The lobby of the Federal Reserve Bank building here contains a money museum where a sign offers visitors "Free Money." It is an amusing anomaly, considering the views of the man in charge of the building.
The free money in the lobby consists of shredded currency in small plastic bags. The free money that distresses Tom Hoenig, in his 20th and final year as president of one of the Federal Reserve's 12 regional banks, is being pumped into the economy by two policies of the Federal Reserve in Washington — very low interest rates and a second "quantitative easing" (printing money).
As the global recovery gains strength, the prices of three things will rise — oil, food, and money. David Rosenberg of Gluskin Sheff in Toronto reports that in the last three months, 100 percent of the $55 billion increase in aggregate U.S. wages and salaries has been matched by increased grocery and gasoline prices. They are absorbing 22 percent of wages and salaries, a portion matched only twice in the last two decades — both times presaging recessions.
Under the $600 billion QE2, which ends in June, the Fed has been buying about 70 percent of the Treasury's new issues of debt. What interest rate might be required to attract buyers to fill the space left when the Fed withdraws from the market? Interest rates are the prices of money, and Hoenig says: "Tell me one product, one service, that trades well" — he means, is put to efficient use — "at a price of zero."
Hoenig notes that cheap money policies predated the recession: He says the real federal funds rate — after discounting inflation — was negative about 40 percent of the time in the 1970s and the 2000s. In 2003, he says, under Alan Greenspan, interest rates were reduced to 1 percent because unemployment was too high. It was only 6.3 percent. Today it is 8.8 percent in the aftermath of the housing bubble and financial recklessness fueled by virtually free money.
Last year was Hoenig's last as a voting member of the Federal Open Market Committee, which sets the money supply and interest rates. Eight times the committee voted to hold rates low; each time, Hoenig was the lone dissenter.
He was at home one Sunday morning when he received a phone call from an 85-year-old woman in Connecticut. She said she and her late husband had lived frugal lives so they could get by in retirement on interest from their savings. Such people are among the losers under low-interest policies that mock the virtue of saving.
The winners include the 20 percent of Americans who own 93 percent of the equities. One purpose of the policy of protracted rock-bottom interest rates is to stimulate credit-sensitive sectors of the economy, particularly housing. In January, for the sixth consecutive month, housing prices plunged, almost to the level at the trough of the recession in 2009.
Perhaps the primary purpose of low rates is to send money flooding into the stock market in search of higher returns. The resulting run-up of equities' values supposedly will produce a "wealth effect," making fortunate people feel even more flush, and hence eager to spend and invest.
Hoenig, an Iowa native, says the provinces have not cornered the market on provincialism. He warns "end the Fed" advocates to be careful what they wish for. The Fed will not go away; under "reform," regional banks such as his might. This, he says, would make the New York-Washington financial axis more powerful relative to "this part of the country."
Would, he asks, America be better off if it were more like Canada, with most credit controlled by five major banks? His answer is that America's innovative dynamism is related to the existence of thousands of community and regional banks attuned to local needs. He thinks the biggest threat to the economy is the existence of too-big-to-fail financial institutions:
"In 1999, the five largest U.S. banking organizations controlled $2.3 trillion in assets, or about 38 percent of all banking industry assets. Currently, Bank of America by itself . . . has the same level of assets — $2.3 trillion . . . and the top five now have 52 percent of all banking industry assets. . . . Creditors and uninsured depositors at too-big-to-fail organizations believe that there is almost no chance that they will have to take a loss."
With all this, could we ever get back to capitalism? "Not," he says, "in my lifetime."
George Will's email address is firstname.lastname@example.org.
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