Book review: Paper Promises, by Philip Coggan

Accessible yet rigorous, this look at the role of money in the 2008 financial crisis - and those who borrowed, lent and lost it - is fascinating, finds Matthew Taylor.

by Matthew Taylor
Last Updated: 22 Dec 2011

It is only with the passage of time that we can start to understand the causes and significance of catastrophic events. So it is with the financial crisis of 2008. As banking crisis turns into sovereign debt crisis and this in turn leads to substantial reductions in living standards, we are having to finally accept that for more than two decades most of the developed world spent and borrowed more than it created in wealth. George Osborne's grim autumn statement made amply clear that the consequence is a long, painful and perilous adjustment.

Indeed, in strongly recommending Paper Promises it is only fair to provide potential readers with a warning. This book is fascinating and authoritative, with the rigour and depth to satisfy an economist and the accessibility and pace to engage the layperson. It is also pretty depressing.

Coggan's focus is paper money, by which we attribute value to something, based not on its intrinsic value or scarcity but by what we agree it's worth. Coggan describes the three core purposes of money: as a store of value, a means of exchange and a unit of account. One of the book's themes is how this ambiguity in the role of money has combined with foolishness, weakness and greed to create a succession of crises, culminating in the present one.

Economists talk about the money illusion that arises from focusing on nominal as distinct from real (inflation adjusted) value. But this is only one of our many cognitive frailties when it comes to 'filthy lucre'. Coggan explains how the bubble of the nineties and noughties was premised on the illusion that rising asset prices make a contribution to the national wealth. As he puts it: 'A belief that a nation can prosper from higher house prices makes one think of the mythical island where every household earned its living by taking in its neighbours' washing.' A third illusion - and perhaps the one most responsible for the asset boom and bust - is that the more debt is sliced up, repackaged and sold on, the better risk is distributed and diffused. As we all now know, the reverse is the case.

As well as the way money (and especially the virtual money of the electronic economy) exposes human weakness and gullibility, Coggan's book explores the fundamental conflict that arises whenever financial systems start to crumble: that between creditors and debtors. He writes: 'One can see all of economic history through this prism - a battle between lenders and borrowers. The former want to be paid back with interest in sound money; in times of crisis, the debtors cannot afford to do so.'

Thus the classic way for nations to deal with having saddled themselves with debt is either to devalue their currency or allow inflation to do so. Notionally, the debts stay the same, but in real terms they shrink; thus the profligate are relieved while the savers and investors are ripped off. It was stopping countries succumbing to this temptation that was in part the aim of the Bretton Woods system of relatively fixed exchange rates. That system was already creaking when Richard Nixon sealed its fate by ending the increasingly notional link between the value of dollars and gold.

As Coggan's analysis makes clear, this moment is doubly significant. It marks the start of the everwidening detachment between money, asset values and the state of the real economy, and it provided a huge boost to the world of financial speculation, creating liquid trading markets and the panoply of financial products that seek to benefit from, and insure against, exchange rate movements. The long march of the Wall Street and City of London masters of the universe had begun.

As one might expect from a former Financial Times journalist, Coggan is even-handed in distributing blame for the crisis. His book isn't comfortable reading for the bankers who not only became obscenely rich but used their wealth to occupy the corridors of power and beat off any possible threat of regulation. But there isn't much comfort for democrats, as governments ranging from Louis XV to New Labour happily closed their eyes to the dangers of asset bubbles as long as the revenues flowed and the punters stayed happy.

If everyone read Coggan's book we might just be a little more circumspect if and when the next burst of irrational exuberance overtakes the economy.

Coggan underlines how deep a hole we are in right now. Not only are we mired in debt but the baby boom generation is totally unready for the strains an ageing population will place on our economy.

Paper Promises concludes by asking what the long-term consequences of the crisis will be. You'll have to buy the book to discover the ending; suffice to say the 21st- century financial system is likely to be stamped 'made in China'.

Paper Promises: Money, debt and the new world order                                                          

Philip Coggan

Allen Lane


- Matthew Taylor is chief executive of the RSA.

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