The blunt truth, however, is that the implicit intergenerational cooperation that represents the best outcome is supported by trust, not money. If the younger generation decides not to support the elder, the existence of tokens will make no difference. And if the older generation has invested in, say, housing, they too could renege on the implicit intergenerational transfer by 'consuming' the value of their housing capital by selling it to foreigners or a minority of the wealthy, leaving the young unable to afford to buy the housing stock. [...]

[...] Money is not principally a means of buying 'stuff' but a way of coping with an uncertain future. We do not know which new goods and services will exist in the future, nor what their relative prices will be. There is no auction mechanism today that will allow us to discover that. Maintaining a reserve of purcashing power denominated in a monetary unit reduces the risk from placing one's eggs in the basket containing only contracts that can be written today. [...]

Banks, too, faced a prisoner's dilemma. If, before the crisis, they had exited the riskier types of lending, stopped buying complex derivative instruments and reduced their leverage they would, in the short term, have earned lower profits than their competitors. The chief executive would likely have lost his job, and other staff defected to banks willing to take risks and pay higher bonuses, well before the wisdom of the new strategy had become evident. Even understanding the risks, it was safer to follow the crowd. [...]

[...] There was a view that being very clever was a justification for making money out of people who were less clever. This attitude encouraged the arrogance of the traders who rigged and fixed prices in what were thought to be competitive markets. [...]

Financial engineering allows banks and shadow banks to manufacture additional assets almost without limit. This has had two consequences. First, the new instruments created are traded largely among big financial institutions and so the financial system has become enormously more interconnected. [...] Second, although many of these positions even out when the financial system is seen as a whole, gross balance sheets are not restricted by the scale of the real economy [...]

[...] There are three reasons to believe that, before the crisis, the banking sector as a whole became too large. [...] The belief that when in trouble banks will be bailed out by the state because they are too important to fail leads to an implicit subsidy, which means a larger banking system than is justified by the underlying economics.

Second, many of the examples of high personal renumeration, especially in the form of bonuses, in the financial sector reflect not high productivity but what economists call rent-seeking behaviour. In other words, the renumeration is far higher than is necessary to persuade people to work in the industry. [...] Many of the transactions in complex financial instruments are zero-sum--a clever trader makes money out of a less clever one. Such activity diverts talent from professions where the social returns are high, such as teaching, to those, such as finance, where the private return exceeds, often substantially, the social return.

Third, financial capital is attracted into the industry by the appearance that there are high profits to be made. [...] a common way of exploiting normal accounting conventions for derivative and other complex transactions was to report as current income the present value of expected future cash flows, even though they had not yet been received. [...]

What does it mean to be rational in a world of radical uncertainty? Once we are liberated from the view that there is a single optimising solution, rules of thumb--technically known as heuristics--are better seen as rational ways to cope with an unknowable future. A heuristic is a decision rule that deliberately ignores information. It does so not just because humans are not computers, but because it is rational to ignore information when we do not understand how the world works. [...] Heuristics are not deviations from the true optimal solution but essential parts of a toolkit to cope with the unknown.

Everyone on the island felt let down. The cult of finance had led to the contraction of a successful fishing industry. Too many talented people had been sucked into trading which, with the benefit of hindsight, was little more than a zero-sum activity generating little or not output. How could so many people have been taken in by the new world of finance?

Eighteenth-century thinkers, such as David Hume and Adam Smith, understood the relationship between the amount of money in circulation and the prices at which goods and services were bought and sold: 'if we consider any kingdom by itself, it is evident, that the greater or less plenty of money is of no consequence, since the prices of commodities are always proportioned to the plenty of money'. In the long run, more money means higher prices. The quantity theory of money, later refined and popularised by the American economists Irving Fisher and Milton Friedman, had been born.

[...] Prices and wages do not adjust instantaneously to clear markets whenever demand and supply are out of balance. Firms change price only irregularly in response to changes in demand; wages adjust only slowly as labour market conditions alter; and expectations are updated only slowly as new information is received. Such 'frictions' or 'rigidities' introduce time lags into the process by which changes in money lead to changes in prices. These lags in the adjustment of prices and wages to changes in demand--so-called 'nominal rigidities'--and lags in the adjustment of expectations to changes in inflation--'expectational rigidities'--generate short-run relationships between money, activity, and inflation. [...]