The Fed's Dissenter: Saying No to Easy Money

With the economy growing fitfully and jobs still scarce, the high priests of the Federal Reserve want to keep the country's cash spigots wide open — all except Thomas Hoenig. If he's right, he may become the prophet for a new age of American austerity

By David Von Drehle Sunday, Feb. 20, 2011
    • Photograph by Marco Grob for TIME

    Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, Mo.

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    But by keeping interest rates near zero indefinitely, the Fed is "asking savers to continue to subsidize borrowers," Hoenig says. "What incentive is there to save and invest?" This insight was gaining ground after the irrationally exuberant Alan Greenspan years at the Fed. The former chief issued a mea culpa for piling too much money onto the economic bonfire that led to the Great Recession. But the crash of 2008 was precisely the wrong time to shut off the fuel supply. Hoenig supported massive infusions of money to save the world economy from a replay of the Depression. Now he simply believes the time has come to start sobering up.

    Certainly, Hoenig's thrifty Midwestern sensibilities sound quaint to the central bankers in Washington and New York City who dominate the FOMC's deliberations. But he is adamant that his perspective is every bit as worthy as the view from Wall Street or from K Street or from the Princeton faculty club. "Provincialism," Hoenig observes, "is not unique to the provinces." He believes that the bad effects of easy money are already cropping up in the heartland. Hoenig's domain stretches across Oklahoma, Kansas, Nebraska, Wyoming, Colorado and parts of Missouri and New Mexico. Surveying those states, his economists find that the price of farmland is escalating wildly. "Agricultural land is appreciating almost weekly," he says. Energy prices are booming as well.

    There is more going on here than a simple rise in economic activity, Hoenig thinks. Rocketing land and energy prices are telltale signs, he says, of too much money sloshing around. "When you put this much liquidity into the system, it has to go somewhere." It won't go into savings as long as the Fed keeps interest rates near zero. So the money starts chasing assets with higher yields — like land, the once again booming stock market and energy (indeed, some savvy Wall Street investors believe quantitative easing is a major factor in the current run-up in oil prices). As more money joins the chase, asset prices rise and keep rising until ...

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    "This is how bubbles are formed," Hoenig says. He has seen it all before. A career employee of the Fed in Kansas City, Hoenig is the longest-serving district president, with more than 18 years in his post. Before reaching the top job, he helped mop up the damage from the oil-price bubble of the mid-1980s. A little bank in the 10th District, Penn Square Bank of Oklahoma City, went wild in that boom, packaging unsound loans and selling them to other banks — sound familiar? When the bubble burst, Penn Square helped drag down the once mighty Continental Illinois National Bank in Chicago.

    During his years as a regional Fed president, Hoenig has watched uncomfortably as the central bank began to play a larger and larger role in the public's perception of the economy. Monetary policy "came to be seen as the solution to more and more economic issues. It has been used to deal with one crisis after another: a stock-market crash [in 1987], a recession [in 1990-91], a bubble in high tech [which burst in 2000], the 9/11 attacks, the Iraq war, a financial meltdown. People came to feel that all you had to do was ease interest rates and everything would be fine. But that's what gives us these bubbles," Hoenig says.

    He knows that many people feel it's too soon to start tightening up on money when unemployment remains high and core inflation in the U.S. is low. As the joke goes, Hoenig has predicted eight of the past zero bouts of inflation. Maybe there's a reason he was all alone in his dissents. But he feels that his critics — notably Nobel laureate Paul Krugman, who has written that tighter money will "perpetuate mass unemployment" — overestimate the Fed's short-term ability to drive down unemployment, while underestimating the long-term damage of superlow interest rates.

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