#BTColumn – An ode to Thomas Hoenig (Part 2)

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by Adrian Sobers

“In his 1979 Per Jacobsen lecture to the IMF in Belgrade, [Arthur] Burns recognised that he lacked political support for slowing money growth to end inflation.” – (Allan Meltzer, A History of the Federal Reserve, Volume 2, Book 2)

Karl Marx did not make many witty remarks but his oft-repeated observation that history tends to repeat itself “first as tragedy, then as farce” is an apt description of the quantitative quagmire – The Great Inflation II – in which we find ourselves today. As it turns out, Marx’s observation is also a good description of the events that led to Thomas Hoenig’s dissent.

Mr. Hoenig’s understanding of the Fed’s track record informed his voting. In his final dissent he summarized his argument in three points, the most important for our discussion being: No exit strategy.

“The Federal Reserve doesn’t have a good track record of withdrawing policy accommodation in a timely manner, no matter how much we say we will.”As Nassim Taleb put it, “Nothing is more permanent than “temporary” arrangements, deficits, truces, and relationships; and nothing is more temporary than “permanent” ones.”

The Fed deliberately encouraged riskier investments by pushing cash further out on the yield curve. One of the locations further out on the yield curve is the debt of developing nations. Places like Turkey who borrowed six times as much money by issuing bonds between 2009 and 2012 than it did between 2005 and 2008.

Mr. Hoenig was concerned about the asset price bubble that will (not might) eventually pop. He worked during Paul Volcker’s tenure and when Volcker was fighting inflation, he recognized two kinds (“cousins” as he called them): asset and price. Two important shifts in Fed policy occured after Volcker’s tenure that are worth exploring in detail but, alas, can only be mentioned in passing.

When Alan Greenspan succeeded Volcker, he ignored asset inflation and focused only on price inflation. (Sebastian Mallaby details this in The Man Who Knew) The second policy shift came during Ben Bernanke’s tenure which saw the Fed cement its role as central planner (and a god awful one at that); not only for the US, but the world. The Fed acts as the world’s central bank in mainly two ways.

The US dollar is the world’s reserve currency, so Fed policy gets exported to economies that are explicitly and implicitly dollar-pegged. The other way is that Fed policy is copied by other central banks. The Fed’s monetary superpower status is the subject of much research (not the Google/social media variety), and has been acknowledged by former Chairs Bernanke and Yellen. While the Fed cannot control which countries peg to the dollar, it needs to be more aware of its monetary superpower influence and act accordingly.

During The Great Inflation (1965–1982), major errors in economic policy were made. The seeds of these same errors, price controls for one, are being sown by the current US Administration. Politicians treat the symptom, and may even hide them briefly (a term or two), but their failure to address the underlying issue costs more in the long-run. In a 2004 report, Fed economist Edward Nelson argued that the most likely explanation for the Fed’s failure during the 1970s was “monetary policy neglect.” He suggests that the Fed didn’t understand that more money was creating more inflation.

This failure, he argues, was a result, not of malice but misunderstanding. Meltzer details the errors from the 1970s in the aptly titled chapter: “Under Controls” where he explains that proponents of price controls “did not understand that unless monetary policy became less expansive, spending would continue to rise, raising prices.” Mr. Nelson is right concerning the 1970s, but one cannot help but wonder if mailce is now the reason that this “misunderstanding” persists today.

Meltzer references a memo from 1975 detailing a staff discussion about “the System’s ability to change the shape of the yield curve. The issue arose under the usual pressure from Congress to assist the housing industry by buying long-term securities to lower long-term rates.” Meltzer conclu
des that it is clear from staff discussions that “they did not understand that monetary policy influenced the economy by changing relative prices, the amount of money relative to the stocks of financial assets and real capital, and expectations of inflation.”

This tragedy from the 1970s would repeat itself as farce in the early 2000s in the form of political pressure that culminated in the 2007-2009 financial crisis. I imagine we will have to fabricate a word, “absurdative” perhaps, to explain the repetition of the farce from the last crisis as we limp into the next one.

Paul Volcker said, “People don’t need an advanced course in economics to understand that inflation has something to do with too much money.” They also don’t need an advanced course in economics to realise that we are in the throes of the Fed repeating the same errors from the 1970s. In his essay Ben Bernanke Versus Milton Friedman, Jeffrey Hummel references a speech given by Bernanke at a celebration of Milton Friedman’s ninetieth birthday.

“I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again. Despite Bernanke’s promise,” writes Hummel, “the Fed did do it again.” And again, under Ms. Yellen; and again with Mr. Powell. Little wonder Meltzer wrote, “It is a melancholy fact that each generation must relearn the fundamental principles of money in the bitter school of experience. It is the mismanagement of the monetary mechanism that most of our recent troubles are chiefly ascribable.”

When Gerald Ford replaced President Nixon, he declared inflation as his main policy problem and introduced the WIN program: Whip Inflation Now. WIN quickly turned to a loss as reality set in. (It always does, and it will set in again when asset prices correct.) As is the case with vacuous political sloganeering, WIN was more public relations ploy than sensible, actionable policy. As The Great Inflation sequel plays out, the public (especially the working poor), deserve more than empty slogans this time around.

Adrian Sobers is a prolific letter writer and social commentator. This column was submitted as a Letter to the Editor.