Global Investing: A central banker and the end of banking alchemy

Dubai - World of 2016 reflects Dr Mervyn King's scepticism

Dr Mervyn King broke with tradition by publishing his book The End of Alchemy: Money, Banking and the Future of the Global Economy. After all, retired governors of the Bank of England do not, as a rule, do not write/publish books, let alone write books that lambast the City of London's culture of greed and hubris. It is no coincidence that Dr King quotes T.S. Elliot at the outset, "Where is the wisdom we have lost in knowledge? Where is the knowledge we have lost in information?" The worst financial crisis since the Great Depression that gutted Britain's banking system occurred on Dr King's watch, even though light touch regulation and political pressure makes the FSA and Downing Street complicit in Britain's banking crisis.
The very title of Dr King's book castigates the bankers who he criticized even during his tenure as the governor of one of the Western world's oldest, most revered central banks. Alchemy was a medieval pseudo-science that is not dissimilar to the illusions of international banking whose epicenter was often the City of London. He castigates greed crazed bankers for their high-risk lending and trading, their faith in impotent financial models and fiendishly complex instruments, their instinctive herd instinct. Dr King fulminates "even understanding the risks, it was safe to follow the crowd".
Dr King believes central bankers should be not just a lender of the last resort but "pawnbrokers of all seasons", a mechanism to link collateral with risk metrics in lending. I was alarmed by his last chapter, "The Audacity of Pessimism", when he compares the financial world of 2016 to the economic uncertainties of the 1930s. It is apt that Dr King quotes from the great Victorian chronicler of the city, Walter Bagehot, whose Lombard Street (1873) is a banking classic. He demolishes the illusion that bankers can model risk and uncertainty, let alone forecast rational decision making or macroeconomic disequilibrium.
The contrast between Dr King's memoirs and former Federal Reserve chairman Alan Greenspan's Age of Turbulence could not be greater. Greenspan, once hailed as a maestro by Wall Street, had faith in the power of free market capitalism to work its magic and economics to model a complex world. Greenspan's worldview, shaped by his mentor Ayn Rand, was shared by successive Nobel laureates in economics - Robert Merton, William Sharpe, Harry Markowitz, Franco Modigliani, Merton Miller, Lawrence Klein and Myron Scholes.
Greenspan's global reputation was tarnished after his policies on financial deregulation and minimal regulatory constraints on investment banks culminated in the subprime mortgage crisis, the seizure of the world's debt markets and the failure of Lehman Brothers in 2008.
Dr King's views the quantitative measure of risk embraced by the iconic names in world finance as largely useless. He leans towards the "radical uncertainty" intellectual tradition in economics whose progenitors included both Lord Keynes and his nemesis Friedrich von Hayek of the Austrian School.
The world of 2016 reflects Dr King's scepticism. The Japanese yen rallied from 124 to 106 against the US dollar despite negative interest rates and the Bank of Japan's quantitative easing programme, the most aggressive on the planet relative to QE. The euro rose against the dollar after the ECB cut its deposit rate to minus-40 basis points and purchased corporate bonds in its asset purchase programme. A December hike in the Fed Funds rate by the Yellen Fed triggered global financial disaster, as did the People's Bank of China's shift in its yuan managed float in August 2015. Financial markets, bank CEOs and central banks face systemic uncertainties that make a mockery of the intellectual pillars of the efficient markets hypothesis and theories of portfolio diversification. A naive faith in risk and statistics based financial models failed international banking in 2016. The real world is complex, messy, prone to serial six-sigma catastrophes, as Black Monday in 1997, the collapse of the Mexican peso in 1994, LTCM and the Russian default in 1998, the Internet crash in 2000 and the global banking crisis in 2008 made obvious. Global "casino capitalism" is prone to epic bouts of raw, visceral, interconnected, leveraged panic at the speed of light.
The writer is a global equities strategist and fund manager.