Kudlow’s Money Politics

One-on-One with Thomas Hoenig

I had the wonderful opportunity yesterday to sit down with Kansas City Fed President Thomas Hoenig. He’s a straight-shooting, hard-money, free market central banker — an unusual combination. Hoenig is also a man of integrity who dissents from the FOMC so clearly in his disagreement with ultra-easy money. Incidentally, he believes that Too-Big-To-Fail and “Bailout Nation” are moving America away from free market capitalism.

Here’s the transcript of the interview:

KUDLOW: Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, welcome to THE KUDLOW REPORT, sir.

HOENIG: Glad to be with you.

KUDLOW: All right. Thank you, Tom. Let me just begin with this. In the last five months–not the last month or two, but five months, the Consumer

Price Index has increased at 5.8 percent at an annual rate. First, do you think this is transitory?

HOENIG: Well, I think part of it, perhaps. The–some of the energy prices will move up and down and may come down a little bit, but I think the fundamentals are that, with the extended accommodative monetary policy, with zero interest rates and with QE2 in place, that the natural movement will be for prices to systematically rise over time. It will take some time, but it will occur, unless, of course, we remove a combination fairly rapidly at some point.

KUDLOW: Well, you anticipated my follow-up because I wanted to ask if you thought QE2 was to blame. The money supply creating, the negative real interest rates and the depreciation of the dollar all seems to have really have occurred during the QE2 period and this remarkable inflation jump. Is QE2 to blame for this?

HOENIG: I wouldn’t necessarily say it’s just QE2. I think it’s–we’ve been in recovery. We’re ending our second year in recovery. We’ve had a zero interest rate during that period. And we’ve actually eased into a recovery. And the effects are, when you increase monetary combination on a sustained basis, you tend to move prices up a little in the economy.

KUDLOW: Isn’t that unusual? Just that point, you ease–the Fed eased into recovery. Isn’t that unusual?

HOENIG: Well, in some sense it isn’t since that’s exactly what we did in 2003, 2004. And we did it in the ’70s. We had a decade where real interest rates were negative for about 40 percent of the time. And the decade of the

2000s, real interest rates were negative about 40 percent of the time. And I think you have a consequence from that.


HOENIG: And in the ’70s it was inflation, and in the last decade it was asset inflation, if you will, or bubbles. And so those are things that follow an extended period of highly…(unintelligible)…monetary policy, and we need to be aware of that.

KUDLOW: As Mr. Bernanke has said, QE2 is scheduled to end in June on schedule. I wanted to ask you, is QE3 dead before arrival?

#more#HOENIG: Well, obviously I don’t know the answer to that. I would not support it, as everyone knows. I didn’t support QE2. I don’t–I don’t — I can’t speak for other members, so that’s the only answer I can give you there. I wouldn’t support it, but I’m only–I’m a nonvoting member besides so we don’t–I don’t know the answer.

KUDLOW: So I wanted to go to that, you didn’t support it. You’ve been a consistent dissenter from the QE2 and earlier policies of the Fed.

HOENIG: Correct.

KUDLOW: And there used to be a tradition of the Fed of this kind of public, outspoken dissent. But for some reason you’ve been the lonely hawk, and may going many years or not–why is this? Why don’t more board members and reserve bank presidents openly dissent from the Fed’s policies?

HOENIG: Hard question to answer. I think that if you have a different view, you should express it and vote accordingly. I think there is concern that you do want to give a very, shall we say, systematic kind of “this is the committee working together” response to the public. I think it’s more important to show the public that policy is made around different views and that majority does carry the day, but that dissenting views are welcome and are valued.

KUDLOW: It’s not unpatriotic to dissent.

HOENIG: Hardly at all. I think it’s–I think frankly it’s harmful, if you do disagree, not to dissent because then you are being quiet when you shouldn’t, and you can get some pretty bad outcomes that way.

KUDLOW: So a lot of your written dissents and your speeches have said your–have stated your opposition to boom-and-bust monetary policies…

HOENIG: Right.

KUDLOW: …and you’ve noted that you get bad recessions, high unemployment. And I wanted to ask you, regarding the current situation, is this story going to end badly with another deep recession and another high unemployment rate, which could do even more damage to this country?

HOENIG: Well, again, I don’t know the answer to that. I do know that when you have extended periods of highly accommodative policy that go on indefinitely and you take the ability to judge risk out of the market, that you create the conditions, if you will, for bad outcomes…


HOENIG: …for either inflation or for other imbalances that occur in your economy that then have to be corrected later. And we need to be mindful of that. We need to learn from history. We need to learn from the experiences that we’ve had in the past and calibrate our policies accordingly.

KUDLOW: Let’s talk about calibration. You would have the Fed do what right now?

HOENIG: Well, the first thing is I’d let the world know we are changing the direction…


HOENIG: …because I don’t–I don’t necessarily believe in surprising people either, to a point. Then I would take the language away of highly accommodative for an extended period. Then I would move as rapidly as I–as I judge the economy could towards a 1 percent Fed funds rate, if you will, so that–and then I’d stop, and I’d see how the economy is doing, I’d watch it carefully as we move forward. And then I’d see if I could normalize it further, depending off that–how things go. Because monetary policy, it — my whole view is monetary policy can’t solve everyone’s problems, and the sooner that the economy and those who are involved in it understand that, the more they’ll look to other types of actions like, `How do we support our manufacturing sector? How do we deal with our federal debt?’ and so forth and focus on…

KUDLOW: I want to get to fiscal. I want to get to fiscal in a minute.

HOENIG: Sure. Sure.

KUDLOW: But let me just follow up. What is your economic outlook currently? You had a very soft first quarter, 1.8 percent real GDP.

HOENIG: Right.

KUDLOW: Some sluggish numbers coming out on manufacturing for the first time, of course high gasoline prices seem to have cut back on consumer spending.


KUDLOW: How do you see the outlook?

HOENIG: I see that we will continue to have a modest recovery. We’ve had one so far, and I see it going forward because the–it’s pretty striking, if you think about it, that the United States is going through a deleveraging–that is we had such a huge carry of debt that consumers, businesses, government had to–has to take on that the fact that we were able to have that debt in place, go through this terrible crisis and still have growth going forward as we deleverage is a testament to the strength of the US economy. A modest recovery, I wish it were rapid, but the fact that we have these terrible imbalances to get back in, shall we say, equilibrium, that’s pretty striking how resilient this economy of ours is.

KUDLOW: If fiscal policy in Washington had slashed business tax rates or even other tax rates, would that have obviated the need for the Fed to go into QE2?

HOENIG: Again, that’s a counterfactual–it’s a guess. I do think that we do–I do think we have a fiscal crisis that’s long term, and I hope both parties and the administration deal with that. The sooner, the better. Because I do know, as I’ve said before in speeches, that if you don’t, then people tend, as real interest rates rise, with the carrying of the debt and the continued recovery and those real interests rise, people look to the Fed to bring interest rates down. And that’s what you–that’s when you begin to monetize debt, and that is a very damaging long-term effect.

KUDLOW: So OK, just to stay with that for a second. If the unthinkable happens and the debt ceiling is not increased on time and the US somehow defaults on an interest payment on treasuries or some such thing, how’s that affect the Federal Reserve?

HOENIG: Well, I think that, only to the extent that it has other effects on the real economy would that put more pressure on us relative to what are you going to do about this? They tend to always turn to the Fed. And I think that would put us in a difficult situation of choice. Do we try and accommodate a carry out some way through monetary policy, the — counteract those effects?


HOENIG: And I worry about that.

KUDLOW: It’s like all scenarios potentially lead to more pump priming by the Fed.

HOENIG: It tends to, when people are, if–shall we say, if they’re used to that…


HOENIG: …if they’ve become accustomed to that, they then turn to that automatically. And I think that can lead to some pretty difficult outcomes, especially in the long term. Because in the long term, you can then create a new set of new imbalances or you tend to change the inflation, expectations going forward, neither of which is good for the US economy, I believe.

KUDLOW: The former chairman of the Kansas City Fed’s board, it’s Herman Cain…

HOENIG: Mm-hmm.

KUDLOW: …businessman Herman Cain, who’s now running for president in the Republican primary, but I interviewed him a week or two ago. He would like to see the dollar re-linked to gold as per the old Bretton Woods arrangement, which died out in the early 1970s. Other people have made a similar call. Lot of people are worried about the fate of the dollar continuing to decline. Do you have a thought on re-linking the dollar to gold?

HOENIG: I’ve been asked that many times and I’ve said for some time that, you know, a gold standard is a legitimate monetary system. We’ve had it for generations. I don’t think it’s going to solve our problems because really the value of the dollar is a consequensive policy. Whether you’re under the gold standard and you have the Depression or prior to that, or whether you’re…(unintelligible). If you have good policy–fiscal, monetary industrial policy in the sense of a market economy, you will–your dollar will reflect that in equilibrium. If you have bad policy, fiscal, whatever, your dollar will reflect that. It’s a reflection of our national policy.

KUDLOW: But how much of it can be laid at the Fed’s doorstep? I mean, the dollar may be stabilizing right now. There is some speculation about that in the markets. I know you don’t care to speculate. But at the end of the day, it’s the Fed who controls the money supply, and the Fed who controls the interest rate, and to some extent the real interest rate. How much responsibility for the dollar is held by the Fed?

HOENIG: Well, the dollar is, like I said, affected certainly by monetary policy, but it’s also affected by fiscal policy. It’s also affected by what’s going on in Europe or Asia. That’s why I think trying to pin it on one particular thing is unwise. I think you have to look at the broad policy issues. Because let’s say you went to a gold standard and that’s a discipline you have. But if you don’t engage in good fiscal, monetary, other policies, you’re still going to have issues, whether it’s the gold standard or fiat system.

KUDLOW: You’re sort of the quintessential grassroots Fed guy out there in

Kansas City. You’re going to retire this October, be–I guess 20 years to the day.

HOENIG: Right.

KUDLOW: Which is a great thing, great service. But let me ask you, you actually spoke to a tea party group, let’s see, last September…

HOENIG: Right.

KUDLOW: …outside of Kansas City. So far as I know, you’re the only Fed representative to do so.

HOENIG: Right.

KUDLOW: So what did they tell you when you spoke to them? What did they tell you about life in general and the economy? What did they say about the Federal Reserve?

HOENIG: Well, I think the–the group that I met with were middle-class


KUDLOW: Mm-hmm.

HOENIG: They were concerned about the debt. They were concerned about monetary policy and about where interest rates were, what it meant long term, how it affected inflation, the things that you and I are concerned with. Their questions were good. They were sensible. You had, you know, you have one or two people that kind of ask an off the wall questions, but I’ve gotten that in the most sophisticated crowds. I was very impressed with middle America and with Heartland’s representation of mid-America.

KUDLOW: Were they angry or are they still angry at things like banks in New York that are too big to fail, for example, or bailout nation that seems — I don’t know that community banks are getting bailed out. That’s not what the evidence shows.

HOENIG: Right.

KUDLOW: The New York banks get bailed out. What’s your own feeling about too big to fail and the bailouts?

HOENIG: Well, I would first of all say the individuals in the Midwest are no different than the individuals on the East or West Coast about the fact that the largest banks were bailed out and other banks were not. They’re trying to understand why that is and why that’s always so necessary and what the disadvantage to that is to their community banks. That’s a very reasonable reaction to that. So I think that’s the most important message that we have from that.

Now my own view is that this is not capitalism. What we’ve done is not capital–this is not free markets.

KUDLOW: Mm-hmm.

HOENIG: This is an instance where you’ve given certain protections to financial institutions, and with those protections I think you have to recognize that you’ve incented them to engage in increasingly risk activities to return their–increase their return on equity. Why not? Your cost to capital is less, you’ve got protection of the safety net, you can get liquidity. And then when you do, in fact, take on too much risk and complicated transactions and derivatives and trading activities, you turn and say, `Well, I know we took our profits, but now we’re going to walk away and it’s yours,’ that’s hardly capitalism and that has to change. And I think we’re a long ways from changing that.

KUDLOW: Right. So we haven’t really fixed that. And so we’re moving…

HOENIG: Yeah. I don’t think…

KUDLOW: We’re moving away from free market capitalism.

HOENIG: Right. We’re moving further away from free market capitalism, because now our banks, the largest banks, are 20 percent larger than they were before the start of this crisis. We do have a new law, Dodd-Frank, that is supposed to enhance supervision. We’ve seen that before. Enhanced capital standards. Before we had the safety net capital standards were much higher in commercial banks in the Americas. And we have a resolution process that I can–experience suggests that on a Friday evening, and you have until Sunday to solve your problem, that you’re probably going to bail them out before you resolve them.

KUDLOW: Right.

HOENIG: And I think that’s not capitalism.

KUDLOW: All right. Thomas Hoenig of the Kansas City Fed, you’ve given us a lot to chew on. Thank you very much, sir. Appreciate it.

HOENIG: Glad to be with you, Larry. Thank you.

Larry Kudlow is the author of JFK and the Reagan Revolution: A Secret History of American Prosperity, written with Brian Domitrovic.

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