Lords Of Easy Money - Review

Monday, 21 August 2023
By Rob Julian

Everyone got used to a low interest rate environment, and as dissenting ex-Kansas Fed President Thomas Hoenig predicted the adjustment back to normality is painful.

Think about it,” Hoenig said. “...The entire market system develops a new equilibrium—around a zero rate..... not only in the U.S. but globally. It's massive. Now, think of the adjustment process to a new equilibrium at a higher rate. Do you think it's costless? Do you think that no one will suffer?”


In his book on Federal Reserve policy called 'Lords of Easy Money' author Christopher Leonard makes a strong case that although the initial Quantitative Easing and low interest rate policy of the Fed after 2008 was justified, further QE and prolonged low interest rates reaching into a decade later was damaging to the US economy. (I don't entirely agree with this book, but I still think is great at arguing a certain perspective). In the book, the authors opinions on this complex subject are brilliantly conveyed by using the story of ex Kansas Fed President, Thomas Hoenig. Hoenig supported Chair Bernanke's radical policies in the aftermath of 2008, believing in the central role of the Fed as 'lender of last resort' in a crisis. But he became a lone dissenting voice later, and up until his retirement from the Fed in 2011. He was unfairly lumped with the inflation doom-mongers and cranks in the simplistic media coverage, but his concerns at the time were more subtle than inflation. The story behind his thinking illustrates the wisdom in his concerns.

The reason for Hoenig's Fed voting rebellion and the authors views on Fed policy, are evocatively illustrated by Hoenig's former role in the Kansas Fed in the 1970s and 1980s, when he was at the coal face of Fed banking supervision. During the easy money late 1970s, assets including farm land were going up in value, and farmers and businessmen were confidently and aggressively taking on debt in an economic environment they thought they understood. Hoenig and his colleagues meanwhile were voicing concern to small banks on their extended portfolios of loans and mortgages, based on historically high asset valuations. But they were being treated as the kill-joy regulators getting in the way of legitimate profitable commerce.

The American economic ecosystem had settled itself around the North Star of low interest rates. Volcker moved the polestar overnight, and everything reoriented. A decade's worth of resource allocation would change”

Then in 1979 Fed Chair Paul Volcker famously started his tight monetary policy drive to crush inflation, changing the financial landscape dramatically. In Hoenig's region, farmland prices eventually dropped by 27 percent, interest rates on loans were rising fast, and a recession was not helping produce prices or the general economic sentiment. Higher up the financial food chain, local banks in the region, whose business was partly mortgages and farm loans, were experiencing high levels of defaults, trashing their liquidity and balance sheets. Hoenig and his colleagues were now in the position where they had to make the life or death decisions as to which small banks should be rescued by the Fed, and which must cease trading. 1600 US banks failed between 1980 and 1994. Hoenig experienced stress and much anger directed personally towards him, with all the people who had resisted pleas to be more conservative a few years before, now pleading for more time and more Fed loans to see them through the storm, as bankers tend to do. For Hoenig, going through this experience shaped his attitude to monetary policy, thereafter believing that to maintain loose conditions for an extended period would lead to financial behaviour by the population that took for granted this environment, and therefore store up trouble for when the easy conditions ended. He and his Fed colleagues had done their best to sort out the mess, but he also believed the Fed's monetary signals leading up to that point were a key part of the cause.

The change was wrenching. It played out very quickly in the Kansas City Federal Reserve's district. The bankers were caught totally off guard. The collapse of asset prices created a cascading effect within the banking system.”

Just like those Midwest US farmers, UK mortgage holders are now experiencing a painful monetary swing or snap-back to normality. One important metric to look at is the ratio between UK average yearly incomes and average house prices, which rose from around 1:6 to around 1:9 during the recent abnormal low interest rate era. There is a good argument to believe that with interest rates 'normalizing' at last, so this ratio needs to, and will, come back down. Like a businessman or accountant who gets an eye for for what the metrics or ratios of a healthy business should look like, so in economics one can get a sense that the ratios and magnitudes of economies are healthiest when they are following historically typical patterns. After all, even Adam Smith noted 250 years ago that when interest rates were low, land prices rose and vice versa. The rarely spoken truth of the present situation is that, unlike the Volcker inflation fight of the early 1980s in the US, interest rates today have actually only risen back to historically typical rates, and it is only the distorted high asset prices which turns this drama into a crisis for some.

Monetary policy operates with what they refer to as 'long and variable lags,'” Hoenig said later. … During the 1980s, Hoenig and his colleagues in Kansas City were left to sort out the long-term problems the Fed's short-term thinking created during the 1970s.”

One effect that this divergence in the housing market from a theoretical steady path causes, is a massive game of winners and losers in UK society. You or your parents could have gained hundreds of thousands in an equity windfall in the last few decades if property owners. Whether one can call upon the house-equity-funded 'bank of mum and dad' is the defining class divide of our times. Signs of winners cashing out can be seen on daytime TV, as baby-boomer couples look for holiday / retirement homes or boats or RV's. Meanwhile new mortgages and rents are crushingly high for those indirectly financing those winners.

The strongest takeaway from Thomas Hoenig's Kansas experience and this book, is the rather paternalist notion that central banks must not let the population and their asset markets get carried away by a prolonged environment of easy financial conditions, that will one day snap back.

From that point where most can agree, I move to more contentious questions and speculative thoughts! One could say that we should not wish away this burst of inflation, but that we had to have it at some point, and we should wish we had had it sooner, before asset values had risen so out of line? The insinuation of this book that all the later QE should not have been done, and that interest rates should have ignored unemployment targets and normalized anyway, for me is unrealistic, as it would have caused politically unacceptable unemployment and recessionary conditions. The pandemic showed that when forced into action, fiscal policy can juice employment and inflation more powerfully than QE. Recent history shows QE to have a weak transmission mechanism to the real economy, exhibiting its effects mostly on rising asset prices, which is exactly the distortion which adds to the pain mentioned above when interest rates normalize. Maybe the solution would have been to have had a form of QE which more directly entered the bank accounts of the spending population, rather than the bank accounts of those investing and speculating in the financial system? This could have thereby juiced the economy and provoked the normalizing of interest rates sooner, and not having had to wait for a pandemic and war? One thing however is as certain as ever, and that is that over 80 years since Keynes proposed the basics of macro economics, its still as messy and contentious as ever.

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