Within a few years, the former Soviet empire, China and other Asian economies, with their combined workforce of over a billion people, entered the world trading system as market economies. Their focus on export-led growth allowed consumers in the West to enjoy rising living standards as the prices of traded goods fell. But the trade surpluses in emerging economies implied an outflow of capital. Relatively poor countries were lending money to richer western ones – the reverse of the traditional model of development. In the process, countries like China built up huge holdings of foreign assets – running into trillions of dollars – matched by equally huge debts in the deficit countries. Such massive imbalances were never likely to be sustainable, and so it proved. If the first fundamental cause of the crisis was the scale of imbalances in the world economy, the second was the inability of our banking system to absorb such large inflows of capital  BIS Review 117/2010  1  without taking excessive risk. In the five years leading up to the crisis, the balance sheets of the West’s largest banks doubled – mainly because banks lent more to other firms within the financial sector than to the wider economy. And the proportion of capital held by banks shrank so that their leverage – the ratio of total liabilities to equity capital – rose to unprecedented levels. Immediately prior to the crisis, the leverage ratios of some UK banks approached 50.
It came care of fixing the exchange rate – first to gold under the Gold Standard and latterly in the post war period to the dollar. With the demise of the dollar standard in the early 1970s, however, the exchange rate anchor had been tossed overboard. At the Bank of England, as elsewhere, the search was on for a new nominal anchor. Into this vacuum stepped Andrew Duncan Crockett. Crockett joined the Bank in 1966 as a graduate entrant, just before the break-up of the Bretton Woods dollar standard. He set to work on the biggest problem of the day, locating a new nominal anchor. In so doing, he began working alongside another young(ish) new Bank entrant, Charles Goodhart. The result was a joint paper published in the Bank’s Quarterly Bulletin in June 1970. It was titled “The Importance of Money”.11 Re-reading it now, it was a prophetic piece of work. In the UK, it laid some of the analytical foundations for what, during the late 1970s and 1980s, became monetarism. More than that, the paper placed commercial bank money and credit at the centre of the macro-economy. It could as well have been titled “The Importance of Credit” or indeed “The Importance of Banks”. After a successful spell at the IMF, Crockett returned to the Bank of England in 1989. In 1994, he then became General Manager of the Bank for International Settlements, the central banks’ central bank. In central bank circles, change was in the air.