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The Man Who Said No to Easy Money

Thomas Hoenig

(Time) – Late in January, the high priests and priestesses of the U.S. economy gathered inside their Washington sanctum for the regularly scheduled ritual known as the Federal Open Market Com­mittee (FOMC). This is the group that decides the value of money, measured by interest rates, which it controls by easing or tightening the money supply. Of course, there are other forces that influence the value of money—a great global whirlwind of forces—but most don’t hold orderly meetings in a grand conference room on Constitution Avenue.

The FOMC’s mission is to steer a course between the shoals of high unemploy­ment and high inflation, putting enough dough into circulation to keep the econ­omy well fed and growing—but not so much that money begins to plummet in value. The priesthood meets eight times per year, reporting its decisions in oracular statements of Olympian voice. This year, when the committee spoke, Fed watch­ers noted something striking: for the first time since z00% the members were unani­mous. All supported the chosen policy of adding $600 billion to the banking system by purchasing that amount of Treasury bills from big banks—a strategy known as quantitative easing.

And here’s the reason they were finally unanimous: Thomas Hoenig couldn’t vote. Throughout zozo, this tall Iowan with thin white hair and cuff links like gold coins was a voting member of the priesthood. He sized up the data, then cast his lonely ballot against the indefi­nite reign of easy money. Eight meetings, eight no votes—a rare unblemished record of recalcitrance that made him a hero to inflation hawks and a pariah to the many economists who believe that, with un­employment above 9%, the engine of the economy needs further priming.

Hoenig would still be issuing dissents if his one-year term as a voting member had not expired (non-New York regional Fed presidents share votes on a rotating ba­sis). With his mandatory retirement at 65 as president of the Federal Reserve’s loth District looming in October, he will never get another chance, though he plans to con­tinue his critique of government policy as a think tanker, consultant or author. When I paid him a visit a couple of days after the FOMC’s unanimous vote, Hoenig (pro­nounced Hawn-ig) was happy to explain his unyielding point of view, one that has become ever more relevant now that ris­ing commodity prices have put inflation worries back on the economic radar screen.

Amber Waves of Grain

Hoenig’s views start, quite literally, with his view. His corner office sits atop a buff-colored tower on a hill overlook­ing downtown Kansas City, Mo., with the gently rolling hills of Missouri and Kansas stretching into the distance. “I’m not sure people in New York and D.C. are thinking about agricultural land prices and mineral rights the way I am,” Hoenig ventures safely. What he sees through his soaring windows are the signs of an economy that supposedly doesn’t exist in the U.S. anymore, a well-balanced one that resists both booms and busts. Hoenig can see a resilient and promising manufactur­ing sector—notice the big GM plant in the middle distance, where the carmaker is in­vesting S136 million to prepare for produc­tion of the redesigned 2012 Chevy Malibu. The high-rises of downtown are home to some of the soundest regional banks in the country. Slicing through the foreground is a freight train hauling the heavy com­modities mined and grown in the nation’s midsection. The horizon contains some of the most productive farmland on earth, and beyond lie rich reserves of oil and gas. Since the start of the financial crisis, the unemployment rate in the roth District has been about 2 percentage points lower than the national rate.

In other words, for all the headlines over the past quarter-century about the death of American manufacturing and the twilight of community banks and the vanishing farmer, those humble build­ing blocks of a sound economy still figure significantly in Hoenig’s perspective. The way to strengthen them, he believes, is not by pumping money into a financial system that encourages megabanks to en­gage in high-risk speculation. You build them up by encouraging savings, which form capital for investment, which builds stronger businesses, which hire workers and pay dividends—which leads to more savings and more investment.

But by keeping interest rates near zero indefinitely, the Fed is “asking savers to con­tinue to subsidize borrowers,” Hoenig says. “What incentive is there to save and invest?” This insight was gaining ground after the ir­rationally exuberant Alan Greenspan years at the Fed. The former chief issued a mea culpa for piling too much money onto the economic bonfire that led to the Great Reces­sion. But the crash of 2008 was precisely the wrong time to shut off the fuel supply. Hoe­nig supported massive infusions of money to save the world economy from a replay of the Depression. Now he simply believes the time has come to start sobering up.

Certainly, Hoenig’s thrifty Midwestern sensibilities sound quaint to the central bankers in Washington and New York City who dominate the FOMC’s deliberations. But he is adamant that his perspective is every bit as worthy as the view from Wall Street or from K Street or from the Princeton faculty club. “Provincialism,” Hoenig ob­serves, Is not unique to the provinces.” He believes that the bad effects of easy money are already cropping up in the heartland. Hoenig’s domain stretches across Oklaho­ma, Kansas, Nebraska, Wyoming, Colorado and parts of Missouri and New Mexico. Sur­veying those states, his economists find that the price of farmland is escalating wildly. “Agricultural land is appreciating almost weekly,” he says. Energy prices are boom­ing as well.

There is more going on here than a simple rise in economic activity, Hoenig thinks. Rocketing land and energy prices are telltale signs, he says, of too much money sloshing around. “When you put

this much liquidity into the system, it has to go somewhere.” It won’t go into savings as long as the Fed keeps interest rates near zero. So the money starts chasing assets with higher yields—like land, the once again booming stock market and energy (indeed, some savvy Wall Street investors believe quantitative easing is a major fac­tor in the current run-up in oil prices). As more money joins the chase, asset prices rise and keep rising until …


Remember pop?

“This is how bubbles are formed,” Hoenig says. He has seen it all before. A career employee of the Fed in Kansas City, Hoenig is the longest-serving district pres­ident, with more than 18 years in his post. Before reaching the top job, he helped mop up the damage from the oil-price bubble of the mid-r98os. A little bank in the ioth District, Penn Square Bank of Oklahoma City, went wild in that boom, packaging unsound loans and selling them to other banks—sound familiar? When the bubble burst, Penn Square helped drag down the once mighty Continental Illinois National Bank in Chicago.

During his years as a regional Fed president, Hoenig has watched uncom­fortably as the central bank began to play a larger and larger role in the public’s per­ception of the economy. Monetary policy “came to be seen as the solution to more and more economic issues. It has been used to deal with one crisis after another: a stock-market crash [in 19871, a recession [in 1990-911, a bubble in high tech [which burst in bomb the 9/11 attacks, the Iraq war, a financial meltdown. People came to feel that all you had to do was ease in­terest rates and everything would be fine. But that’s what gives us these bubbles,” Hoenig says.

He knows that many people feel it’s too soon to start tightening up on money when unemployment remains high and core in­flation in the U.S. is low. As the joke goes, Hoenig has predicted eight of the past zero bouts of inflation. Maybe there’s a reason he was all alone in his dissents. But he feels that his critics—notably Nobel laureate Paul Krugman, who has written that tight­er money will “perpetuate mass unemploy-ment”—overestimate the Fed’s short-term ability to drive down unemployment, while underestimating the long-term dam­age of superlow interest rates.

“Inflation isn’t a not-here-today, here-tomorrow phenomenon,” Hoenig says. It builds slowly. “The sequence of events that led to runaway inflation in 1979 got started back in the mid-196os. That’s what I mean by long term.”

Hoenig supported the Fed’s dramatic actions in 2008 and 2009 to pour trillions into the staggering financial system. But now the economy is growing fitfully, and all that money “is looking for places to go.” A lot of it is pouring into places like Brazil and China, where, Hoenig notes, inflation is rising sharply. Global food prices have risen 25% in the past year, according to the U.N., and many nations are starting to hoard commodities.

Wall Street vs. Main Street

Meanwhile, in America, the most rapidly rising prices aren’t factored into the core inflation rate, because food and oil are considered too volatile to produce a reli­able measure. But just because these costs aren’t part of the inflation rate, it doesn’t mean that people don’t have to pay them. In fact, the poorest 6o% of American households spend 12% of their income on energy alone, compared with the 3% spent by the richest 10%.

“Inflation is so unfair,” Hoenig declares passionately. “It is the most regressive tax you can impose on the public,” he adds. “It erodes the buying power of the poor and people on fixed incomes. The people who have money and are savvy come out ahead. In fact, they end up stronger than before.”

It’s not just the Fed’s loose-money policy that bothers Hoenig. He feels that little  has been learned from the crisis and that government policy continues to smile on Wall Street but not on Main Street. Instead of breaking up the financial giants whose gambles crashed the economy, the gov­ernment has let the biggest banks grow even bigger. Now they’re gorging on free money. Where is the penalty for failure? “We don’t have a market economy now,” Hoenig says. “I hate to use this term, but it’s almost crony capitalism—who you know, how big your political donation is.”

If Hoenig made policy, instead of dis­sents, he would set his course toward “high savings rates, low leverage and a strong currency.” He would bring back the Depression-era Glass-Steagall rule  that barred commercial banks from tak. ing excessive risks. He would reduce government debt and promote a manu­facturing revival. “We can become a low-cost producer again,” he says. “It won’t be easy—there is no painless approach. But Germany has done it, and we can too.”

Hoenig acknowledges that he has been accused of grandstanding at the end of his Fed career. In his mind, there’s no point in giving regional Fed chiefs a vote if they’re not going to vote with their conscience. His stand has attracted admirers, like the octogenarian from Connecticut who dug up his unlisted phone number and called him at home one Sunday last year to urge him not to back down.

He won’t.

One of the great novels of Kansas City, Evan S. Connell’s Mr. Bridge, tells the sto­ry of a man who would have applauded Hoenig’s dissents. A lawyer who invested “in companies that he considered essen­tial,” Mr. Bridge abhorred “speculations” and lived by the principle that “it is bet­ter to trade too little than too much.” That spirit of thrift and caution is out of style in a world that’s still awash in complex deriva­tives and computerized trading, a world of trillion-dollar deficits. But it lingers in Kan­sas City and in the impulses among people like Thomas Hoenig, who may come to be seen as a prophet for a future that looks a little more like a distant past.

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