western governments improve the ‘supply side’, lowering taxes and regulation, allowing enterprise to flourish. ‘Bad government policy is a factor in the relatively poor performance we’ve seen since the global financial crisis,’ he says.

I’m broadly with Ferguson, sharing his long-standing concerns about the Western world’s on-going reliance on spiraling government debt and quantitative easing – a state of affairs the ‘secular stagnation’ thesis advanced by Summers has been used to justify. I also very much agree with Ferguson’s analysis that the 2008 financial crisis came about because ‘of the cosy relationship between government and Wall Street and the City of London – with governments allowing the big banks to assume they’d be bailed out in a crisis’.

Where we part company is on the question of how to limit the chances of yet another debilitating financial meltdown, a collapse that would cause yet more economic fallout, further damaging the reputation of capitalism.

‘The financial crisis began in the parts of the economy that were most heavily regulated,’ says Ferguson. ‘Yet the more complicated the regulation, the more the large financial institutions are able to game those regulations’. As such, Ferguson argues, the raft of new, even more complex regulations we’ve seen since 2008 are also destined to fail because, once again, powerful corporations will find ways to ‘game’ – or subvert ­­– them.

‘We are in danger of learning exactly the wrong lesson from the financial crisis,’ Ferguson declares – and I agree with him. ‘Excessively complex regulation is the disease of which it purports to be the cure’. The answer, then, is to use far more direct, straight forward and emphatic regulation – which cannot be ‘gamed’. And that brings us to Glass-Steagall.

Since before the global financial crisis, this columnist has banged the drum for the US and UK to re-impose a decisive split between commercial banks (that take deposits and lend to ordinary firms and households) and investment banks (which take big risks). Why? Because since this divide was incrementally removed in both nations during the late 1980s and 1990s, financial markets have lurched from crisis to crisis. No other single act did more to cause ‘sub-prime’ and transform it from a banking crisis into a broader fiscal and economic collapse.

Once the depression-era Glass-Steagall legislation was repealed in America in 1999, Wall Street investment banks systematically used taxpayer-backed deposits to take ultra-risky bets, knowing they’d be rescued if their bets backfired – precisely the ‘moral hazard’ problem Ferguson rails against. In so doing, US bulge-bracket bankers were competing with their City brethren, the UK having ended its ‘informal’ banking split during the 1986 ‘Big Bang’.

The re-introduction of a proper separation would prevent investment banks from betting with government-guaranteed deposits, so exposing them to the full force of the market. At a stroke, our banks would be far safer and the ‘too big to fail’ issue largely resolved. Since the 2008 crisis, though, the ‘co-mingling’ of investment and commercial banking has continued, despite new measures designed to separate trading and deposit-taking – measures repeatedly watered-down by the mighty banking lobby. Important elements of the sweeping 2010 Dodd-Frank Act have been repealed under the Obama and Trump administrations – and there are signs of more dilutions to come.

Banking reforms on both sides of the Atlantic have stopped short of separating investment and commercial banking into entirely different institutions. That would involve breaking-up some extremely powerful and well-connected mega-banks. America’s ‘Volcker Rule’ and, in particular, Britain’s ‘Vickers reforms’ have aimed to ‘ring-fence’ such activities instead, within the same institutions – which is utter folly.

‘Ring-fences tend to be permeable and if you really want to separate operations very clearly and decisively, you put them in different organisations,’ said Paul Volcker himself, a former US Central banker, before a UK Parliamentary Committee in 2012. ‘You don’t put two functions in the same organisation and say they cannot talk to each other or interact, of course you don’t – anyone with even a modicum of financial nous knows that’.

Mervyn King, too, told the same committee he ‘always thought total separation was the way to go’, making clear the banks would be able to circumvent any ring-fence if the interpretation of the separation depended on near-constant discussion between the banks and the regulators – as it would under the Vickers’ measures. ‘If the judgment turns into a negotiation there will be only one winner,’ warned Sir Mervyn, who at the time had just a few months to go as Bank of England governor. There is a ‘clear risk’, he said, that bankers would be able to ‘pull the wool’ over the eyes of watchdogs.

Of course, that is true. Everything we have seen in the City and Wall Street since before and, indeed, after the global financial crisis confirms it is true. The banks must instead be presented with a clear line in the sand, an explicit, institutional separation between retail and investment banking, that everyone can see – a line, the breaching of which is a criminal offence, resulting in custodial sentences. Only that will protect taxpayers, and the broader economy, from another banker-induced crash.

The renewal of a Glass-Steagall split is, of course, anathema to ‘hot-shot’ bankers who’ve relied on state handouts for survival and from whom politicians, in turn, receive campaign donations and cushy jobs once they’ve left office. That’s why those of us who’ve long backed Glass-Steagall have been derided by the banking lobby and their various media chums.

As a serious, independent thinker, Ferguson obviously does not fall into this category. Yet he has concluded that reinstating Glass-Steagall would be wrong. ‘I struggle to see what role the repeal of Glass-Steagall has played in the recent crisis,’ he told the Washington Post in 2008. In his 2012 BBC Reith Lectures he went further, saying it is ‘hard to think of a major event in the US crisis – beginning with the failures of Bear Stearns and Lehman Brothers – that could not equally well have happened with Glass-Steagall still in force’. This, I would suggest, confuses the issue. Yes, Lehman and Bear Stearns were pure investment banks, rather than ‘universal banks’ combining commercial and investment banking but they were pumped up on lending from, and partially owned, by taxpayer-backed universal banks, who were sharing in and exposed to the same recklessness.

And many universal banks themselves, moreover – the likes of Citigroup and JPMorgan in the US, along with RBS and HSBC in the UK –­ would clearly have gone under, causing financial, commercial and social havoc, had they not received multi-billion dollar bailouts.

Today, ten years on from the financial crisis, people of massive experience and expertise are openly advocating a formal Glass-Steagall separation. Two are Paul Volcker and Lord King. Two more are Sandford Weill and John Reed, the two US bankers who relentlessly pushed the Clinton Administration into repealing the split back in the late 1990s.

The former Labour City Minister, Lord Myners, argues for ‘complete separation’, as does Terry Smith, a City denizen with a deserved reputation for speaking truth to power. The late Sir Brian Pitman, probably the most successful and respected UK retail banker of the past 30 years, also backed Glass-Steagall – admitting as much in the final interview before his death (with the author, as it happens). It is deeply significant that Lord Lawson, who, as Tory Chancellor oversaw the mid-1980s ‘Big Bang’, is also a forceful Glass-Steagall supporter.

‘Investment banks should live on their wits, without the corrupting influence of a government-funded safety net,’ argues Sir Peter Hambro, scion of the old British merchant bank. ‘It’s the unlimited liability that made merchant – or investment – bankers more circumspect in the past because they put their balls on the block,’ he says:

“Most of today’s financial problems are because the investment bankers, using the balance sheets of the retail banks, don’t share the pain. They don’t lose anything – and their culture has infected retail banking. They should never have been together and now they should be split, completely”.

The Dodd-Frank legislation, the centre-piece of the US response to the 2008 financial crisis was an astonishing 849 pages long. It contained 398 new rules, many of which Congress, ground down by endless lobbying, failed to enact. The legislation was precisely what the Wall Street banking giants wanted – massive, complex, full of loopholes and eminently avoidable.

The 1933 Glass-Steagall Act, in contrast, was just 37 pages long – and most of those were concerned with the creation of what we know today as the Federal Deposit Insurance Corporation or FDIC, which guarantees the deposits of ordinary firms and households. Back then, Congress understood that commercial banking should be about making sound loans to viable businesses that create jobs and growth, underpinning economic progress. With the Wall Street crash fresh in their minds, lawmakers in the early 1930s were determined that gambling in stocks, futures and hard-to-price derivatives should never be an authorised use of taxpayer-guaranteed deposits.

This Glass-Steagall divide worked for 66 years, until Wall Street lobbyists forced its repeal in the late-1990s. It worked because it was simple – and anyone who violated its extremely clear rules faced five years in jail.

So how is Dodd-Frank working now? Well, in 2012, JP Morgan’s so-called ‘Whale Trades’ came to light. Two years after Dodd-Frank was introduced, the investment banking arm of a ‘thoroughbred’ bank had once again taken on massive exposure to complex and volatile synthetic credit derivatives using funds, JP Morgan was later forced to admit, belonging to ordinary depositors. This came to light not because of corporate reporting or prudent regulatory oversight, but because the related losses were so massive that they shook financial markets across the globe.

US Democrat Senator Elizabeth Warren has correctly recorded how the too-big-to-fail problem is as big as ever[2.  Read my previous UnHerd column on Senator Warren from last month: “From Jeremy Corbyn to Bernie Sanders to Elizabeth Warren; what the Left is getting right”.]:

“Banks have been in a feeding frenzy, swallowing up smaller competitors to become more powerful and too big to fail… And today, eight years after the financial crisis, three out of the four biggest banks in America are even bigger than they were before.”

Warren was citing evidence from the Federal Reserve and FDIC, which shows the five biggest US banks are, once again, too-big-to-fail – which means the state will bailout them out and makes them liable to excessive risk-taking.

Very few Conservative politicians and thinkers, on either side of the Atlantic, have called out the post-Lehman banking reforms for the inadequate half-measures that they are. Warren, almost alone among senior legislators anywhere, is carrying the flame for necessary root-and-branch changes.

Niall Ferguson is right when he says the 2008 financial crisis was caused by over regulation. Western banks were subject to vast swathes of absurdly-complex, easily-avoidable rules before the crash, just as they are now. And Ferguson is also right that ‘all the new regulation’ has not made ‘the financial system significantly more stable that it was ten years ago’.

Yet the answer isn’t no regulation, it is smart, stream-lined, easy-to-understand regulation, measures that have a track-record of working, measures that the bulge-bracket universal banks – which remain too big-to-fail – are determined will not be introduced.

‘The finance industry has effectively captured our government,’ wrote Simon Johnson, another smart British economist who, like Ferguson, made his career in America. ‘Recovery will fail unless we break the financial oligarchy that is blocking essential reform’. A former Chief Economist of the International Monetary Fund, Johnson wrote those words in May 2009, in an extraordinarily prescient article in The Atlantic magazine, just a few months after the crash. Years later, the banking titans on Wall Street and the City are still vigorously resisting meaningful legislation.

The public is desperately hoping our politicians are regulating the big banks. The reality is the big banks are still regulating our politicians. Legislators need to get a grip, finally yanking the high-rolling gamblers from the teat of taxpayer-backed depositors, ending the related moral hazard. Until that happens, the big banks will take ever increasingly risks, as asset prices become ever more bloated – storing up a crash that could make 2008 seen tame.

Glass Steagall is no panacea. Banks must also observe clear capital requirements and leverage ratios if they are to be run prudently, and avoiding blowing up the broader economy once again. But a proper divide between investment and commercial banks is the most basic requirement, a necessary if not a sufficient condition to maximise our chances of relatively financial stability.

‘Students today have no memory of the great ideological battles of the 1980s that led to the defeat of socialism,’ said Niall Ferguson to UnHerd. ‘They are ready to lap it all up as if the 1980s never happened’.

They certainly are. And the quickest way to ensure that socialism does return would be yet another banking crisis, caused by too-big-to-fail banks again making massive bets with the savings of ordinary firms and households. And all because the heavily lobbied political class failed to reintroduce historically proven rules that have prevented such reckless behaviour in the past and could do so again.

On everything from housing, to tax increases, to student loans, to redrafting PFI[1.  “The private finance initiative (PFI) is a way of creating “public-private partnerships” (PPPs) by funding public infrastructure projects with private capital.” More at Wikipedia.] contracts, to nationalising utilities, it is Labour’s socialist vision which is chiming with the electorate, as evidenced by an alarming report on the anti-capitalist state of British public opinion by the think tank Legatum published last week (and analysed by UnHerd’s Editor, Tim Montgomerie, here). For instance, some 76% support renationalising the railways and 83% renationalising water companies.

This week, it is the annual conference of the UK’s Conservative Party and while the media is focusing on what Prime Minister Theresa May might say, it is actually the Chancellor of the Exchequer, Philip Hammond who has the bigger task. Only he can address the economic concerns exposed by Jeremy Corbyn’s rise. What is more, if Britain is to make a success of Brexit, what is done to enhance productivity, spread prosperity and attract investment is going to be just as important as the details of any exit deal with Brussels.

Sadly, nothing in what Mr Hammond has said so far suggests he has any appetite for the radicalism necessary to respond to the Corbyn challenge. We must hope that this is a cunning ruse and he has in fact spent the last few months preparing a secret plan. What we want to hear from him is a robust, optimistic defence of an enterprise, market economy, accompanied by an honest programme for “the correction of proved abuses and the redress of real grievances” as the great Victorian Conservative reformer Sir Robert Peel promised in his Tamworth Manifesto.

What explains Corbyn’s rise is not simply the zeitgiest, or his success at social media (as explained by Helen Lewis), or even the inevitable swing of the political pendulum – but the fact he is actually addressing real experienced consumer grievances like, for instance, rents rising faster than wages[2.  Liam Halligan noted Jeremy Corbyn’s leadership on the housing issue in one of his recent columns for UnHerd: “From Jeremy Corbyn to Bernie Sanders to Elizabeth Warren; what the Left is getting right”, 11 September 2017.] or rubbish and expensive trains.

The broad economic consensus around what one might describe as Osborne-ism – reduce the deficit, cut corporation taxes, and rely on monetary activism to stimulate growth – has completely collapsed. This is because its time has passed. It got us out of the financial crisis, but only at the cost of creating too many losers, especially among the young.

However, young people are in employment, so their sense of animus is derived not from lack of a job, but other insecurities, notably shrinking disposable incomes (compulsory pension contributions following student loan repayments as the latest deduction), and a lack of capital and adequate housing. It is also my firm impression that there is a sense that some companies, like airlines, train companies and BigTech get away with murder because the Government is too complacent to stand up to them.

When set alongside the high rates of income tax, the ongoing corporation tax cuts are looking like a bung to large and unscrupulous companies. Ultra-low interest rates and quantitative easing have deepened company pension deficits (which have to be filled by young workers) and pushed up asset prices, thereby creating a chasm of generational unfairness. Mark Carney, the Governor of the Bank of England, is Jeremy Corbyn’s unwitting recruiting sergeant.

The Bank is at last indicating that it may raise interest rates, perhaps as soon as November. This potentially dangerous inflection point gives Mr Hammond the perfect excuse to revisit Government policies and to work with the Bank to wean us gently off the drug of cheap money. What we need is some fiscal and monetary methadone, so we do not lurch from dependency to a crash in a few short months.

The place to start is with housing. Sajid Javid, the Communities Secretary, has made some progress in the Housing White Paper to address the planning system, but with the Treasury encouraging a boom in over-priced flats with both its tiered stamp duty rates of up to 12% and the stoking of a corporate buy-to-let boom, fiscal policy has piled more distortions on top the distortions of monetary policy. Mr Hammond should cut stamp duty to a flat 1% for both buyers and sellers on all properties and then flatten the forest of property-related VAT rates to a level 20%.

A reform of property taxation to a more rational system would make the market work more efficiently and stimulate housebuilding, including the construction of proper family houses. It should be accompanied by regulatory measures, such as restoring the minimum size rules for flats and introducing compulsory licences for landlords in return for their tax breaks (both Labour policies opposed, incredibly, by the Conservative Party). Help to Buy, Starter Homes and all the other foolish interventions which have pushed up prices and enriched the big housebuilders should also be scrapped immediately – although it is now sadly clear that this is not the intention.

Mr Hammond must next address the running sore of the student loan system. Incidentally, we could ask Steve Lamey, the chief executive of the Student Loan Company, for his advice, but he has strangely disappeared. As he was a previously highly regarded person from HMRC, we must be suspicious of his continued suspension by the Company due to a mysterious investigation. If somebody could please find him and find out what has happened, they would do the nation a service.

Given the gravity of the situation with the student loan system (which is effectively bust), Mr Hammond should announce an urgent review, so we can get to the bottom of what has gone wrong. Such a review would examine raising or staging the repayment threshold (potentially beyond the new level of £25,000), putting the system on a proper legal footing and bring it under the aegis of the Financial Services Authority (it is currently unregulated). In the meantime, he should immediately cut the interest to the pre-2012 rate of 1.5%.

The next leg of economic reform should be to encourage investment, especially in infrastructure. I have numerous friends who commute via road or train and all of them have horror stories about overcrowding, delays and high prices. This has been caused by population and economic growth not being matched by investment since the financial crisis. This, in turn, has held back productivity growth.

According to the Office of Road and Rail, public investment in rail was £4.8bn in 2015-16, substantially down from its peak of £7bn in 2005-6. Of this, nearly £1.3bn was gobbled up by HS2 and CrossRail[3.  Office of Road and Rail, Finance, Annual Statistical Release 2015-16.]. Indeed, the House of Lords Economic Affairs Committee has calculated that on a per mile basis, HS2 costs nine times as much as the TGV, the French equivalent[4.  House of Lords Economic Affairs Committee, the Economic Case for HS2, March 2015.].

The causes of lack of investment in transport would require an essay in their own right. They include Treasury cuts, poor productivity at Network Rail (a nationalised company, all Corbynistas should take note); faulty franchise contracts for train operators (eg Southern Rail). The syphoning off of money to pay for HS2 can only make things worse and the failure to introduce sufficient private investment via, for instance joint ventures.

Again, only a forensic review will get to the bottom of this, but in the meantime Mr Hammond can announce the creation of a project bond market to allow semi-autonomous public/private partnerships in rail, roads and housing to borrow cheaply, financed by tolls, fees and rents, but with a partial guarantee from the Treasury or local authorities.

The sense that something has gone badly wrong with the money and that Britain is being exploited by unscrupulous international investors also needs addressing. It is a little known fact that the big City institutions, like our pension funds, have spent the last decade dumping UK shares in favour of gilts, with the consequence that, according to the Office for National Statistics, they only own a combined 10.1% of the FTSE 100. In 1998, our pension funds owned 21.7% of UK equities, that has been reduced to a paltry 3%. They sold another £6bn in the second quarter of this year. Foreign investors now own more than half of the index[5.  Office for National Statistics, Investment by Insurance Companies Pension Funds and Trusts, April to June 2017.]. No wonder our tech companies are all being sold on the cheap.

I fear that properly addressing this complex long term issue will require another review (sorry about that), but the creation of an independent Sovereign Wealth Fund to act as a long term investor in British companies and infrastructure would be a start. It could be gifted government assets, such as the shares in Royal Bank of Scotland, to get it going.

These ideas are necessarily brief and they not exhaustive. I have not touched, for instance, on enhancing consumer protection legislation for the digital age; or the need to ensure BigTech companies are properly regulated and taxed as French President Emmanuel Macron has, perhaps overzealously, suggested[6.  Financial Times, 29 September 2017, ‘Macron Slams Anglo-Saxon tech giants for distorting competition‘.]; or binding votes on executive pay; or cutting daft taxes like air passenger duty on domestic flights and small business rates.

But the main thing to get across is that Jeremy Corbyn is winning. He is growing stronger and getting closer to Downing Street every day. Labour is ahead in the polls, by 43% to 39% according to the most recent YouGov survey and has fire in its belly.

The great institutional pillars underpinning our market system – the Treasury, the Bank of England, the City and indeed all of us who work in that system – must wake up. It is time for a well-aimed Tory kick in the backside. If it is not administered quickly by Mr Hammond and his Conservative colleagues, then the Labour lynch mob will apply more painful and destructive measures of their own. That would not only be counterproductive, but be infinitely more horrible too.

There’s nothing wrong with theory as long as it’s scientific theory; and economics, despite the number-work, is not a science. Its theories, not being scientifically constructed, cannot be scientifically tested. Which is how they can persist for so long in the face of evidence to contrary.

Assumptions that may or may not have been accurate at one time can become fossilised within economic theory; thereby exercising an influence over economic policy-making long after times have changed.

There’s an excellent example in an article by Gary Shilling for Bloomberg (the second part of which is here). His subject is the stubborn adherence of central bankers to the idea that high levels of employment carry the danger of inflation (through upward pressure on wages):

“Wages have been either stagnant or declining in the U.S. and other developed economies for more than a decade once inflation is taken into account. Yet, the Federal Reserve and other major central banks remain convinced labor markets are tight, and that a surge in employee costs and inflation are just around the corner. Hence, their recent shift toward credit restraint.

“But inexplicably, policy makers are failing to take into account the many significant economic changes in recent decades that are holding down wage growth.”

Shilling explores six main reasons why the relationship between employment and inflation has weakened so dramatically. The most obvious is the ease with which businesses can now draw upon a global supply of labour:

“Manufacturing employment in the West has seen a dramatic drop as production in the last three decades shifted from developed countries in Europe and North America to developing economies in Asia, where costs are much lower.

“There’s also downward pressure on jobs and compensation in the service sector due to legal, accounting, medical billing and other services being outsourced abroad.”

Even within national labour markets, we’re seeing an expansion of supply. Though the great historical shift of women into paid work is more or less complete, there are further sources of new supply – not least from groups that had previously exited the labour market such as young adults or retirees:

“Indeed, the labor force of those age 20 to 29 has been growing since 2012. At the same time, people over 65 who are employed or actively looking has been rising since the early 1990s. Many seniors are in good health and prefer active work to vegetating in front of the TV. Others, among them many postwar babies born in the 1946-1964 years, have been notoriously poor savers throughout their lives and need to keep working due to a lack of retirement assets.”

Various trends look set to underpin this return to the workplace – for instance, the trend towards less physically demanding work; the backlash against the scammier facets of higher education; and the continued pressure to reduce welfare bills.

Then there’s a much overlooked generational effect:

“…within industrial sectors, wages have been restrained as postwar babies at the top of their pay scales retire and are replaced by lower-paid new recruits.”

On the face of it, the retirement of the babyboomers suggests a tightening of the labour market, but in fact it is giving employers an opportunity to rethink their business models and reduce their reliance on expensive labour (not only through those fresh-faced new recruits, but also outsourcing, automation or simply doing without).

Taking all of this into account does not require new theories, but more careful observation – which is what the best of economics does already. Policy-makers need to catch-up.

According to one recent survey, a waiter who squirrelled away a tenth of their salary would take over a century before they had accumulated enough to put down a deposit on an average first time property [1. Survey by HouseSimple, quoted in the Telegraph 10th June 2017] .  Without any help from mum and dad, the average cook would have to save for 94 years.  A receptionist, 85 years.

Surveys such as this highlight the way in which home ownership has become a distant dream for millions of people in Britain.  It also tells us something about the real nature of economic inequality in many Western countries today.

Economic inequality

Mention economic inequality, and people usually think in terms of income inequality; the difference in pay between, say bankers on one hand, and waiters, cooks, receptionists and other workers on the other.

But that kind of income inequality in Britain is actually at a thirty-year low.  The Gini coefficient – statisticians’ wonky way of measuring income inequality – shows that income inequality is falling in Britain [2. Office of National Statistics data, July 2017].  In fact, in many Western states the big increases in income inequality happened a generation ago – and income inequality has since slowed or even, as in the case in the UK, gone into reverse [3. For example, in Australia and other Western states income inequality is also declining. See John Slater from The Spectator; “Up the pointy end“]  .

The problem in most Western states is not inequality of income – the gap between what waiters earn relative to bankers.  Rather it’s the gap between what millions of other ordinary workers – such as waiters, cooks or receptionists – earn, and the soaring value of assets, whether those assets are houses or hedge funds [4. Office of National Statistics, Statistical Bulletin, Housing affordability in England and Wales: 1997 to 2016].

You don’t have to listen to a discussion about economic inequality for very long before someone mentions globalisation. But economic distress in the West is caused less by the new-found productivity of Chinese or Mexican workers. Cheap consumer imports have lowered the cost of living for Western workers [5. See HumanProgress.org for more detail, for example on the declining cost of groceries].  Asset prices have not increased compared to ordinary incomes because of globalisation, or foreigners – but thanks to our own central bankers.

The easy-money orthodoxy

For at least the past twenty-five years, central bankers in Britain, America, Japan and much of Europe have kept interest rates low and credit cheap.  The effect of this has been to raise asset prices, with everything from houses to hedge funds rising in price relative to labour.

Its difficult to say when precisely this easy money orthodoxy took hold amongst Western policymakers.  In Britain, it was sometime after September 1992, when we crashed out of the EU’s Exchange Rate Mechanism. While the UK had been members, policymakers had been prepared to raise interest rates to eye-watering levels in an attempt to ensure that Sterling closely shadowed the German Deutschemark at a particular rate.

The low interest rate orthodoxy has dominated for almost all of the period since 1997 – when the Bank of England was made independent by then Chancellor Gordon Brown. This is hugely ironic given that central bankers were granted autonomy because it was feared politicians would use it to offer easy money as an inducement to the electorate to borrow and spend. Independent central bankers, as you can see from the graph below, have presided over a far looser monetary policy than the politicians ever managed.

Of course, this easy-money orthodoxy didn’t just take hold in Britain.  Other countries started it even earlier.  Japanese monetary authorities cut interest rates aggressively from the early 1990s, and have had near negative rates ever since.

The US Federal Reserve has had a policy of cutting or holding down interest rates in the face of almost any perceived threat to output;

• the 1987 stock market panic known as Black Monday;
• the Mexican crisis of 1994;
• the collapse of Long Term Capital Management in 1998;
• the Asian and Russian financial crises of the late 1990s;
• the dot com bubble;
• the September 11th terror attacks…

After the 2007 financial crisis, when the threat of falling output was all too real, rates were cut (to effectively zero) in many Western states.  Unable to ensure more easy-money by lowering the price of credit, central banks began to buy up gilts, Quantitative Easing (QE), giving banks room to lend [6. Quantitative Easing means central banks and corporate banks do a swap; rental banks give corporate banks new money in return for financial assets. Corporate banks give central banks financial assets in return for that new money – which means they have more of it to lend out. Exchanging billions of pounds of bank assets for this new money has increased the ability of banks by billions to lend – as well has pushing up the price of those assets giving banks room to lend] .

Far from causing Western policy makers to seriously question their easy-money orthodoxy, that has prevailed over the decade since the financial crisis, they have doubled down on it.  Why?

The economic consequences of central bankers

In the 1960s and 70s, Western economic policy makers believe that they could and should steer economic growth – and avoid nasty downturns – by spending more.  The current crop of policy makers believe that they can use monetary stimulus in much the same way. Easy money raises output, they say.  And for the past two decades, central bankers have been lauded as the omnipotent gurus, able to conjure credit and growth from no where.

Of course, those old fashioned Keynesians from yesteryear, we now know, never proved quite as good at cutting spending during an upturn as they were at increasing it in a downturn.  So, too, today those who advocate monetary stimulus have proved good at hosing the economy with cheap credit.  They have been less good at finding the right time to raise interest rates and unwind QE.

The kind of critical questions that ought to have been asked have seldom been considered by politicians and financial journalists.  Yet it is becoming increasingly clear that there are downsides to easymoney economics.

The haves have got richer for simply having [7. In many parts of London, for example, someone who bought an average house in 1997 would have earned more for simply owning the deeds of that house than they would have done if they had earned the average income over the intervening years].  With the cost of borrowing so low, there has been an incentive to take out loans and invest the money in assets – the value of which would rise faster than the interest on the loan.  This has been the basic business model from big time hedge funds to buy-to-let investors.

More credit means more debt.  UK household debt is higher now in relation to income than at almost any point since the Second World War [8. See speech by Bank of England’s Alex Brazier, “Debt strikes back or return of the regulator?”. July 24th 2017 and Bank of England’s website for more detail].  Recent Bank of England figures show 140,000 people taken out home loans of more than 4.5 times their income over past year – a sharp rise on previous year [9. Bank of England report.].

Easy money economics means less incentive to save.  Official data shows the savings ratio in the UK has fallen to 1.7% in early 2017 – the lowest rate since records began in the 1960s [10. The Daily Telegraph, 30 June 2017] .

Excess credit encourages excess consumption. It’s perhaps not a coincidence that Western states with the most relaxed monetary policy, such as Britain and America, have had the biggest trade deficits, importing more than they export.

With the price of credit set low, it has been harder for businesses and entrepreneurs to assess risk.  Too many things look like a good bet and as a consequence a lot of bad investment decisions have been made – which will become evident when rates rise.

According to some estimates, 9% of non-financial firms in Europe are so-called zombie firms [11. CNBC report, 25 July 2017: “The plethora of monetary support in Europe over the last 5 years has allowed companies with weak profitability to continue to refinance their debt and stave off defaults”]  – able to service the debt at low interest rates, but unable to pay it back.  As the OECD has pointed out, these zombie firms – kept alive by low interest rates – help explain poor productivity performance and slow growth not just in Britain, but in America and much of Europe too [12. OECD paper, The Walking Dead? Zombie firms and productivity performance in OECD countries].

Easy money economics is also starting to produce political consequences. With little prospect of getting on to the property ladder, millions of young voters in Britain – including no doubt plenty of waiters, cooks and other ordinary workers – are drawn to the radicalism of Jeremy Corbyn’s Labour party. Corbyn’s economic platform, often dismissed as simply old fashioned socialism, can also be seen as an effort to address some of the imbalances and injustices caused by our central bankers.  Instead of QE, for example, the Corbynistas want People’s QE – a kind of massive fiscal and monetary stimulus rolled into one.  Their answer to rising house prices is to toy with the idea of rent controls.

These left-wing interventions might only deal with some of the symptoms of monetary mismanagement.  But unless we want them to become public policy, we need to find an alternative.

THE ALTERNATIVES?

1.Higher interest rates

The price of credit is going to have to go up, whether policymakers choose to put interest rates up or not. Why? Because prices cannot be fixed forever – and artificially low interest rates are a form of price fixing.  There will come a time – sooner or later – when Western governments discover the they need to raise interest rates in order to borrow.

Of course, even a modest increase in interest rates would mean tens of thousands of households going bankrupt in Britain, as the UK Insolvency Service has pointed out.  Firms across Europe and the US would cut payrolls.  Unemployment would rise.  The pain and disruption will be enormous. But we are going to enter a world of least worst options, and easy-money is not going to be sustainable forever. And it won’t be all bad news…

A rise in rates would mean a fall in house prices.  Middle England and America might howl but housing would become more affordable for millions, not least workers of modest means.

The massive transfer of wealth to those with houses or hedge funds or any other kind of asset from those without, would end.  It might even go into reverse.  Good.

Thousands of zombie firms would be killed off.  The bout of creative destruction [13. The term “creative destruction” was coined by the economist, Joseph Schumpeter. It refers to the way in which innovation and change within capitalist systems involves finding new ways to organise finite resources. That creative process necessarily means disrupting some of the older established ways of ordering resources – which is destructive. In this context, the resources currently tied up with zombie firms, unable to expand and innovate, would be reallocated to new firms that were not so mired in debt, and could not only serve their current customer base, but expand and innovate.] that would follow a rate rise would see lots of immediate destruction – but the creative bit would eventually follow and productivity would finally rise.

2. Accountability for central bankers

It is rare that a central banker ever seems to get the sack [14. Charlotte Hogg, Chief Operating Officer at the Bank of England was forced out in March 2017. Why? She apparently failed to declare that she had a brother working at a big corporate bank. Failure to comply with such bureaucratic requirements is seen to be seen as a resigning offence. Setting interest rates recklessly low, or allowing the reckless accumulation of debt in the wider economy does not.]. This is not because they never make mistakes (see the financial crisis of 2007 for details).  It’s because central banker independence has come to mean an almost complete lack of accountability.

Congress and Parliament need to assert oversight over those that make key economic decisions which affect us all.  Somehow the European Central Bank needs to be made answerable for how it runs the Euro, too.

If central bankers were properly answerable, politicians, financial journalists and commentators might at last begin to ask the kind of questions about monetary policy that are long due.  The fact that they have failed to do so is not a case of conspiracy (these aren’t the kind of people competent enough for that), but complacency and group think.  When it comes to reporting on financial matters, the mainstream media too often resorts to cliché (see the BBC coverage of the financial crisis over the past decade for details).

3. Government debt – turning off the taps

If the mainstream media was up to the task of informing and educating us, they would alight on the fact that easy money economics isn’t really about giving the people cheap mortgages and credit. It happens, fundamentally, because it suits big government.

Governments, you see, like to borrow and spend beyond what they take in tax.  Rather than just rely on this year’s tax revenue, governments issue bonds; IOUs in return for ready cash.  Easy money economics makes it easier to borrow this way. In order to normalise monetary policy, we must stop it serving big governments’ fiscal appetites.  As debt becomes more expensive, governments will have to accumulate less debt.

4. Radical bank reform

Government isn’t the only vested interest that favours easy money.  Big banks do rather well out of it, too.  (And, of course, with so many central bankers having a background in corporate banking, why wouldn’t they assume that easy-money economics is a Good Thing?  For their former – and possibly future – employers, it is).

For as long as corporate banks are able to conjure almost unlimited amounts of credit out of thin air, they will have a vested interest in easy-money economics. An end to this lax form of monetary policy will expose the way in which many big banks have been living off a form of state subsidy.  All the more reason to start raising rates and unwinding QE.