The Fed's top policy committee, the Federal Open Market Committee, doesn't just prize consensus, it nearly demands it. The most powerful governing body in American economic affairs is what the committee likes to present to the public. The appearance of unanimity was shattered by the string of dissents by Hoenig. The economy has never been the same since, it was a hinge point in American history.
The Federal Reserve printed more than $3.5 trillion in new bills. It is roughly triple the amount of money that the Fed created in its first 95 years of existence. Three centuries of money supply growth was crammed into a few short years. The money poured through the financial system and helped drive up prices for assets like stocks, corporate debt and commercial real estate bonds. The Fed leader who voted against this course of action was Hoenig. He put himself against Ben Bernanke, the Fed's powerful chair at the time, in order to make him dislike him.
He lost his fight. In 2010, the votes were consistently 11 against one, with Hoenig being the one. After retiring from the Fed in late 2011, he became known as the man who got it wrong. He is remembered as a cranky Old Testament prophet who warned about the threat of inflation.
This version of history is not true. While he was concerned about inflation, he was also driven to lodge his dissents. According to the historical record, the Fed was taking a risky path that would deepen income inequality, stoke dangerous asset bubbles and enrich the biggest banks over everyone else. He warned that the central bank would not be able to escape without destabilizing the financial system, and that it would suck the Fed into a money-printing quagmire.
On all of these points, he was correct. He was ignored on all of these points. We are living in a world that was warned about.
The Fed is in a tough spot. Inflation is rising faster than the Fed thought it would, with higher prices for gas, goods and automobiles being fueled by the Fed's unprecedented money printing programs. After years of the Fed pumping up the price of assets like stocks and bonds through its zero-percent interest rates and quantitative easing, this is the first time. The Fed will start hiking interest rates next year. If that happens, there is a good chance that stock and bond markets will fall or even go into a recession.
In a recent interview, Hoenig said there was no painless solution. It is going to be difficult. The longer you wait, the worse it will be.
The kind of pain that Hoenig is talking about involves high unemployment, social instability and potentially years of economic decline. He has seen it before. During the Great Inflation of the 1970s, he saw it most acutely. The lodestar that ended up guiding so much of the thinking of Hoenig as a Fed official is an eerie similarity to that episode in history. It explains why he was willing to throw away his reputation as a team player in 2010, why he was willing to go down in history as a crank, and why he was willing to accept the ridicule of his colleagues and people like Bernanke.
When the Fed got things wrong, and kept money too easy, he voted no.
Thomas Hoenig was given the job of cleaning up the mess left behind when America experienced a long and uncontrollable period of inflation. The period in the 1970s known as the Great Inflation was characterized by long lines at gas stations and price hikes at grocery stores that came so fast that the price tags were replaced midday. The Federal Reserve wasn't just a bystander to this inflation, it was an institution. It helped make it.
As a bank examiner in the 1970s, he watched as the Fed's policies helped build on the inflationary tinder that would later ignite. The Fed kept interest rates low so that borrowing was cheap and easy, which is known as an easy money policy. The Fed kept interest rates low so that they were effectively negative by the late 1970s. It is called a super- easy money policy when rates are negative. All that easy money is looking for a place to go in this environment. Economists call this phenomenon "too many dollars chasing too few goods", meaning that everybody is spending the easy money, which drives up the prices of the things they are buying because demand is high.
The economists say that the Fed creates these conditions by creating more and more dollars.
As a bank examiner, he realized another important thing. The price of consumer goods like bread and cars can be increased by easy money policies. The money drives up the price of assets. Low interest rates in the 1970s caused asset bubbles across the Midwest, including in heavy farming states such as Kansas and Nebraska, and in the energy-rich state of Oklahoma. When asset prices rise quickly, it creates an asset bubble.
In farming, the logic of asset bubbles was painfully evident, and it reflected the dynamics that would play out in the housing bubble and the over-heated asset markets of 2021.
Farmers around Kansas City were encouraged to take on more debt and buy more land when the Fed kept interest rates low. Cheap loans pushed up land prices, which might be expected to cool off demand.
The logic of asset bubbles has a different effect. The borrowers expected the land value to only increase and so they borrowed more money to buy more land. Higher prices led to more borrowing. As long as debt was cheap, the wheel continued to spin.
The logic of the bankers was similar. The bankers believed farmland would only rise in value when it was used as a security on their loans. This gave bankers the confidence to keep extending loans because they believed the farmers would repay them as land prices increased. The reality of today's higher asset prices driving the value of tomorrow's asset prices ever higher, increasing the momentum even further, is how asset bubbles escalate in a loop that intensified with each rotation.
The bubbles were not limited to farmland. The business of oil and natural gas was the same. Oil companies were encouraged to drill more wells because of rising oil prices and cheap debt. The banks built a whole side business dedicated to risky energy loans to pay for these wells and related mineral leases, all based on the value of the oil they produce. It was the same thing in commercial real estate.
It all came to an end in 1979. The Federal Reserve was chaired by Paul Volcker who wanted to beat inflation by hiking interest rates. The Fed raised short-term interest rates from 10 percent in 1979 to 20 percent in 1981 under Volcker. The unemployment rate was pushed to 10 percent and homeowners were forced to take out high interest loans. When he was fighting inflation, Volcker was fighting asset inflation and price inflation. He acknowledged that they were created by the Fed.
Volcker wrote in his memoir that the real danger comes from the Fed encouraging or inadvertently tolerating rising inflation and its close cousin of extreme speculation and risk taking.
Demand for loans slowed down when the cost of borrowing was doubled, which in turn depressed the demand for assets like farmland and oil wells. The price of assets collapsed, with farmland prices falling by 27 percent in the early 1980s and oil prices falling from more than $120 to $25 by 1986. The cascading effect was created by this. The value of bank loans were underpinned by assets like farmland and oil reserves. The banks had to write down the value of the loans when they failed because they didn't have enough assets to cover their debts. The entire system fell apart when land and oil prices fell.
Even after Volcker began to address inflation, no one anticipated that adjustment. They did not think it would happen to them. The failure rate was the worst since the Depression.
This was the time when Hoenig traveled around the Midwest to check on banks' solvency during the recession. When his team declared that the value of the banks assets were not enough to meet their liabilities, he argued with a lot of bankers.
The bankers could become stressed and vocal in their objections. You could empathise with them. You could understand the pain. People lost everything in this environment. I didn't blame them for being upset.
John Yorke, a former senior vice president at the Kansas City Fed, observed a stubbornness in Hoenig that persisted through his entire career. It was difficult to shut down community banks, but Hoenig didn't seem to flinch from the responsibility. Yorke said that Tom's German was the ethnic origin of his name. He is strict. There are rules.
It would have been easy for Hoenig to blame the bankers for making so many risky loans after the bubble burst. There were many examples of banking grotesquery. The stupidity in lending was not the fault of the bankers. The asset bubbles were encouraged by the Fed.
The fact is that bankers made the loans. They made them optimistic in terms of asset values. By "inflation expectations", Hoenig was referring to something called "optimism." The bankers expected asset prices to keep rising and that demand for loans would cause the price to rise. It was the fault of a decade of too-accommodative monetary policy.
There were many counterarguments to explain inflation. The idea of cost push inflation, which is what these arguments were about, meant that all the forces outside the Fed were pushing price higher. The labor unions were pushing up the price of labor while the Middle Eastern cartels were boosting the price of oil. The federal government spent years trying to fight inflation under this theory, even going as far as to impose wage and price controls. It didn't work.
There is strong evidence to support the idea that the Fed was causing inflation. The most likely cause of inflation during the 70s was monetary policy neglect, according to Edward Nelson. The Fed kept its foot on the money pedal because it didn't understand that more money was creating more inflation. This type of inflation is called "demand pull" inflation because the Fed stokes demand, which causes prices to increase.
Allan Meltzer, the author and economist who reconstructed the Fed's decision-making during the 1970s in his history of the central bank, delivered a stark verdict. The problem was created by monetary policy. Policy choices placed more weight on maintaining high or full employment than on preventing or reducing inflation, which resulted in the Great Inflation. The choice reflected both political pressures and popular opinion.
These lessons were carried with him by Hoenig. In 1991, he became the president of the Kansas City Fed, which gave him a seat on the FOMC. He was there during the tenure of Greenspan and then the successor. Between 1991 and 2009, Hoenig rarely dissented.
He believed the Fed was repeating the same mistakes it made in the 1970s.
After the crash of 2008, the FOMC faced a terrible dilemma. In the wake of the banking crisis, the central bank kept interest rates at zero. The unemployment rate is close to the levels that depict a deep recession. The committee began considering new and experimental ways to use its power after members of the committee agreed that another recession was unlikely.
When it became clear that the Fed wanted to keep interest rates at zero for an extended period of time, Hoenig began voting no. A review of his comments during the 2010 meeting of the Federal Open Market Committee shows that he rarely mentioned inflation. Keeping interest rates pegged to zero could endanger even deeper. His warnings were hard to understand for people who didn't follow the politics of money.
Keeping interest rates at zero was something that Hoenig liked to talk about. The allocative effect was something that affected everyone and not something that people debated at the barbershop. The Fed shifted money from one part of the economy to another in ways that were discussed by Hoenig. This is what he saw during the 70s. Wall Street speculation could lead to ruinous financial crashes if the Fed's policies are encouraged.
It did more than that because it encouraged speculation and asset prices also shifted money between the rich and the poor because the rich own the majority of assets in the United States. He was worried that a decade of zero-percent interest rates would have the same effect.
These arguments were unpersuaded by Bernanke. The Courage to Act was the title of the memoir that Bernanke published in 2015. The theory of Bernankeism holds that central bank intervention is necessary, but even brave and noble, and that it was not until June that the questions about the dissents were sent to Bernanke.
The Fed kept rates at zero throughout the year. In August of 2010, with unemployment high and growth sluggish, he publicly unveiled the plan to create $600 billion new bills through an experimental program called "quantitative easing." During the financial crash, this program was used. It had never been used as an economic plan to be used outside of an emergency.
If he had learned anything from his time at the Fed, it was that keeping money easy for too long could cause disastrous side effects. During the 1970s and the mid-2000s, low rates fueled the housing bubble. Quantitative easing would encourage risky lending and asset bubbles if it were to be voted on by Hoenig.
The goals and basic mechanics of quantitative easing are easy to understand. The goal is to pump a lot of cash into the banking system at a time when there is no incentive for banks to save money. Banks don't earn much from saving cash when rates are low. The Fed uses its own team of financial traders who work at the regional bank in New York to create money.
These traders buy and sell assets from a group of 24 financial firms called "primary dealers", which include the likes of Goldman and JP Morgan. Reserve accounts are special bank vaults at the Fed. A trader at the New York Fed would call up a primary dealer and offer to buy $8 billion worth of Treasury bonds from the bank in order to execute quantitative easing. The Treasury bonds would be sold to the Fed trader. The Fed trader would tell the Morgan bankers to look inside their reserve account. Voila. The Fed created $8 billion from the reserve account in a matter of seconds.
Morgan could use the money to buy assets in the wider marketplace. Until the Fed had purchased $600 billion worth of assets, Bernanke planned to do such transactions over and over again. The Fed would use money it created until it had filled the Wall Street reserve accounts with 600 billion new dollars.
Quantitative easing was debated inside the closed-door meetings during 2010 for being a large-scale experiment with unclear benefits and risks. There was more opposition to the plan than was publicly known. The plan was strongly objected to by other members of the FOMC. The presidents of the regional bank were concerned about it, as were the Fed governor.
The research done by the Fed was discouraging. If the Fed pumped $600 billion into the banking system in eight months, it was expected to cut the unemployment rate by.03 percent. It was something and it wasn't much. A small change to the unemployment rate could create a lot of jobs by the end of the year.
There were many negatives to the plan, but the risks played out over time. Risky lending and asset bubbles were the main worries pointed out by Hoenig. There was concern that quantitative easing could cause price inflation, encourage more government borrowing, and that it would be difficult to end once it began because markets would become addicted to the flow of new money.
The final vote on quantitative easing was held in November of 2010. The risks of quantitative easing were large and uncertain, according to the president of the Fed. Lacker asked if he should be in the nervous camp.
The Philadelphia Fed president was blunt. He said that he did not support another round of asset purchases. We should be more focused on the downside risks of this program, given the small anticipated benefits.
The president of the Dallas Fed said he was concerned about the plan. He said at the time that he saw considerable risk in conducting policy with the consequence of transferring income from the poor to the rich.
According to transcripts of internal debates, the Fed faced risks if it didn't intervene, and that's why Ben Bernanke defended the plan with an argument that he would use frequently in the future. He knew he had the votes to pass quantitative easing. Fisher, Lacker and Plosser didn't have a vote that day due to a quirk in the voting rotation. According to the memoir of the Fed governor, Warsh, he came to an agreement that he would support quantitative easing, although he would write an op-ed expressing his concerns about it.
If the Fed unleashed quantitative easing in late 2008, there would be no going back. The Fed might end up keeping money too easy for too long as it tries to juice the job market, chasing short-term gains as it piles up long-term risks.
If he had supported quantitative easing, he would have been praised by his peers. He would have allowed the Fed to appear united in the decision to embark on a new and experimental course if he had broken his long string of dissents that year. Something held him back.
The long history of working with serious numbers has led to a stubborn streak when it comes to such decisions. During his childhood in Fort Madison, Iowa, Hoenig worked at his dad's plumbing shop. He was sent to the back room with a clipboard to record the plumbing parts inventory. If he made a mistake, his dad would be short of supplies. After graduating high school, Hoenig served as an officer in the Vietnam army, where he calculated the firing range of mortar shells to make sure they landed in enemy territory. Getting numbers right was a dangerous job. He felt obliged to get it right. He explained the decision to his sister, Kathleen Kelley, when he enlisted to fight in Vietnam.
Kelley recalled that he said he hoped to be able to enjoy all the benefits of being an American citizen. He characterized his dissents in this language. He called it his duty.
There were 10 votes in favor of quantitative easing. When he voted, he said: "Respectfully, no."
In late 2011, he retired from the Fed. The round of quantitative easing he voted against was just the beginning. By 2012 economic growth was still not strong enough to warrant more quantitative easing. The Fed printed over a billion dollars. The Fed kept interest rates at zero for seven years, which was the longest stretch in history, and it was only briefly.
The Fed tried to reverse its easy money programs but failed. The central bank tried to raise interest rates slowly, while withdrawing some of the excess cash it had injected through years of quantitative easing. The markets reacted negatively when the Fed tried to withdraw theStimulus. The stock and bond markets fell sharply in late 2018, after the Fed reversed quantitative easing and began to raise rates. Fed Chair Jay Powell halted those efforts in a move that traders dubbed the Powell pivot.
The most dispiriting part seems to be that zero-percent rates and quantitative easing have had the kind ofocative effects that he warned about. The very rich were the main beneficiaries of quantitative easing. By making money so cheap and available, it also encouraged riskier lending and financial engineering tactics, which did not improve the lot of millions of people who earned a living through their paychecks.
In May of 2020 he published a paper that said the age of easy money was over. The two periods of economic growth were between 1992 and 2000 and between 2010 and 2018). He argued that the periods were similar because they were long periods of economic stability after a recession. The Federal Reserve's money printing during the last part of the year was the biggest difference. During the 1990s, labor productivity increased at an annual average rate of 2.3 percent, which is twice as much as during the age of easy money. Wage and salary employees' real median weekly earnings rose by 0.7 percent annually during the 1990s, compared to only 0.26 percent during the 2010s. During the 1990s, real gross domestic product growth rose an average of 3.8 percent annually, but only 2.3 percent during the last decade.
The market for assets was the only part of the economy that seemed to benefit from quantitative easing and zero-percent interest rates. The stock market increased in value. After the crash of 2020, the markets continued to grow. Corporate debt hit a record $10 trillion at the end of the year, rising from about $6 trillion in 2010 to a record.
For the first time since the 1970s, consumer prices are rising quickly along with asset prices. Strong demand created by central banks is to blame for that. The Fed has been pumping money into the banks and encouraging government spending. There are a lot of dollars chasing a limited amount of goods. That is a big demand pull on the economy. The Fed is helping that.
The 2020 paper by Hoenig didn't get a lot of attention. He was the vice chairman of the FDIC and pushed for the break up of the big banks. He lives in Kansas City and publishes papers. He is still issuing warnings about the dangers of money printing, and he is being ignored.
After another decade of weak growth, wage stagnation and booming asset values that mostly benefited the rich, Hoenig isn't optimistic about what American life might look like. He talked about this a lot, both publicly and privately. He thought economics and the banking system were intertwined with American society. One thing affected the other. When the financial system only benefited a few people, average people lost faith in society as a whole.
Do you think that the political turmoil, revolution, and divide we had in 2016 would have happened if it weren't for this? Had we not had the effects of the zero interest rates? He asked. I don't know. It is a counterfactual. I would like to pose the question.
