Our Reserve Bank’s new governor, Anna Breman, seems well qualified – she’s a former deputy governor of Sweden’s Riksbank. But it’s a little odd that Breman – who will be one of the country’s most powerful people during the next five years at a time of economic crisis – had never visited the country before July and will operate outside any form of democratic accountability.
In the rarefied world of central banking this is completely normal: macroeconomics is a global technocracy; the role of state banks is to interact with commercial banks and markets rather than voters – and they are supposed to be scrupulously apolitical.
David McWilliams, an economist, author and financial commentator, is a guest at the upcoming Word festival in Christchurch. He believes central bankers are deeply political but present themselves as a detached, priestly caste: a small, self-selected elite with shared doctrines and rituals who study at the same seminaries, read the same texts and chant the same hymns.
Their public role is to project mastery over the money system – a mechanism he believes they do not fully understand – and regulate the economy, a domain he predicts they cannot fully control. And he suspects the golden age of independent central banking is coming to an end.
“We’re moving into an era of economic nationalism – larger governments, more political responsibility, tariffs, immigration controls: the new centrist palette,” McWilliams told the Listener. “I don’t think central-bank independence will be something we’re talking about in five or six years. It will have felt like an aberration in democratic terms.”
McWilliams was an economist at the Central Bank of Ireland before moving to London and working as an investment banker and economics commentator. He’s back in Ireland these days, writing and teaching.
His most recent book, Money: A History of Humanity, runs through the story of our species, from the shekels of Sumeria – c3000 BCE – to the dubious miracles of bitcoin. He makes the case for money as one of the central technologies of human civilisation, comparable in importance to fire or agriculture but often overlooked because it is social rather than physical. A fire is a fire, and a bushel of grain is a loaf of bread, while money has value only if everyone agrees it does.
But once you have consensus that a coin or banknote represents value in and of itself – this is often imposed by governments insisting taxes and fines be paid in the currency they create, thus generating demand for it – money allows a society to operate on an entirely new scale at new levels of complexity and abstraction.
You can have thousands (millions, billions) of people who don’t know each other and have no reason to trust one another co-operating and co-ordinating via markets and prices purely because they trust the currency of exchange.
Once you have more sophisticated financial techniques, such as interest rates, insurance or ledgers, co-operation can extend across longer timelines; it can manage uncertainty and risk.
Social scientists have long argued disruptions to communications technologies drive profound transformations; that the invention of the printing press transformed an oral culture into a literary one, driving centuries of political change. McWilliams makes the same case for money: when an economy adopts double-entry bookkeeping its mentality shifts from miracles and guesswork to precision, accountability and forecasting.
Of course, there’s a dark side. Money amplifies human traits, notably greed and domination: we spend much of our lives acquiring it and the failure to do so can doom us to misery.
The power of money also allows governments to take on debt, increase spending or both, and then debase their own currency to inflate away their financial problems, ruining everyone else in the process.
Inflation and political unrest are recurring themes of McWilliams’ book. A succession of Roman emperors debased their coins to fund military spending as tax revenues declined, leading to hyperinflation and economic collapse as the trade network broke down. In post-revolutionary France, the Jacobins printed assignats – paper money backed by the value of confiscated church property. This funded the revolutionary wars, until they printed too much: by 1795, inflation hit 80% a month and food shortages broke out. The revolution introduced price and wage controls; farmers and merchants refused to sell at fixed prices. The response was a war on “hoarders” which unleashed the Terror.
The most infamous instance of hyperinflation – Weimar in the 1920s – follows the same pattern. The state prints money to inflate away the value of its debt, this wipes out people’s savings, impoverishing the middle-class, the economy crashes, the political system fractures.
For McWilliams, there is an implicit social contract between the state and its citizens. We expect that if we work, save, obey the law and pay our taxes the state will protect the value of its currency. When governments breach that trust they poison the entire political order.
Money Money Money
All of this seems to make the case for independent central banks with inflation targeting as a core mandate – an arrangement specifically designed to prevent politicians from wrecking their own currency. What does McWilliams think they get wrong? And why could their days be numbered?
“The first thing you can divine from New Zealand asking a Scandinavian central banker to be the head of the central bank is the perception that money is absolutely the same wherever it’s used. And that’s not the case. Money is a part of culture. It’s idiosyncratic. New Zealanders use money very differently to Irish people, for example: different savings ratios, different investments, different perceptions of trust.”
He likes to compare economists to plumbers. They understand how the pipes beneath your house work, but they don’t understand why water is essential for life. Central bankers may grasp the practical mechanics of monetary policy while remaining oblivious to money’s cultural, psychological and social power. But he’s also not sure they grasp the mechanics, claiming the high priests of the economy have less power than they think they do.
This is a debate that dates back to the 1970s that’s fired up again with post-Covid inflation. Do central banks really control the money supply or do they merely attempt to steer it while commercial banks and governments make most of the key decisions?
The standard theory of monetary policy – the hymns economists learn in seminaries, as McWilliams puts it – is that central banks create cash and reserves and set interest rates. Commercial banks generate most of our money by lending it out based on the criteria set by the Reserve Bank.
Money is simply too important to be controlled by tech bros with a printing press.
According to the RBNZ website there is about $9 billion in cash washing around the New Zealand economy, $55-60 billion in settlement balances (the assets the bank creates to resolve payments between commercial banks) and $439 billion in deposits created by those commercial banks.
Under standard theory, the central bank speeds the economy up or slows it down by raising or lowering interest rates on the settlement balances, and this flows into the wider economy by affecting the rates commercial banks charge for your mortgage, or the returns on your savings account. During the pandemic, the RBNZ lowered interest rates close to zero and cheap money flooded into the economy, which roared back into life after the lockdowns. Then prices surged because there was more money chasing the same amount of goods.
Heterodox economists such as McWilliams argue this model doesn’t describe what actually happens; that it works well in theory but breaks down in practice because nearly all the money in an economy is created by commercial banks.
If the economy is a river, the textbook preaches that central banks function as a massive dam controlling the flow of the water. McWilliams believes they’re more like levees or sluice gates along the tributaries. They’re not powerless – they can set the price of money, slowing currents, slightly – but they’re always responding to the deeper flows of commercial bank credit creation, government borrowing and global capital markets.
The reactive nature of this reality means their tools often have long, uneven lags, creating spells when credit markets dry up, or surge over their banks before monetary policy can calm the waters.
The gap between theory and practice is, McWilliams claims, “the most valuable secret in the world”.
Digital next
During the past 100 years, money has been transformed from bills and coins backed by gold, to bills and coins backed by nothing, to digital entities backed by nothing. McWilliams points out this transformation has accompanied a period of staggering global prosperity.
What will the next transformation look like? “Crypto is not the future of money,” he says. “Is it an innovation? Yeah, it’s fine. But money is simply too important to be controlled by tech bros with a printing press. The government won’t stand for it, in the same way as the New Zealand government wouldn’t stand for the abolition of the police force in New Zealand.
“Currency and money are as elemental to the democracy or the regime or the administration as the police force. So it’s just not going to be given away. And nor should it be, for democratic reasons.”
For him, the obvious next step is a digital currency, also known as a central bank digital currency, or CBDC. This is like crypto, but it’s also the opposite. Bitcoin is prized for its anonymity – two of its primary use cases are illegal transactions and tax evasion. CBDCs track the movement of every dollar in a centralised government database. Every transaction goes on record. Governments could see where all their spending flows; see how much of your money sits where, then follow it wherever it goes.
There are profound privacy implications, but tax evasion becomes a lot harder – and this has attracted the attention of finance ministers around the world.
“That’s the future of central banking,” McWilliams predicts. “They’ll function as a giant tally stick.”
If his forecast is correct, and his broader, grand, unified theory of money holds true, then as the nature of our money changes again, we’ll change along with it. As it becomes even more complex, abstract and impossible for even the experts to understand – so will we.
David McWilliams on Money, Word Christchurch, Tuesday, October 14, 7.30pm.