Hoenig Explains His Dissenting Views One Last Time

This October, Thomas Hoenig, president of the Kansas City Fed (10th Federal Reserve district) is retiring from the Fed.  With him the US loses one of the few central bank officials who consistently diverged from the party line (the party line being a mixture of neo- and post-Keynesianism with a bit of monetarism strewn in, all of which we would regard as left-fringe economic philosophies. 'Mainstream' they may be these days, but that doesn't alter their essence).

During his stint as a voting member at the FOMC, Mr. Hoenig was well known for being the lone dissenter who regularly voted against additional easing measures.  In the US heartland central economic planning is evidently not as highly thought of as elsewhere.

In our opinion, Mr. Hoenig was always the one FOMC board member who really seemed to 'get it' – namely, that no wealth can possibly be created by printing more money and that an enormous mistake was made when certain financial institutions were declared to be 'too big to fail' (in fact, in a speech in July Hoenig said verbatim: “You print money, print money and print money, but you don’t create real wealth.”)

Hoenig took the opportunity last week to criticize current Fed policies one more time before retiring. His former colleagues would do well to consider his words, but most of them probably won't.

Along with the current crop of dissenters (Richard Fisher, Charles Plosser and Narayana Kocherlakota), Hoenig is living proof that it would be highly problematic if Barney Frank's attempt to remove the voting powers of regional Fed presidents were to succeed. Precisely because the regional presidents are not subject to political nomination and vetting, they are an important feature of the central bank's nominal independence. It is of course clear that in the bigger picture, said independence is a sham anyway; but if not for the dissent uttered by the Fed's politically least compromised members, an important contribution to public debate would simply be missing.

The Fed does after all not exist in a vacuum and the fact that it is apparently worried about public opinion (as evidenced by its recent 'big brother'-like  initiative of monitoring social media) goes to show that there is a feedback loop between the central bank and public opinion. Every bureaucracy is first and foremost concerned with its own survival and the monetary bureaucracy is no different.  As Etienne de la Boetie showed in his famous monograph 'The Politics of Obedience' (pdf), even tyrants need the grudging consent of the populace if they want to remain in office and survive.

The Fed's self-preservation instinct may eventually stop it from 'overdoing' it with its inflationary policy. It faces political headwinds due to increasingly negative public perceptions and may also face resistance from the banking system itself at some point down the road. The banks are only in favor of the current policies as far as they help bailing them out – but they would surely balk if a large decline in the purchasing power of money were to eventually occur or become a tangible threat.

Below we excerpt the most important points from various press reports on Hoenig's last official speech and interviews he gave thereafter.

Reuters reports:

“A departing Federal Reserve official lit into the U.S. central bank's ultra-easy policies on Wednesday, saying they may be doing more harm than good and could harm economic growth over the long term.

"When you encourage consumption by inhibiting your interest rates from rising to their equilibrium level, you will in fact buy problems, and we have in fact bought problems," Kansas City Federal Reserve Bank President Thomas Hoenig said in his final speech in office.


Hoenig leveled blame at lawmakers as well, saying the Fed's stimulative policies were a band-aid for a failure to credibly commit to lowering the United States' long-term debt. Lack of political courage to curb spending and government subsidies and rein in debt would likely lower the U.S. economy's long-term growth potential from about 3 percent a year to as low as 2.5 percent, he said.

"We will not fall off the cliff," Hoenig said. "But what it does is it lowers the potential growth rate of your economy."


(emphasis added)

What Hoenig refers to as the 'equilibrium interest rate' is what we would call the 'natural interest rate' as dictated by the social rate of time preference. We agree of course that artificially lowering interest rates below their natural level 'buys problems'. Note also that Hoenig's view of the federal debt markedly differs from those crying for more fiscal stimulus.

The Denver Post reports:

"History only defines what was right in the long run. I am not prepared to say I was right and someone else was wrong. But I wouldn't change my mind," he [Hoenig, ed.] said on Monday during a visit to Denver.

Hoenig said his issue isn't so much with low interest rates as with the Federal Reserve distorting market signals and creating a false faith in monetary policy.

Artificially high rates can crush an economy as readily as low ones can misallocate resources and fuel asset bubbles, he said.

"We can't rely on monetary policy. We can't solve the international imbalances with monetary policy, but people don't know that yet," warned Hoenig, who oversees banks in Colorado, which is part of the Fed's 10th District based in Kansas City, Mo.

The core problem is that the United States has consumed more than it has produced for 20 years running. Consumers and governments in the developed world have piled on too much debt.

Every time a crisis arose, the Fed would cut interest rates and inject money into the system. Easings after the Asian financial crisis, the Russian debt crisis and dot-com bust boosted confidence that lower interest rates were the answer.

But each crisis required more medicine and triggered more side effects, including the construction of 3 million more homes than necessary between 2002 and 2007.

Now the patient isn't responding, he said.

Although he voted twice against Fed easing in 2001, Hoenig wishes he had been more vocal back then. His boldness is born in part of regret.

"What you do when you artificially hold rates down is ask the savers to subsidize the debtors. In an emergency and a crisis that is justifiable, perhaps," he said.

But to do it repeatedly and indefinitely risks distortions in the market and creating unintended consequences and eventually inflation, he warns.

"It would be better if we were not as accommodative so the market could function and send out proper signals," Hoenig said. "I think interest rates would be low. I just don't know how low."

Excessive debt took years to accumulate and will take years to resolve, he said, adding that the bipartisan Bowles-Simpson Commission offers a good place to start debt reduction.

"I am optimistic that the hard choices can be made," Hoenig said. "The American people understand it better than we give them credit for. They know it is serious, but they want the sacrifices to be shared."


(emphasis added)

There is nothing in this analysis we disagree with. In fact, Hoenig seems to fully espouse the Austrian position that too low interest rates cause capital malinvestment by distorting an important market signal. His remarks on the imbalance between production and consumption and the error of 'papering over' every crisis by lowering interest rates are spot on as well, as is his observation that 'the patient is no longer responding'. As we have often pointed out, once the economy refuses to respond to monetary pumping, it is a sign that deep structural damage has occurred during the preceding credit boom. The possibility that more wealth is in fact consumed than produced must be considered in this case, and if so, then there is no longer much of a time lag between monetary pumping and its ultimately negative effects. 

If Hoenig weren't a central banker himself, we would almost think he is making an argument against the institution of central banking as such. For instance, he pleads for 'letting the market function' to determine interest rates. It should be obvious that as long as there is a central bank this is simply not possible.

As Hoenig notes at the beginning, the administered interest rate can be set both too high and too low by the central bank, with negative consequences ensuing in either case. The central problem is enunciated when he says that “I think interest rates would be low. I just don't know how low”.

Neither does anyone else know of course – it is simply not possible for a 'body of experts' to make the correct determination. Note here that this is independent of the motives and good intentions of the committee charged with doing so. As an aside to this particular point, here is J.H. De Soto quoting Janos Kornai (in “Socialism: Economic Calculation and Entrepreneurship”):

The people at his [Lange's – this is a critique of Lange's defense of socialism, ed.] Central Planning Board are reincarnations of Plato’s philosophers, embodiments of unity, unselfishness, and wisdom. They are satisfied with doing nothing else but strictly enforcing the ‘Rule,’ adjusting prices to excess demand. Such an unworldly bureaucracy never existed in the past and will never exist in the future. Political bureaucracies have inner conflicts reflecting the divisions of society and the diverse pressures of various social groups. They pursue their own individual and group interests, including the interests of the particular specialized agency to which they belong. Power creates an irresistible temptation to make use of it. A bureaucrat must be interventionist because that is his role in society; it is dictated by his situation …”

The FOMC's position is very similar to that the central planners of command economies found themselves in. In order to get around these limitations, various rules of thumb have been invented, such as e.g. the 'Taylor rule' or 'inflation rate targeting' (such as employed by the ECB). However, all these approaches are by necessity flawed – the economy is simply too complex and too dynamic to allow for such simple rules to work, or in fact for any rigid mathematical system to deliver the desired results. In the end, the same problem keeps getting in the way: it is not possible to 'know' what the natural interest rate is – unless it is freely determined by market forces.

In 'Critique of Interventionism', Ludwig von Mises noted that even the interventionists themselves are bound to be thwarted in terms of the results they want to achieve and what they do in fact achieve:

“…all varieties of interference with the market phenomena not only fail to achieve the ends aimed at by their authors and supporters, but bring about a state of affairs which – from the point of view of their authors’ and advocates’ valuations – is less desirable than the previous state of affairs which they were designed to alter.”


Not surprisingly, Hoenig also expressed skepticism about 'Operation Twist' and Charles Evans' idea that the Fed should aim for higher 'inflation' (a higher rate of change of CPI). According to Bloomberg:

“Federal Reserve Bank of Kansas City President Thomas Hoenig said the Fed’s plan to push down long- term interest rates may produce accidental outcomes and policy makers risk creating “imbalances” in the economy.

I have real concerns about trying to fine-tune and micro- manage the economy when monetary policy is a blunt tool,” he said today in an interview with Bloomberg Radio’s “The Hays Advantage” with Kathleen Hays. Efforts to “redefine yield curves” may “introduce new complexities and risk new unintended consequences,” he said.


“We ought to be very, very humble in our expectations of what we can do with this instrument we call monetary policy.”


The Kansas City Fed chief rejected an idea posed by Chicago Fed President Charles Evans, who suggested policy makers tolerate higher inflation for some time in order to bring down unemployment.  “That is a terrible policy,” Hoenig said. “I just can’t believe that we would think that as economists.”


(emphasis added)

We never thought we'd be sad to see a Federal Reserve official sail off into retirement, but we will miss Thomas Hoenig. With him, one of the few voices of reason will be gone from the Fed.



Retiring Kansas City Fed president Thomas Hoenig: “You print money, print money and print money, but you don’t create real wealth.”

(Photo via: crestresstest.com)









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