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Voice of a conservative populist

The morning Tom Hoenig, president of the Federal Reserve's regional bank here, announced that he would retire Oct. 1, newspapers nationwide reported that henceforth the Fed's chairmen will hold quarterly news conferences. This is probably both regrettable and inevitable.

The Fed is called "independent" because it was created to insulate monetary policy from political pressures. But it was created by Congress, which can do what it wants with the Fed. Also, for more than three decades the Fed has had a "dual mandate" -- to protect the currency as a store of value (restraining inflation) and to promote "maximum employment." The latter inserts the Fed into inherently political calculations and decisions.

Furthermore, the Fed's current chairman, Ben Bernanke, speaks of the Fed's tasks of "economic management" and "economic engineering." (See his Sept. 24, 2010, speech at Princeton.) Such language, Hoenig says, is "the language of a central planner." If the central bank acts like this, it will face the scrutiny that comes with the political functions of consciously shaping society's allocation of wealth and opportunity.

Hoenig can see a liquidity-created bubble from where he sits. He sees farmland, the value of which is soaring throughout the Midwest, for several reasons. One is that food prices are increasing rapidly because the Chinese, Indians, Brazilians and others in emerging markets are eating more calories.

But another reason is that extremely low interest rates and the rapid expansion of the money supply have caused lots of money to slosh around, seeking assets that will produce higher returns. The Fed's policy seems designed to pursue a very elastic interpretation of its mandate -- to manipulate the stock market.

Since Bernanke's speech at Jackson Hole, Wyo., last August signaling another "quantitative easing" (printing another $600 billion), the Dow market is up more than 20 percent. In theory, with interest rates low and lots of liquidity, enough money will flow into equities to create a "wealth effect" stimulus: The expanding portfolios of the 20 percent of people who own 93 percent of equities will quicken their owners' animal spirits and acquisitiveness.

Hoenig is proof that the phrase "conservative populist" is not quite an oxymoron: "One of the great tragedies of this era is that 'too big to fail' has been codified." He thinks that if something is too big to fail, it is too big to exist. He believes, as Milton Friedman said, that America has a profit and loss system -- the possibility of profit is an incentive for risk, the possibility of loss is an incentive for prudence. Because "too big to fail" short-circuits this, Hoenig favors restoration of "something like" the Glass-Steagall law -- passed in 1933, repealed in 1999 -- that separated commercial banking from the more risky investment banking. So he favors breaking up the largest banks: He says the 20 biggest are, cumulatively, 20 percent larger than they were before the financial crisis.

Is it, he is asked, mere coincidence that the Great Depression was (a) America's longest slump and (b) the one combated by the most government activism? Hoenig answers: "There were a lot of government activities that caused people to hesitate."

Is it mere correlation, not causation, that the recession that ended in June 2009, although not the nation's most severe, has received the most ambitious government attempts at amelioration yet has been followed by the most sluggish recovery from a sharp contraction in modern times? Hoenig's answer is oblique but suggestive: Given uncertainties, including those created by government policies, investors "freeze up and pull back. When you don't know, you go still." He says, "Capitalism isn't a straight line, it's a zigzag, and when you introduce policies to eliminate the zigzag you can introduce instability."

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