The Fed Needs to Back off!

The last voice of sanity at the Fed? Thomas Hoenig in his address to the National Association for Business Economics in Denver


Well, at least there's one voice of sanity in the gentleman's club known as The Federal Reserve Board! That is Thomas Hoenig, President of the Federal Reserve Bank of Kansas City. And while the pop-eyed other voting members of the Fed seem bent on even more "quantitative easing" and holding interest rates near zero or lower, at least Hoenig can see the writing on the wall.

In an address to the National Association for Business Economics, Mr. Hoenig stated:

"I'm not saying when the next bubble will be, but I do see the conditions that are at least agreeable to the creation of bubble, and that is the risk we face"

He then went on to criticize the Fed's policy of holding short-term interest rates near zero (they're currently at 0.25%) and its plan to begin buying 10-year Treasury bonds to lower long term rates and "stimulate the struggling economy". According to today's Financial Times, the Fed plans to purchase nearly $500 billion worth of 10-yr. T-bonds which act (called "quantitative easing") is sure to drive yields down to historic levels and not make bond holders (including China) very happy.

And we won't even get into how the miserably low short term interest rate is punishing savers. For many, even with $100,000 in a money market account, they're barely eking out $1,000 a year in interest payments. That's barely $83 a month, and not enough to cover the premiums on Medicare Part B, or even a fraction of the Medicare Part D drug premiums! Add that to the fact there's no Social Security COLA this year, and you have many seniors resorting to splitting their pills, or not taking them at all.

Hoenig in his address added that the majority Fed plan would have little impact on the economy. But it would increase the risks of inflation and speculative bubbles — when asset prices rise sharply above real values and create the danger of a crash as happened in the housing market. People, mainly those who criticize Hoenig, evidently forgot recent history and the famous saying of philosopher George Santayana: "Those who forget the past are doomed to repeat it"..

That lesson is that the rock bottom interest rates sustained by former Fed Chair Alan Greenspan and his crew (over 2003-2006), directly fueled the giant asset bubble that erupted in 2008, culminating in the meltdown of the stock market, and the close shave to another Great Depression that was only (barely) avoided by Obama's stimulus spending - since all demand (both corporate and consumer driven) had crashed.

Once more, we see Hoenig is more aware than anyone else (it seems) that the continuance of super low interest rates mean Wall Street banks and large corporations are able to borrow for almost nothing and hoard cash. The corporations alone have been estimated to have hoarded more than $870 billion, rather than plow it into job creation. Meanwhile, retirees and other (normal, non-investment oriented) bank depositors subsidize this cheapo borrowing and earn almost nothing for their trouble. Many get screwed twice over, because not only do they receive chump change in interest on their accounts, but have to pay four or five times the interest (to the same bank) just to do a home remodel job!

As Hoenig has said:

"It's distortion, and it favors the large institutions over the smaller ones, and Wall Street over the saver".

Some former colleagues, like Robert McTeer, who served as Dallas Fed President from 1991-2004, argue that Hoenig's position "made more sense earlier in the year when the economy looked stronger".

But McTeer misses the obvious: the economy looked stronger earlier because much less free money was being hoarded by businesses. Since then, and the continued Fed "crack", businesses have hoarded nearly $400 billion more and plowed that into their personal kitties, or into long term T-bonds where they can make a certain profit. This "hoard syndrome" along with the cheap money, is what's fueling the economic dysfunction because it's metastasizing the low demand.

Hoenig also has history on his side in warning of the possibly dire effects of sustained low interest rates. In his Denver address he pointed to the 1960s and 1970s when inflation rose from under a percent to double digits as the Fed pursued low interest rates to stimulate employment. While in the mid-60s high interest rates of 4-5% allowed savers to benefit, and even enabled (partly) the one income couple (which is now an anachronism) this fell through by 1971-72. Not suprisingly the end of high bank interest rates and the emergence of high inflation also helped propel the insane speculator mentality that arose under Reagan, culminating in the Bank Holding De-regulation of 1984, and the "junk bonds" of Michael Millken. Then we beheld the 1987 crash.

All of us who understand Hoenig's message also fret that the putative cognoscenti of economics don't get it or don't want to get it. They will be the first I'll blame when unchecked inflation re-emerges in 3-4 years.

As Jim Bicksler, a Professor of Finance and Economics at Rutgers University has put it:

"The Fed is keeping rates so low they don't reflect reality. When can you think of a product market in which people give away things?"

As for one lamo Hoenig critic from Boulder who said:

"It seems odd to me that with 200 economists at the Federal Reserve in Washington, that Tom Hoenig has discovered some wisdom that escaped all of those people"

Not really, dude!

And for history, may I remind you that months before the 2008 crash and market meltdown, out of more than 200,000 economists worldwide, barely 5 saw it coming?

The bottom line is that denial, like cheap money, is a drug. Economists, including those at the Fed, need to come off it before it's too late. For that: taking Tom Heonig seriously is the best antidote!