The Magazine

It’s the Money, Stupid

Papering over our economic problems.

Oct 18, 2010, Vol. 16, No. 05 • By JEFFREY BELL and SEAN FIELER
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Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, is the only significant public official on record in opposition to the easy-money, zero-interest-rate monetary policy being pursued by Fed chairman Ben Bernanke. So there were multiple layers of irony when Hoenig journeyed to Lenexa, Kansas, on September 23 to deliver a dinner speech to the Hope for America Coalition, a local affiliate of the Tea Party movement.

It’s the Money, Stupid

According to Bloomberg Business Week, a Kansas-based Tea Party leader named Steve Shute praised Hoenig for his willingness to go “toe-to-toe with Ben Bernanke and the Boston-New York-Washington-San Francisco elite axis at the Fed.” He added that most members of that day’s dinner audience “believe the Federal Reserve should be abolished,” on the ground that it is “helping to destroy the country.”

Two days earlier, at the most recent meeting in Washington of the Federal Open Market Committee (FOMC), Hoenig had cast his vote against Bernanke’s latest easy-money scheme, which sets the stage for another round of “quantitative easing,” a reflection in turn of the fact that for almost two years, the short-term interest rate target controlled by the FOMC has been as low as it could possibly be, yet the U.S. economy is still stagnant.

It was Hoenig’s sixth consecutive FOMC meeting at which he cast the only vote against Bernanke’s policy. But the December FOMC meeting will be the last of his long career. He then rotates off the FOMC and in September 2011 reaches the mandatory retirement age of 65, so Team Bernanke can expect to face even less questioning of its policy—particularly given the current complacent state of the Republican party.

At the moment, Republican leaders and policy elites are advancing exclusively fiscal solutions that address only the government response to the economic crisis and not the crisis itself. Fiscal deficits did not create the crisis, and reducing deficits won’t put our economy on a stable footing. From its inception in 2007 right up to the present, the crisis derived from the interaction between excessive investment leverage and dysfunctional interest-rate policy—in other words, a predominantly monetary phenomenon, albeit one that has had grave fiscal consequences. 

As long as the GOP enjoys the luxury of being the only alternative to Barack Obama and the Democrats, the party is understandably reluctant to delve into the murky depths of monetary policy. But after November 2, the Republicans’ role will change. They could do worse than pay attention to the only public official, elected or unelected, who is speaking out against current monetary policy, telling anyone who will listen—including an increasingly impatient Tea Party movement—that the root of the crisis is monetary. 

Shortly after the fifth of his six “No” votes at the FOMC meeting of August 10, Hoenig delivered a speech in Lincoln, Nebraska, that explains in considerable detail the thinking behind his stubborn and lonely dissents. He recalls being on the FOMC in the third quarter of 2003, when (with strong urging from the most influential new George W. Bush appointee, governor Ben Bernanke) the Alan Greenspan Fed cut short-term interest rates to 1 percent—during a quarter, it turned out, when the economy was growing at nearly a 7 percent annual rate. The Fed then left rates at 1 percent for several months, even after it had become evident that the economy was taking off in the wake of the 2003 Bush tax cuts. This excessive loosening, Hoenig argues, allowed credit to explode and “set the stage for one of the worst economic crises since the Great Depression.” 

Hoenig also believes that a milder but similar overeasing by the Green-span FOMC triggered significant dislocation a decade earlier, in the 1990s. In his review of the ominously escalating pattern in the financial crises as well as in Fed policy responses, Hoenig raises the possibility that the worst train wreck of the dying paper-dollar system may still lie ahead. Summoning his strongest language to date, Hoenig condemns as a “dangerous gamble” the Bernanke FOMC’s decision to pursue a zero-interest-rate target for months, perhaps even years beyond its appropriate time. If zero interest rates constitute a dangerous gamble, the Fed’s ongoing public campaign for additional quantitative easing must have him terrified.

It’s not that no one has noticed the policy shipwreck. But Bernanke has remained immune to criticism even from conservative inflation hawks because they can’t articulate what they would have done differently. Substantive criticism needs to extend beyond Bernanke and dissect the nature of the paper monetary system. Conservatives’ inability to offer a systemic critique, despite the fact that the paper standard is in the process of breaking down, shows the extent to which the right has been coopted by the idea that the monetary authorities should micromanage the economy. 

In a sense this is not surprising, since it was the iconic Milton Friedman who helped convince Richard Nixon to suspend gold convertibility and float the dollar on August 15, 1971, leaving the Fed with full discretion to intervene in the economy to smooth out business cycles. Friedman deserves enormous credit for bringing the conservative movement and even many nonconservatives to embrace free-market theory, especially deregulation, at a time when it wasn’t in vogue. But unfortunately his long shadow extends to include his quasi-Keynesian belief that the Fed should engage in economic planning. 

The awkward truth is that conservatives have grown to rely on the Fed to right the economy in a recession. After all, monetary fine-tuning can soften the blows of economic turbulence. For two decades, Republicans cheered on one of their own, Alan Greenspan, in this endeavor. President George H.W. Bush even begged Greenspan (unsuccessfully) to further cut interest rates as the economy pulled out of the 1990-91 recession.

But this dependence on monetary policy to smooth out the business cycle has proven short-sighted. Easing the downside of recessions comes with a huge cost—the pileup of debt, which opens the door to riskier financial behavior and more traumatic crises. Consider the year Hoenig singled out, 2003, when the Fed brought the Fed funds rate down to 1 percent on its exaggerated fear of deflation. The housing bubble that grew out of this easy-money policy burst with consequences no one from Greenspan on down ever imagined. And the Fed is still trying to figure out how the economy will emerge from that catastrophe. 

Unfortunately for would-be incrementalists, there is no viable way to maintain the Fed’s current role as guarantor of short-term financial stability and still reform the paper money system so as to remove its tendency toward the unsustainable accumulation of debt. For the paper money system that the Fed manages not only encourages debt, the system is debt. A newly issued dollar is in fact a form of government-issued debt whose only value comes from its mandated ability to pay off existing dollar-denominated debts. In this system, more debt will always be the painless short-term cure for the general problem of overindebtedness, even though more debt is an insane long-run response to the problem of too much debt. 

The self-perpetuating feature that has kept this perverse system alive is the dollar’s position as the world’s reserve currency. Before the dollar assumed this role between the two world wars, gold—something of independent value and no particular country’s liability—was used to settle international payments between central banks and composed their primary reserve asset. But with the dollar performing those functions, its oversupply has often been absorbed abroad. So Bernanke and his predecessors in the paper-dollar era have been able to print a lot of new dollars, over time inevitably driving down the global value of the dollar, without necessarily generating domestic inflation. That is the enabler of, among other things, relatively painless federal budget deficits. For a red-ink-hemorrhaging Greece or California, the specter of default is always on or near the table. For Bernanke and Congress, colossal deficits are just another day at the office.

Republicans, far from broaching this unwelcome subject, have correctly concluded they need say little new to achieve a huge comeback in Congress, given the electorate’s mounting dislike of Obama’s European-style paternalistic elitism. The challenge (and danger) for Republicans will come after the November election, particularly if they regain control of one or both houses of Congress and find themselves in need of a legislative agenda to send, or attempt to send, to the desk of President Obama for his signature or veto. 

By focusing solely on fiscal policy Republicans are setting themselves an impossible task. They don’t seem to have grasped the extent to which our debt-driven monetary system enables (and therefore encourages) irresponsible fiscal policy. As was true under President George W. Bush, Republicans will be operating in a monetary environment that precludes the possibility that the federal government can ever run out of money to spend, which makes it virtually impossible to control spending. 

Instead of praying that the Republicans will not fall victim to the same pressures to spend as everyone else who has served in Congress since the dollar was unmoored from gold, we must limit the power of the federal government in a way that is consistent with the reality that most elected officials, most of the time, act out of self-interest rather than in the public interest. As the past four decades have shown, our system of limited government cannot include an institutional printing press that stands ready to absorb any unwanted government issuance of debt.

That the party ostensibly in favor of limited government has left Hoenig, a reformed Keynesian, to sound the alarm is worrisome. To be effective, the Republicans will now need to show the same courage Hoenig is demonstrating by his willingness to attack his longtime central banking colleagues at Tea Party events. This courage will come only once Republicans realize, as Hoenig already does, the dangerous game the Fed is playing: calling into greater and greater question the currency by which economic values are measured and on which our financial security depends. 

But embracing Hoenig’s critique of the Fed will not be enough. Republicans must go a step further. The debt-driven global monetary system inadvertently started 39 years ago by Nixon is both opaque and dysfunctional. Not a single official any longer seems to understand it, with the possible exception of one regional Fed president, a 64-year-old man who after receiving his doctorate in economics from Iowa State in 1973 went to work at the Kansas City Fed and has worked there ever since. And even Hoenig, in 2003, voted in favor of the policy that he now rightly criticizes.

Conservatives should take this opportunity to swear off the paper dollar standard and monetary micromanagement for good. This needed catharsis will allow the founding republican principles of limited government and human fallibility to inform our monetary policy. As always, the world is looking to the United States for leadership. If we do not begin to return to the simple, transparent workings of the international gold standard, where the world’s final money once again is something of independent value, the future not just of money but of global capitalism itself is likely to be cast into even greater doubt than we’ve seen so far.

Sean Fieler and Jeffrey Bell are chairman and policy director of the American Principles Project, a Washington-based advocacy group.


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