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it's um it's really a privilege a great privilege to have Mervyn King with us this evening Lord King is of course in a esteemed economist and former British central banker he worked in the Bank of England fort for 22 years arriving in 1991 to be chief economist and then rising to deputy governor and ultimately serving as governor for a decade he was at the bank's how helm during the tumultuous years when the Western banking system collapsed and the Great Recession followed but his book the the end of alchemy isn't behind-the-scenes memoir about the cataclysmic events of of 2007 and 2008 instead as Lord King says in the introduction it's more book about ideas and what's still wrong with our system of money and banking and what fundamental changes are needed to ensure greater stability going forward Lord King came to the to the bank after a distinguished career in academia as a professor of economics at the London School of Economics and teaching stints at Cambridge Harvard and mi MIT in that sense he's part of a recent group of academic economists turned central bank chiefs that has included Ben Bernanke here and Axel Weber in Germany since leaving the Bank of England in 2013 Lord King has returned to the London School of Economics and also is on the faculty at New York University but just so everyone doesn't think he spends all his time immersed in economics textbooks I should note that Lord King is a big sports fan rooting in soccer for birmingham's Aston Villa and promoting and occasionally playing cricket and I also read somewhere that that he used to play Alan Greenspan and tennis Lord King will be in conversation here this evening with the Washington Post's David Ignatius who writes the the best reported most insightful column on foreign the national security affairs in the mainstream media today David also is an accomplished novelist and if you haven't read any of his spy novels including his most recent the director then you really should and in in the interest to of full disclosure david was once a student of Professor king's so ladies and gentlemen please join me in welcoming Mervyn King and David Ignatius so it is testimony to Lord Kings patience his brilliance is well established but to his patients that he was my tutor when I was a graduate student at Cambridge and he put up with some of the dumbest questions imaginable for a professional economist great training for right to book Venona : well here here we have this as a somber day with somberness we have a light-hearted subject tonight of economics to distract people I was trying to explain to my dad who was sitting in the third row just how successful and significant Lord King has been and I said pop Lord King is a member of the Order of the Garter and my father knows Britain well enough to know that that really is the ultimate honor for an English British subject and so it's a measure of what the Queen herself and her establishment think of of Mervyn I want to talk about all sorts of things in the book but maybe you just begin with the basic question of why you decided to write it well that's a good question this is working you can hear me fine I didn't want to write an account to the crisis we've got more than enough of those to fill all these bookshelves here and I didn't run away to write a memoir either because I really do think that the that should be written by historians down the road who couldn't have access to all the papers and write objectively about what actually happened in 2007 eight and as I thought about the crisis and reflected on it both while I was still at the bank and afterwards it did seem to me that this should be a book about economic ideas I wanted to write about it but I was prompted to do it by a conversation with my Chinese opposite number one day in Beijing and David and I have played tennis over the years and the the sport for the elite in China is tennis so in the middle of some tedious international meeting I mean they all looked pretty tedious but this one was especially tedious my opposite number said why don't we go and play tennis so we did and I can tell you that in the state guest house the facilities for playing tennis are unbelievable I mean Wimbledon and the US Open have nothing on the facilities in Beijing for tennis I had my own enormous dressing room bathroom and separate drawing room and then we had a banquet afterwards and so rather carried away by this I said to my was it number I said well you'll remember the famous story about Chou Enlai being asked what he thought about the French Revolution and is reputed to have said too early to tell although Henry Kissinger denies that but I I said to my opposite number so what do you make of the Industrial Revolution because 500 years ago China was the biggest most prosperous country in the world but the Industrial Revolution at which point GDP around the world started to rise began in my country what do you make of it and he looked at me and said we've learnt a lot about the market economy and about competition and how these two factors competition within a market economy can boost productivity growth and hence raise living standards and we are keen to emulate that but then he looked at me at but a paused and but I'm sure a sort of twinkle in his eye said but I'm not sure that you in the West have quite got the hang of money and banking yet and that was what prompted me to write the book it inspired me to get going on it because of course the crisis of 2008 is one we hear a lot about but it was merely the latest in a very long series of crises in our monetary and banking system which date back certainly to the Industrial Revolution and indeed in terms of monetary policy the two biggest hyperinflations in history were in the past 60 years and the banking crisis in 2008 was arguably the biggest financial crisis ever in the history of the world so these aren't things which are belong to the misses in history they are current and recent and we still suffer from I thought it might help people to understand the intellectual scope of the book if you early on explained what you mean by alchemy because that helps us to think with you about what banking and finance really are so obviously alchemy is is conventionally described in terms of people turning base money into into gold in other words pretending that something is what it isn't in fact and money is rather like that I mean I used to when I spoke at schools I'd take out a pound note or a ten pound note and say to kids what is this and they're all shout back it's money and I'd say no it's a piece of paper look and I'd pretend to tear it in two and they'd say no stop stop it's money and I saw what's the difference between a piece of paper and money and because you can buy stuff with it they said so essentially there is something about money which is pretense we trust it and we trust it for good reason because we trust the issuer of money some more than others some government's more than other governments but it's nothing intrinsically valuable in it and we have the same problem with banks which is we put our money into bank accounts it and we have deposits with the bank and we believe if we went to the bank we could take the money out the trouble is if we all went to the bank at the same time and asked for our money back we wouldn't get it because it's been lent on to businesses or households and form of long-term loans banks borrow short Len long that's how they make money but the problem is they're very vulnerable to the loss of trust or confidence in banks and if we lose confidence as many people did in banks in 2008 then there's no way they can repay the money so there's an element alchemy of pretense about the way we organized money and banking one fascinating theme of this book is the crisis that you lived through as governor of the Bank of England in 2008 and and 2009 I suspect that many maybe most people in the audience have seen and maybe also read the big short by Mervyn's friend Michael Lewis student and see you know just it helps to be as a former student of Mervyn Kings but your account of how that crisis happened is different from Michaels Michael focuses on the creation of these synthetic instruments and the the real estate bubble and a whole story that we've seen in the big short you have a different account and maybe you could explain that explain how we got to 2008-2009 also I think people would love to hear a little bit about your own life at the center of that storm at the at the Bank of England so Michaels account is in many ways a typical American view of the crisis I mean America is a very confident and dynamic but there is a view that somehow the world is America and I'm surprised at how many people in the US are willing to accept blame for the financial crisis on the ground that it started here in the subprime mortgage market extended to the wider us American financial system and that was the story of the financial crisis and I think that's a very partial view I don't disagree with the story that Michael portrays about the subprime mortgage market but the question is how long why did that happen now people didn't suddenly wake up one day and say wouldn't it be fun to try people in the subprime market and lend to them basically the story is I think you go back to the fall of the Berlin Wall and at the time people said well that's the end of communism the end of socialism famously the end of history actually it started a train of events that led to the biggest crisis in capitalism since the 1930s and what I mean by that is that it was the period after which China other Asian countries the former Soviet Union all decided that a market economy was a good idea they wanted to get into it they wanted to get into manufacturing and to produce goods that they could trade in world markets and have large export surpluses which was the route to economic growth pioneered by Japan and Korea the consequence of that is that they were exported so much and their economies grew so rapidly that they were saving more than they were conserving more than they were investing and dumping the excess savings into the world capital market something which Ben Bernanke talked about in the phrase the savings glut and that pushed down long-term interest rates real interest rates after allowing for inflation however historically almost always been in the range three to four percent a year and that's been a key part of a market economy and providing an incentive to save and also a way of discriminating between good investments and bad investments good investments have to earn enough to justify the cost of Finance bad investments aren't undertaken but over 30 years real interest rates just kept coming down and down now we in the West were not entirely passive in this respect we looked at what was going on and we saw that we had trade deficits because many other countries insisted on export-led growth and trade surpluses but instead of resisting this fall in real interest rates what we did in the West and in central banks was to say well you know this is like a structural trade deficit this is a drag on our growth so we better cut our interest rates especially short-term rates to low levels to persuade people to spend to boost domestic spending so that the high level of domestic demand after subtracting the drag from a trade deficit was just big enough to demand output equal to our potential and ensure we could grow at a steady rate with stable inflation and steady employment and so what we had was something that became known here as the Great Moderation and the big mistake in all this was to confuse a stable outcome with a sustainable outcome and although this was a stable outcome with steady unemployment and stable inflation as steady growth all looked the kind of things with the years we've been tried to achieve after the inflationary 1970s what was happening behind the scenes was that the imbalances between countries and within countries were building up and a market economy cannot function with real interest rates that are just getting lower and lower and lower and that happened before the crisis and of course it's happened since the crisis because the underlying imbalances here but I call the disequilibrium have not been corrected so the result of the crisis was far from putting matters right to mean that the fall in interest rates just carried on so that now there are many central banks in the world especially in Europe and in Japan which have actually got negative interest rates and you know if we carry on like this before long you'll all be receiving letters from your bank saying no dear customer I'm most grateful to you for borrowing from us and in return our gratitude is to be expressed I enclose a cheque for you know a thousand and twenty two dollars in gratitude for the fact that you've borrowed from us this is not how a market economy can operate and that's how the the crisis built up because as interest rates fell and got lower and lower then the prices of assets which are essentially the future returns on those assets dividends whatever simply got higher and higher the discount rate at which we were discounting the future was getting lower the price today the value today of these future returns was getting higher and higher so house prices went up stock prices went up bond prices went the price of art went up price of fine wine went up it really went up and with it was a decision by people who wanted to buy these assets to borrow more to finance those purchases the young people had no choice but to borrow more to buy the housing stock which they're buying from their parents generation so debt went up and banks you know banks don't lend to people who don't want to borrow people wanted to borrow more because they had to to finance the purchases of assets and so the banking sister was encouraged to extend lending they themselves borrowed more to finance that lending and what is called the leverage of banks that is the extent to which banks themselves are financed by by borrowing got to a point where banks were incredibly fragile and when some event occurred such as a shock in the housing market that triggered the realization that banks have become so fragile that they were likely to collapse hence the loss of confidence in banks one of my favorite memories with Mervyn is taking Mervyn and Larry Summers to dinner and listening to the two of them talk economics and anybody who knows Larry Summers knows that he is not a man who's easily intimidated intellectually but for the first and maybe only time I watched him and this is sort of like a you know economist version of a face off basically get you know put in his place by Lord King so I do want to ask you just because it's a fascinating part of the book and it's the you know in the in the eye of the hurricane part you describe one of the themes of the book is that in this crisis people kept thinking this was about liquidity let's just pump more liquidity in the markets and that the Bank of England was really maybe the first to realize that this was not about liquidity hosing the markets with more money to conduct transactions but about solvency and that the basic capitalization of the banks was the problem and you face that if I remember with Northern Rock and maybe you just describe what that was you know the this was like Lehman Brothers in that it was pretty tense I mean you're really on the edge tell us a little bit what that was like so Northern Rock was a was a very interesting example of a bank that basically did one simple thing it lent money for mortgages and that it packaged those mortgages and sold them in what was known as the market for securitized mortgages mortgage-backed securities when people realize that house prices could go down and not just always up then they realized that the pieces of paper which represented the claim on repayments of mortgages could no longer be valued simply by saying well we don't care whose mortgages these are because we'll get the house back and that'll repay the loan it actually mattered if house prices could go down whose mortgages they were and no one had any idea whose mortgages they were these pieces of paper didn't describe the characteristics of the p rsons whose mortgages they were their zip codes their incomes anything at all so the market just shut so Northern Rock suddenly found that his business model ended literally overnight you know he it lent anymore mortgages how on earth would it finance them and it couldn't so we actually drew a line on a charge of saying well we know when Northern Rock will run out of money because the loans it's got will simply not be rolled over and it will come to an end now the the extraordinary thing about Northern Rock was that it had an annual general meeting a few months before it failed and it said on the basis of the new international regulations we are the best capitalized bank in Britain and we proposed to return capital to shareholders within a matter of two or three months it had run out of money which is quite a good definition of insolvency the bizarre thing was that the ratio of the total liabilities of the bank to its own shareholders funds was over 80 to 1 that's called leverage so it was a most highly leveraged Bank in the UK despite the fact that it met all the international regulations at that point I started to lose confidence in the international regulations as other people lost confidence in norther Rock and we could tell what it was going to run out of money and it did so the next year we spent our time urging the banks to to acquire more capital in order to earn the trust of the financial markets and the interesting thing and why the phrase alchemy is relevant I think is that before the crisis we know that actually banks didn't need to have very much equity finance in order to persuade people to lend to the banks no one believed a bank could get into serious trouble or could fail so people quite happy to lend to banks even though they had these extraordinary high leverage ratios after the crisis who asked a question how much equity finance did a bank need to have to attract people's trust or confidence a hell of a lot was the answer and far more than the regulator's were saying the banks should have in other words the loss of innocence in the banking system was so great that actually it would take a long time for banks to earn it back now the fact that the US authorities moved pretty swiftly in 2009 here and the UK moved in late 2008 helped our banking systems earn back some of that trust but in Europe in China or in parts of Asia the banking system is still very fragile and Trust is is tenuous and I should ask you because it's something we all think about it's part of our political campaign this near-death experience for our financial markets in 2008-2009 shattered trust but led to a lot of reforms led to a process of stress testing of banks led to different standards for bank capitalization and I think this audience would be interested in whether you feel that our financial system the UK financial system really are in better shape now you said other countries you still have concerns but should we have confidence that these stress tested institutions now are sound so I think if you look at this in the historical context and in particular examine the 19th century history of this country what you see is there are two reasons why you might be concerned about a bank one is that it's some of its loans will go sour it will lose money could become insolvent now the amount of equity finance banks have which can absorb those losses is a crucial feature in preventing insolvency and our banks have about twice as much equity finance as they did before the crisis so they're better off I mean they're not in a great position but they're much better off than they were that's not true in the rest of Europe but it's true in the US and the UK however the feature of the banking system in the 19th century was regular and frequent bank runs but as this people lost confidence in a bank didn't quite know what how sound it was they thought well rather than mess around I'll take my money out and either put it in a different bank or keep it in the mattress or whatever and banks are very vulnerable to bank runs and of course as we saw one in 2008 where it wasn't ordinary people that were taking their money out it was other financial institutions like money market funds that were running on the banking system if that leads to the need for the central bank like the Fed to throw money at the problem well maybe you can rescue the banks but it generates a loss of confidence in the economy which led to a very deep recession which is a costly thing to have so it would be a jolly good idea to get rid of bank runs now it's very interesting that in the next hundred years after the Federal Reserve was created that many of the most famous American economists decided that fractional reserve banking there is a banking system where the bank doesn't have enough reserves to pay out the deposits in one go was a bad idea and we should get rid of French fractional reserve banking and many of the great names Fisher Knight Friedman Tobin or it thought this was a jolly good idea it's never happened why is that actually because it's not such a good idea and the reason is that if you insist on that then you end up with banks that can create deposit accounts for us all but they're not allowed to do anything with the money apart from buying government securities well the banks are then safe but the trouble is we haven't got anyone to finance lending to business or mortgage lending so who is going to do that well answer Kamath none so in the book what I put forward is a idea for a different approach the traditional role of a central bank as lender of last resort which I mean when the Fed threw money at the banking system in 2008 you could hear the mumble Badgett lender of last resort to explain what they were doing and this is an old idea which Badgett had in the 19th century actually water Badgett wrote his famous book Lombard Street a stone's throw from Centre Court Wimbledon Tennis keeps coming back to these things Mervyn among other things if you look at the Royal Box at Wimbledon you will see Mervyn it's always interesting to see who Mervyn is sitting next to near this is one of the many reasons why you really would like to be Mervyn King if you could come back say Lombard Street Lamar Street Badgett had the idea that in a crisis it was important to lend to banks otherwise they would fail and caused a collapse of it's a bit like electricity failing and the economy not being able to function properly if you can't make payments pay bills receive salaries the economy starts to to wind down now in his day he said look we have no idea where the banks are really solvent or not but it doesn't matter because banks have so much assets in the form of government securities that we can lend against it and 30% of the assets of banks in his day were in the form of government securities against which the central bank was very happy to lend at a moment's notice without any inspection of the this collateral that the bank was leaving with the central bank in order to obtain cash fast forward to 2006 when banks wanted to borrow from central bay the total proportion of their assets in this form that they could bring to the Fed for example to obtain cash was not 30 percent of their assets but less than 1 percent so when Royal Bank of Scotland rang me up one day and said terribly sorry we can't get to the end of the day and I could see Armageddon coming with the ATMs shutting and everything else we had to lend against collateral which took the form of people's mortgages and I said to my staff so what do we know about these mortgages and they said well to be honest mr. Gardner nothing it could be mrs. Jones at 17 acacia Avenue I said do we know where a case or Avenue is or who mrs. Jones is no we don't so we couldn't lend one-for-one against that we had to lend a proportion of the value of the of the mortgages that's called a haircut central bank lending as a proportion of it it's actually a bit like a pawnbroker you take the gold watch to the pawnbroker he'll lend you some cash less than the value of the gold watch and sufficiently less to give you an incentive to come back and reclaim it and repay the loan so my idea is that that's what we should do with central banks now in 2007/8 the the gold watches that banks brought actually but half of them were broken but nevertheless we had to make judgments about how much it was safe to lend the trouble is that's not the moment when you want to make decisions about how much to lend you don't take out insurance after the accidents happen you do it beforehand so my idea is that we should make sure make banks take out the insurance before they're allowed to drive as operators banks then what banks would do is in normal times when there's no crisis no I think special going on bring some of their assets to the central bank central bank would take a month or two to look at this this collateral value it we have teams of people who can do that in central bank's now and they could say to themselves okay if at any point in the next five years you needed some cash in an emergency you bring us these assets and we'll give you either 95 cents in the dollar if it's a fairly you see the value I said or fifty-five cents in the dollar or twenty-five cents in the dollar or if the instruments are completely incomprehensible nothing and in that way the bank will know how much cash it would be able to get from the central bank in the crisis and here's the key point my rule would be that each Bank must have enough collateral examined by and pre-positioned with the central bank that everyone would know that whatever a crisis happened but whenever it took place but whatever type of crisis it was that the bank would always be able to go to the central bank and get enough cash to repay all the depositors who could take their money out on demand and in that way there would never be a bank run again because nobody would have any incentive to join a bank run or to take their money out because they would know now in this way this doesn't this banks can then choose what they what loans they make to whom they lend how they finance themselves with only one constraint you don't need tens of thousands of pages of legislation to regulate banks your one rule which says in order to allow the central bank to play its role as pawnbroker for all seasons to replace the lender of last resort enough collateral must be positioned by the commercial bank with the central bank so that the central bank has said we were willing to lend you this amount of cash now this may sound a bit airy-fairy but what's interesting about it is that it would actually be relatively easy to do today because one of the accidental byproducts of the measures taken to restore the economy in the last few years has been the creation of money by central banks electronically through purchasing government bonds QE as it's called and the consequence of that is that when the central bank the Fed buys bonds from people in the market people get a check written by the Fed they deposit in their bank account their bank account is credited with with money and the commercial bank takes the check to the central bank to the Fed and the Fed credits the bank with money in its deposit account with the Fed the result is that US banks today have on average twenty percent of their total assets in the form of deposits with the Fed so their balance sheet is a lot safer than it was long may this last but what it means is that if you've got a bank with a balance sheet of say a hundred now it twenty is already completely secure in a form that the Fed would immediately give you cash on the spur of the moment that lives 80 of the other assets of loans of different kinds let's suppose that on average the Fed says well the haircut we would impose on those assets is on average fifty percent that means the Fed is saying we guarantee you that as long as this collateral has been examined by us in advance that you'll get 40 in cash just like that drop of a hat whenever you need it 40 plus 20 that's 60 it turns out that the proportion of the total funds raised by banks equity finance long-term debt medium term debt and deposits the share of deposits is about 60 so actually we can make this work by giving banks a 10 years to pre position a lot of this collateral and then the banking system would be as safe in the sense of avoiding bank runs as those American economists in the 20th century wanted but you don't have to tell banks they have to split themselves into safe bits and then worry about who's going to finance the rest of the economy and I would say keep current regulation for ten years get to the point where the alchemy has been ended and then you say to the banks okay since you went along with this and you did lobby against it and you've got to the end of the process will that now but only now get rid of a lot of the regulation the tens of thousands of pages that dodd-frank and other regulatory bodies have imposed much of which seems to me to serve little purpose other than the equivalent of the parent you know the parent in the kitchen looking out of the window suddenly the children are quiet and what do you do you you say Johnny I don't know what you're doing but whatever it is stop it and that is what we're doing to banks now and it's unnecessary detailed regulation so the port broker for all seasons is only one of the extraordinarily interesting creative ideas in this book I'm gonna quote Larry Summers who says a shrewd man shrewd man Mervyn King may well have written the most important book to come out of the financial crisis and understand why that's true you have to read it and to read it you have to buy it but I'll say that for their so I do want to leave time for questions from the audience before Mervin signs books maybe one last quick question for me and then alternate the audience I would love it if you would paint a word picture for this audience of a place that you and I love where we were both students and that's at King's College Cambridge which is John Maynard Keynes's College was John Robinson's College I'm sure you have memories of her and can just briefly describe because this book is in many ways a commentary on an elaboration of Keynes's economics just describe that world of King's College economics so at school high school I was a mathematician and I thought you know I'd like to do cosmology that was my aim but I realised the school that to do cosmology at Cambridge you had to do three years science first and I've been doing experiments and my wife will describe me charitably as the least practical person she has ever met so my in chemistry I got the top mark in theory but in four years of doing experiments to identify compounds you were given these substances and told her you know heat them up and weigh them and do all kinds of things to them to identify them I didn't get one right in four years and you know the Bureau she would drop out of the clamp and break on the floor so I decided science perhaps wasn't the way to go and the subject you could study where you didn't have to do experiments was economics and so I went to I went to soon we had a can opener exactly so I went I went to Cambridge to study economics and why it was so exciting was that people like Galbraith were giving the wreath lectures that year and were invited to lunch groups and I as a student was invited along too so there was a sense that you really were meeting people who were writing at the frontiers of the subject but what happened in the time when I was an undergraduate was that the group of people in Kings who were they were disciples of Keynes I mean they were his junior colleagues and who worked with him on the general theory and gave him comments on drafts of it they thought this man was God and that nothing useful could be said on economics after Keynes as a result they stood in the way I think of the application of mathematical approach to economics which produce many interesting insights but and this is a key point in the book the way in which those mathematically inclined economists approach the subject led them into the temptation that they wanted to beat like physicists they thought economics could be like physics there were laws of nature that we could discover n w that the the the proof that this is not true is given by one simple observation as computing power has got bigger and bigger meteorologists have got better and better at forecasting the weather because they build very complicated computer models and because they are describing laws of nature the more sophisticated those models the more accurate the predictions the opposite is true in economics because you're dealing with people and their behavior the more complicated the model the bigger the mistakes you are likely to make in assuming that the future will be like the past and there are many examples of that and the fact that people did not predict the financial crisis illustrates why economics is not like either meteorology or like physics and Keynes was adamant in his his writing that the world was characterized by what we now call radical uncertainty that is uncertainty that is so pervasive that you cannot imagine what the future holds and if you can't do that you certainly can't attach probabilities to future events and you can't price risk and the application of mathematics to economics led people in the area of Finance to think that whatever risks there are out there could always be priced by creating new markets new financial markets new instruments with price all the risks and yet when crises come along is because something wholly unexpected happens that wasn't anticipated and wasn't priced and and this I think is goes to the heart of why modern economics failed to understand the movement of the economy as a whole I like the analogy between Newtonian physics and Einstein so there are many situations in the world where Newtonian physics there's a very good approximation to how the world works and you can make calculations about the speed at which billiard balls rebound around the table and speed of which things fall from the ceiling onto the floor there are lots of practical uses of Newtonian physics but Einstein pointed out that in certain situations you know time and space get bent and things are not described well by Newtonian physics and it's just the same in economics that the application of mathematics in certain situations for example if people's incomes go up by 10% how much are they likely to spend on food as opposed to holidays and other things these things can be relatively stable predicted and they're very useful and firms you know selling products thinking of what how much they should charge for a product can use these methods very sensibly but when it comes to thinking about the future and big decisions which are which which will only be realized in the future the investment projects or saving for the future to understand booms and slumps in the economy it's like an Einstein's theory of relativity you need to think about expectations in a world of total uncertainty and modern economics has thrown that out of the window and as a result the models which central bank's use when they forecast the economy and decide on interest rates believe it or not have no role for money or banks at all money and banks are the institution's we created to deal with an unknowable future so I have this vision of Keynes wandering around the River Cam talking in words and if you look at every now and then the Sunday newspapers have a list of the hundred most important books written in the 20th century and you're supposed to read them all or at least have them in the library and the general theory of Keynes the general theory of employment interest and money is one of those books but if you've ever tried to read it even I find that most of it is incomprehensible bits of it are wonderfully written an excellent but a lot of it is Keynes trying to explain to other economists why the world is not why they why the economy a market economy is not self stabilizing and he found it very hard to explain and what I try and do in the book is to explain it using the insights of modern economics to show why an economy is not necessarily self-stabilizing and why it's possible to have booms and slumps and why expectations are absolutely fundamental in those circumstances so I would invite people to come to the microphones here and here if you would line up keep your questions brief if you would so we can get as many questions in as possible yes sir go ahead I like the correspondence of cosmology to economics because it's hard to do experiments in both and I was originally going to get up and ask I know there's a Nobel Prize for economics but is it possible the economics is actually a science in the sense that you can do reproducible experiments so the reason economics tried to become a science was that I remember as a student reading about macroeconomics the behavior of the economy as a whole and a lot of the stuff that was written was plausible but it wasn't entirely rigorous and what modern economics has done is to produce something that's completely rigorous but not entirely plausible and and the application of scientific methods I think is a good idea so the collection of data the the looking at observations in a systematic way the application of statistics these are scientific methods which have great value in economics the big difference is that economics is not about discovering immutable laws of nature which once you've discovered the law of nature will be something you can rely on and that is not true in thinking about how an economy behaves and that's why I found during the crisis but all of the the useful insights I had in thinking about the crisis did not come from studying mathematical or statistical models they came from reading financial history and seeing how many of the problems we faced had been faced in previous crises in one guy's or another good evening I was thinking in the 1960s when I was studying economics we were crowded out by the engineering students coming over and to us and I decided to move on got into the satellites but now I'm back to earth last time here I was here I asked a question and they I think the speaker politely told me that was answered wing the his delivery of discussion of the book but I want to ask a question anyhow has to do with the stability of our economic system where we're headed and I think this phrase too big too to fail has been used a lot and maybe overused I was thinking which is a dangerous thing maybe the phrase should be too big to be held accountable what what were the standards thirty years ago on accountability in the financial world what are they today and what will he be where we headed right now that's my question well it's a big question and there isn't a simple answer to it I think it's fair to say that regulation is a lot more intrusive today so it's not that we've sort of abandoned regulation but banks have become very big in the last 30 years banks grew very rapidly and the biggest banks grew the fastest not clear that's necessarily a good thing and the biggest change I think was that for one reason and another investment banks which are based on a trading mentality in part at least were taking over commercial banks and the individuals that were running these big banks came more from the trading side than the commercial side so to run a retail bank I think it's closer to running a supermarket you've really got you've really got to understand what the customers want if you're a trading operation there aren't any customers as such you're trying to do deals the culture of these two types of institution is very very different and it's not obvious that it's a sensible idea to put them into one institution where the culture is is very different and we certainly I think got to a point where I don't think the size of banks was the biggest problem the crisis but it has been an issue because the phrase I use in the book is that banks because they were large and and central to where the economy operated the government's couldn't let them fail and because they were so large and important to the economy the US prosecutors here found it very difficult to go ahead with prosecutions where they would have done it for a very small bank but were worried about the impact on stability of the financial system if they were to prosecute a big bank and where the banks were so large that not the shareholders could hold them accountable the managers found it very hard to manage what was going on so you have HSBC suddenly discovering there was a lot of money laundering going on and it's Mexican operations tax evasion illegal tax evasion and it's Swiss operations so I you could use the phrase you know banks had become too big to fail too big to jail and too big to sail and and this is a problem which the market I think is now beginning to correct it is very striking that since the crisis the size of the biggest investment banks are shrunk some banks are actually splitting off operations between commercial and investment of their own accord many of the Swiss banks that have got very big by creating large investment banks shutting down the investment banks going back to their traditional successful role of wealth management so I don't think we should we should ignore the fact that people now realize they've you know that we've learned a lot from the crisis and the people running banks realized that maybe the set up before was not the most efficient or effective way of doing it but as I say when it comes to regulation I don't think I'm not a great fan of incredibly detailed legal regulation but I am a fan of is saying why are we worried about banks answer because they could become insolvent or because they could generate a bank run if we could solve those two issues please make a big dent in them would have gone a lawfully long way to make the banking system safer without having to have a large number of highly intelligent very competent and presumably well-paid people as lawyers and compliance officers even legislators putting in place a regulatory system that doesn't actually have a lot of social value so let me ask each questioner to keep the questions short so we can get as many in as we as we possibly can yes sir who buys a dead instrument with the negative interest rate and why well it's not clear that many people today are buying it but the question is what's the alternative and if you are very nervous about the future you may be willing to accept a safe capital value at the cost of paying some instrument some interest to others now this is not likely to be very successful for the reason that I gave if a mortgage borrowers being paid to borrow this is likely to cause serious problems and I think but again one of the consequences of economists relying on mathematical models is that the view you will see expressed by most economists every day in the newspapers is that if only we can get interest rates low enough negative enough then people would suddenly spend more I don't think that is true and the reason why is that the models economists use are far too simple if I were to tell you tomorrow because this is what many economists advocate though they don't describe it in these words if I told you tomorrow that for the next year there'll be a wealth tax imposed by the government to 5% on any of your assets fixed in money terms economists were saying well you'd brush out and spend I think it's just as likely that you'd say what the hell are these people doing and what an earth are they going to do next year and you'd say well maybe I should pull in my horns if not get your wealth out of the country altogether but the this is why expectations are so important and why economic models typically are far too simple so I sympathize with your concern Mervyn glad to see you here I have not had the pleasure sir reading your book yet but I have read some a little bit about the book and and I know one of your themes in general is globalization and how national barriers don't work or money and national barriers don't match up and in particular you have some observations on the whole European experiment and I think it would be useful for the audience to hear you on that which I'm sure will be appropriately provocative as if you haven't been provocative enough so I'm sure the audience would benefit from hearing you on the world economy and mr. Truman one of the feds greatest exponents of international economics I'm very critical of the euro area in the in the book because I point out that there is a natural relationship between nations democratic legitimacy and decisions on money and the European Union started the euro area project from the very best of motives the idea was to bind Germany in to a project such that the rest of Europe will never again fear Germany as an overwhelming dominant power in Europe to do that Germany sacrificed the deutsche mark the one symbol of great post-war German success something which the German nation itself valued enormous ly and they were willing after exactly 50 years to give up the deutsche mark and join the monetary union with the objective that never again would Germany seem too powerful what has been the consequence of this the result is that Germany is more powerful economically and politically today than it was before monetary union was created and that's because other countries in the euro area after monetary union started lost competitiveness against Germany and as a result built up large trade deficits if they were at full employment and in effect had to borrow from the rest of the world and now in effect are going to have to borrow from Germany that puts Germany in the driving seat of the European economy we have mass unemployment in the south of Europe and Germany with a massive trade surplus of 8% of GDP when I was a student in Cambridge we looked at photographs from the 1930s and of the Great Depression and we knew why it happened because the people making decisions just looked like old fuddy-duddies they had hats and whiskers they didn't study modern economics they hadn't heard of Keynes at that point it's not surprising it was a disaster it would never happen with us what's happened in Greece in the last few years is worse than the experience of the United States in the 1930s I never thought it was feasible for a modern industrialized economy in Europe to experience something worse than the Great Depression surely of all the things we had learned we knew how to stop that happening but it's become part of the inevitable process of monetary union now it's very striking that two or three weeks ago the central bank governors of France and Germany published a joint article saying what the euro area needs now is a single finance minister to take decisions on taxes and spending for every country in the euro area I dread to think of how many people will vote for extreme political parties around Europe if they are told that their national government the government they elected no longer can set taxes and spending for their own country it's been taken out of their hands and given to an unelected group of bureaucrats in Brussels that is a recipe for going back to the disaffection with governments in Europe that we did see in the 1930s and there are far more parallels with what's going on in the euro area today with the 1930s than I care to to mention there could be were some parallels here to some some of us think Sir with respect let's have to follow up on the euro perspective your your position with respect to brexit Britain's exit I'm curious to hear you since you've been there what are the pros what are the cons as well as a different type of question the concept of FinTech the concept of Bitcoin as well as blockchain well I'm going to answer your last question I won't do the first one because the although I'm sure you're very eager to know my views it's three and a half months to go before the referendum and I'm still waiting for either side to give a set of coherent arguments for or against but I'm not going to take a public position because I don't want to put my successor in a difficult position which I would do by anything I said the FinTech is interesting because what I was teaching last fall to my you I'd ask how many of the students had purchased a Bitcoin and actually quite a large number had and when asked I asked him why that was the case it was clear that they weren't quite sure whether hey've done it but it was a bit like owning an apple or doing something exciting in in high tech I don't think Bitcoin will ever become a successful currency the fraction of transactions used with bitcoins is very very very small indeed the reason is because it goes back to this question of trust in money and alchemy now this is digital money if you want to know how much trust you should place in digital money you ought to have some feeling as to whether you trust the issuer of bitcoins do you really know either who started it or what the algorithm is that's going to determine the ultimate supply of bitcoins I'm sure I don't and I don't really want to trust my money to that set up and it's very striking that the price of bitcoins has been unbelievably volatile so the kind of digital gold but without the knowledge and security which we all can have that if you decide you want to hold gold at least you can be pretty confident that the supply of gold in the world in the short run is pretty much fixed can't be doubled easily can't be hard easily it's fixed now that I'm not saying gold is a good thing to invest in all that it could be used successfully as a currency but at least the supply of it is known I don't think we really understand the algorithms which generate the supply of digital currencies please thanks for the talk understanding that we've touched on a lot of this I have a two-part question both can be very short answers though what do you view is the single biggest threat to the global financial system is it globalization and interconnectedness financial engineering market structure and technology and on the flip side what do you think is the highest value thing that can be done to shore up the system is it something like a counter-cyclical buffer that would prevent something like a bank run so I don't think the biggest threat or any of the things that you mentioned I think it's the macroeconomic policies pursued by governments around world historically where banks have lost a lot of money is where there's been a mistake in monetary or macroeconomic policy and I think the that's my biggest concern at present the best way of dealing with it is as I said this very simple two-part rule a strong enough leverage ratio and the pawnbroker for all seasons rule to prevent bank runs thank you you've really already answered my question so this should be should be very short I was waiting for you to talk I was reading the industries of the future by Alec Ross who was here not too long ago and one of those industries is digital banking Bitcoin and so I guess I'll make the point that one of the people he interviewed for this twice was Larry Summers once in 2013 who was a little bit skeptical about it like you but by 2014 late 2014 he was much more enthusiastic about the potential for to give trust especially in kind of worldwide across the lesser developed the world I guess you could say in as in substituting for their currency so I guess my question just narrow it a little bit would be if that came to be true and we had a lot more reliance on Bitcoin and we have right now globally would that have made any difference in their in the monetary crisis of 2008 no I don't think it would and I don't think that I mean I think you should distinguish between Bitcoin on the one hand and digital banking on the other okay it you could easily imagine a system is I think the sort of thing that Larry says we will discover in the future where we go let's suppose that we made our transactions using a card but instead of transferring money from my account to your account when I come to your restaurant for example what we do instead is my card would have a very fancy algorithm on it and when I paid $50 to you in your restaurant the algorithm would automatically sell stocks and shares which I owned on the market the algorithm would be would link to your card and your would have an algorithm that says when something worth $50 is sold by your restaurant you get the money but you don't get money you get a number 50 and your algorithm buys stocks and shares according to a predetermined algorithm and so you don't need to hold money at all money would disappear it all be digital transactions now I used to think there was some future in that in the in the long run because real time transactions could take place what we've learnt from Michael Lewis's book not the big short but the flash boys is that what's interesting a course nothing happens in real time even electronic transactions could at most go at the speed of light and some people have worked out how to get their transactions to move faster than others so if you and I were making transactions say in a restaurant through buying and selling shares you can be absolutely certain that there be some flash boys outside trying desperately to get their messages to the stock market faster than you and I could get our messages and when it's just a question of buying selling the stock market as it is today it can be relatively easily managed but if every transaction in the economy goes through this digital Banting banking type of approach there is massive scope for people front running all our transactions so I don't think money or cash will ever actually disappear so the important economic transaction tonight is actually buying books and I am gonna ask let's just get four more questions - from here - from here and then come back to Mervyn for final words and then we will sell books my question is about the porn broker for all seasons Mervyn has I think described this as only applying to banks so what about large non banks will they also be required to do this and if they're not won't activity move to the non-bank sector or what what role would the porn broker have with respect to non banks so I think it's a good question very high-powered audience today it the pawnbroker rule has to apply to any institution that above a certain de minimis level offers runnable deposits so any institution that creates deposits which can be called in on demand will be subject to this rule yes please I was Cruz about this core proposal that you were presenting earlier with respect to this insurance mechanism with respect to banks and banks depositing some assets with the central bank that might later be called if needed I was curious how there would be different given that the value of this asset is highly cyclic cyclical so and how is this different if actually as compared to just simply increasing the the capitalization of banks and require raising the capital requirement of banks because when the cycle does hit the low these banks for example can still put them forward at 25 cents of the dollar and it probably would be the same valuation that the central bank would give one accepting this assets as a deposit for insurance so the point is that the central banks will choose the haircuts conservatively because it's making a commitment for a long period five years or possibly longer and saying at any point in that period if you bring this collateral this is the number of cents in the dollar that you'll get in cash and you've got to have enough of that well in advance of the problems occurring so it's it's in that sense it's filling in some stability into the system and it automatically acts as a brake on excessive lending in good times but because it prevents bank runs it prevents the decline in lending that we saw occurring in 2009 after the crisis let's make this the last question or on my right well thank you and thank you for coming I can't wait to read the book I have a question about trade and I teach economics at GW and so I'm always trying to find easy ways to explain complicated things I could teach tax but a couple weeks ago The Wall Street Journal had an article about how we need to teach economics at a younger and younger age and so they asked a bunch of sixth graders you know what's the most important economic principle and the answer is that free trade is good because you get to consume more things lately a lot of really smart economists have been saying you know trade is not such a great thing so can you give me a non textbook answer to the people like carrier air-conditioning who lost other jobs on the factory moved to Mexico about why trade is still a good thing well of course the clever economists can prove almost any proposition and that's in a sense that's what you've got a PhD for which is demonstrating something no one really believed can actually be true and and I do think that in general terms one of the reasons why the post-war period was a time of prosperity and rising living standards was because after the Second World War we went back to an open trading system and encouraged trade and different countries have different individual products different ideas different processes and we all learn buy from each other and the best way of doing that is through trade so you know I'm I will be in favor of trade and indeed I think in our current situation where we're struggling to find ways of improving productivity I think that the industrialized world has a an opportunity now to say to the major emerging market countries look you you in effect stopped the Doha round from making any further progress so what we're going to do is to carry out a further round of trade liberalization with in the industrialized world but in services focusing on services which now account for the bulk of things that we produce and increasingly contray to so you know I think if you put children into a room and they look across the room and say well I'd quite like to have some of that they soon get the idea that trading and swapping things is quite a good idea so you can imagine what it was like to have Mervyn as your tutor please join me in thanking Reuben Lord King [Applause] you