Book Reviews

In The End of Alchemy former Governor of the Bank of England Mervyn King examines the role of money and banking in the 2007–2008 financial crisis and asks the question, ‘‘How did this happen?’’ (p. 1). He analyzes the forces that resulted in the financial crisis and asks whether it was a failure of individuals, institutions, or ideas. King argues that most accounts of the financial crisis focus on the ‘‘symptoms of the crisis,’’ such as the rise and fall of housing markets or bad lending decisions by banks, rather than on the ‘‘underlying causes of the events that overwhelmed the economies of the industrialised world in 2008’’ (p. 26). He further argues that we will be unable to understand what happened or prevent a repetition unless we focus on the underlying causes rather than the symptoms. Although he does not directly address the role of accounting, his discussion of what went wrong and his framework for financial reform is highly relevant to the debate regarding the role of accounting in the financial crisis and post-crisis accounting reforms that rely on the same way of thinking that King argues made the crisis more probable. Rather than blaming institutions or individual policy-makers or bankers for the crisis, King states that the crisis was ‘‘a failure of a system and the ideas that underpinned it’’ (p. 3). He argues there are fundamental weaknesses in the intellectual economic framework that are important in understanding what happened. Specifically, he criticizes the mathematical models that rely on the ‘‘idea that rational individuals would lead the economy to an efficient equilibrium’’ (p. 12) while saying nothing about the importance of money and banking. He notes that ‘‘the paradox of money is that people choose to own something that has no intrinsic value, and pays no interest’’ (p. 59) and that ‘‘money in the form of private banknotes and deposits is a claim on illiquid assets with an uncertain value’’ (p. 60). He argues that the mathematical economic models that ignore money and banking ignore important concepts and ‘‘lose site of the informal analysis of disequilibrium, radical uncertainty and trust as a solution to the prisoner’s dilemma’’ (p. 12). King argues that ‘‘the economic path on which the world economy was proceeding was clearly unsustainable’’ (p. 40) and the crisis does not represent a temporary deviation from the steady equilibrium growth path, but instead reflects a disequilibrium as the global economy transitions to a new equilibrium path. In his view, ‘‘the crisis was not so much a financial earthquake, releasing pressure that had been built up, as a sudden shift to a lower path than seemed normal only a short time earlier’’ (p. 42). The primary evidence that he provides in support of this claim is the slow economic recovery after the financial crisis despite ‘‘the biggest monetary stimulus the world has ever seen’’ (p. 44). The resulting fall in the real interest rates encouraged increased consumption and investment. ‘‘Households and businesses came to believe that levels of domestic demand were sustainable’’ (p. 319). If his supposition is correct, then attempts to use monetary and fiscal policy to ‘‘speed up the return to the underlying path of steady growth’’ (p. 45) are doomed to fail. This alternative view of a stable but unsustainable path also seems relevant to concerns about the cyclical effects of accounting and policies designed to reduce accounting-induced procyclicality. The concept of radical uncertainty, which King defines as ‘‘uncertainty so profound that it is impossible to represent the future in terms of a knowable and exhaustive list of outcomes to which we can attach probabilities’’ (p. 9) has important implications for the validity of accounting measurements. King states that ‘‘at the heart of modern macroeconomics is the same illusion that uncertainty can be confined to the mathematical manipulation of known probabilities,’’ (p. 121) but argues that ‘‘there is an inherent problem in linking a known present with an unknowable future’’ (p. 11). He supports his argument by