Over the decades of (relative) macroeconomic stab- ility in the second half of the 20th century, profit-seeking com- mercial banks and state-owned central banks worked together to lower the cash-to-asset ratios in the banking industry. An understanding grew that profitable and well-capitalised commercial banks should be able to borrow cash from the central bank if they had trouble maintaining a positive cash reserve balance. The associated arrangements were technical and complex, and were of no interest whatever to politicians and journalists. Fashionable economic commentators regarded them, or rather ignored them, as the municipal drainage of the financial system.

Meanwhile the long period of peace between the world’s leading nations encouraged lending between banks in different countries to an astonishing extent, so that by early 2007 the value of the international inter-bank market was on some measures over $40,000 billion or almost two-thirds of global output. In the middle of 2007 this market suddenly closed. Banks that had been relying on it to finance their asset growth found, in many cases, that they were actually or potentially short of cash. Even if their assets were good, their capital was ample and they had complied with regulations, they had a cash problem. Of course, if their assets were partly of low-quality (or ‘toxic’, in the argot) and their capital stretched, the cash problem was severe.

But even in the exuberance of 2006 and early 2007 all banks — including those taking the greatest risks — had to comply with regulations, not least because only by such compliance could they qualify for central bank cash loans or equivalent support measures. When the international inter-bank market closed on 9 August 2007, skilful management of the emerging crisis and responsible commentary on its main features were essential to avoid a macro-economic calamity. Instead the management (by central bankers, regulators and so on, as well as the commercial bankers) has been low-grade and often chaotic, while the commentariat has indulged in spiteful banker-bashing. The result has been a disaster, with tens of millions of jobs destroyed and avoidable output losses running into trillions of dollars.

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