Banking on KC – Thomas Hoenig, former KC Fed President
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Kelly Scanlon:
Welcome to Banking on KC. I'm your host, Kelly Scanlon. Thank you for joining us. With us on this episode is Thomas Hoenig, the current Senior Fellow of the Mercatus Center, and he's the former president of the Federal Reserve Bank of Kansas City and the former vice chair of the FDIC. And today he's here with us to offer insights into our current economic situation. Thanks for joining us, Tom.
Tom Hoenig:
Glad to be with you, Kelly. It's a pleasure.
Kelly Scanlon:
Let's talk about interest rates. It's a topic that is a matter of an intense focus right now. During your tenure, you are known for having a cautious stance on interest rates. So can you elaborate why you have concerns about prolonged low interest rates and their impact on economic stability and inflation?
Tom Hoenig:
Sure. Well, first of all, I understand the role of interest rates and I think people associate low interest rates with prosperity rather than inflation. And I think sometimes they get that confused. And if you leave interest rates too low for too long, you invite inflation, which we had here recently at 9%. So one of the things that I've pointed out in my earlier career was history, and that is when you extend and force, what I call suppressed interest rates artificially, the Federal Reserve and the expectation you're going to stimulate the economy, you also cause the effect of those to be other than what you intended. You invite the, what I call unintended consequences from too low, too long. And so that's what was going on. During the great financial crisis, we started that. The Federal Reserve brought interest rates to zero. They began massively to print money, that is create money. And in doing so, they initially created significant asset inflation. Now that may not sound bad. They were saying consumer inflation was still very low, but the fact of the matter is asset inflation is harmful.
Kelly Scanlon:
When you talk about asset inflation, are you talking about the cost of housing and things like that?
Tom Hoenig:
Yes. Housing for sure. And we saw since 2007, housing has more than doubled in price and fewer people can afford it. We've seen the stock market expand enormously. The effect is uneven on the American public. If you're an asset holder, if you're in the stock market, you're a winner. If you're a wage earner and inflation increases and productivity doesn't increase, you are a loser. So you reallocate wealth within the economy, favoring debtor and the speculator over the saver over time. And that of course has harmful effects on the long run growth of your economy.
And so my point was, yes, lower them during the crisis, the immediate crisis which we did both in the great financial crisis and with Covid, but then normalize quickly as soon as you can so that you don't invite these unintended consequences into the picture. And that's the lesson we tend not to learn. We wait until the inflation is 9%, we wait until houses are more than doubled and then we say, oh my goodness, what are we going to do about that? And of course that process is slow and daunting as we're finding, and therefore I say let's avoid it in the first place.
Kelly Scanlon:
Right there with inflation, labor market is in the news. Reflecting on your experience at the Federal Reserve, how do you assess the relationship between today's labor market conditions and monetary policy decisions? What should current policymakers be watching?
Tom Hoenig:
Well, certainly the labor market after Covid has improved markedly. And even with the adjustments that the Fed has made, the unemployment rate is 4.1%. We've had very good job growth in this country. Those are all favorable things and I think the Fed should be proud of that. And in fact, the problem with this in the long term is what about the future? And there is going to be growing pressure on the Fed to lower rates with a 50 basis point reduction that we recently had. Immediately the market say oh, we're going to have at least another 100 basis points, at least, maybe even more than that. We've got to have that to keep the economy going. And that's what I call kind of a presumption. So what we really need to do and what the Fed needs to do is be very cautious in how much they lower interest rates.
Some are saying they have to be at least 3%. If you look at it more, I think systematically when they finally get inflation down, 4% is probably where they ought to stop. And that will give the markets time to clear, time to adjust to this new rate and not invite future inflation and future crisis as we go forward from here. And I'm hoping that the Central Bank and the Congress for that matter, are thinking further ahead than just six or seven months from now or nine months from now. Let's think of the long run. And in that context, we need to be much more cautious in our choices.
Kelly Scanlon:
Do you think we're headed towards a soft landing that Powell and the Fed had been trying to steer us toward? Or is recession still a strong possibility?
Tom Hoenig:
Well, certainly I like everyone else, hopes for a soft landing. I think we're going to find out because one of the things that we've learned from history in the 1970s, we experienced episodes like currently. We had inflation. The Federal Reserve raised rates, inflation came back down, they lowered rates in anticipation of inflation coming down further. And instead when they lowered the rates, they re-invited inflation. So that question is still out there. And so that's why I say they should be cautious. I was myself not overly surprised by the 50 basis points, but a little bit surprised by the 50 basis points because I didn't think it was necessary. The economy the second quarter of this year was 3% growth. The third quarter was very strong. Even though people had some adjustments in the labor market, the labor market was still even then got as only as high as 4.2%. It's back down to 4.1%.
So I think we could have been a little more modest in our rate cut, but the Fed decided to go for it a little longer. And I think that is now set expectations, which the Fed will have to manage very carefully or there will be a lot of pressure for them to lower interest rates. And remember, the thing that people aren't talking about is the debt of the United States continues to increase at fairly significant levels and the Congress and the administration will expect the Federal Reserve to accommodate that increase and not allow interest rates to rise, which means they'll have to put more downward pressure on interest rates through their open market operations and their purchase of government securities. And that's a big question mark for the future that will affect long-term inflation and long-term economic activity. So they have a big job ahead.
Kelly Scanlon:
What are some of the major risks that we face if Congress doesn't act, if we continue to maintain a national debt that's as high as it is or perhaps even higher?
Tom Hoenig:
Well, I think it's pretty ominous as far as the outlook goes and long-term inflation and long-term, the distribution of wealth. For example, since 2010, all right, when the Fed started its massive quantitative easing program, the debt level in the United States has increased from about 11, $12 trillion to over $35 trillion. And that's a very short period of time for that growth in our national debt. And the Fed's balance sheet over that period has increased from less than a trillion dollars to $9 trillion. And as of suppressed interest rates over that period, we've seen the asset inflation that I talked about grow and finally price inflation. So let's look ahead and let's use Congress's own projections by their congressional budget office. They are projecting that if we stay on our current path, that is current spending laws, then our national debt will grow to over $50 trillion over the next decade. $50 trillion.
From $35 trillion now. That's the least it will grow based on current law. If they renew programs and tax cuts, it'll be greater than that. So that is an enormous increase. And with that, they say that the debt to our national income, which is now 120% of our national income, it was far less than 100% just a decade ago. It will continue to grow depending on how much inflation there is. And the most important thing about that is our interest on our debt alone is now close to a trillion dollars larger than our defense budget. That means that we will have a national debt that is growing quickly, interest on the debt is growing, more of a national income has to go through it. And what that means, and this is the most important part, is that the growth and real wealth, a real national income will slow from an average of 2.2%, which is fairly modest today to less than 1.8%.
Now think about what that means in terms of real wealth within our country. It means we are giving up more than a trillion dollars of real wealth for our country. That means the pie is smaller, it'll have to be divided up, and of course the asset owners will be the winners and we will redistribute wealth even more. And the implications of that for social unrest I think is pretty dramatic. So it's not something that you just think about and put away, it's something you have to think about and a policymaker has to begin to do something about. And that's the challenge for the Congress and I think for the Federal Reserve going forward, and it's not an easy challenge. It will require difficult decisions. And the most important thing, putting the country first and that I think rather than short-term party rule or party goals or party conflicts, but national interest first.
Kelly Scanlon:
You talk about asset holders, particularly the stock market and as we know it's been breaking records right and left the last several weeks closing at all time highs many times this year. The Dow in particular is up about 10,000 points over its lowest close earlier this year. So what's your take on that? Is it overheated? Is it defying other economic indicators?
Tom Hoenig:
Well, I think it reflects the market's confidence that the Federal Reserve will keep interest rates from rising too long. And remember, the stock right now is more of a financial asset. You lower interest rates, it tends to increase in value. So the Fed has in fact lowered interest rates and the expectation is they will lower it more. And over the last year, and this is I think important, over the last year, the Federal Reserve itself has indicated it is a one-way bet. They thought they were going to lower interest rates last December, inflation got in the way temporarily, but they made it very clear that yes, they were going to hold for now, but they would decrease interest. That makes it a one-way bet. So if you're a speculator, you go long and so you buy stocks. I don't blame them, I would do it and you win.
But at what long-term cost? So we now have in a sense an asset bubble. If inflation, I don't know that it will, but if it does re-erect itself as the debt grows, as more pressure is put on the Federal Reserve to print money to buy that debt, that is to create money to buy that debt. The long end will continue to rise, asset values will rise, and there'll be intense pressure on the Fed not to raise interest rates. That means we risk re-inviting inflation, not only asset inflation, but price inflation in the future, which I think is a real risk given our history. And I keep pointing people to the 70s where we made those mistakes. So let's think about it. I tell policymakers and think ahead more than six months.
Kelly Scanlon:
We keep talking about the asset inflation. We've talked about the stock market, but where do you see real estate headed?
Tom Hoenig:
Well, I think number one, the real estate market itself is probably headed up. Now if you're in commercial real estate and office buildings that has seen the effects of Covid, seen the effects of how we work. That's slowly reverting back to being in the office, of course, but that will take time. So that will be more of a troubled area for some time. We've seen some slowing in the industrial area, but in the housing market, it has been a very significant increase in prices.
And I think that's number one, because housing has rebounded more slowly than other areas, number one. So there is a housing shortage. Number two, interest rates while they've risen, haven't risen as much as people thought they would. So there is still affordable in the sense of the 6% interest versus the fact that housing prices have gone up so much. And so people are saying, well, if they're going to go up more or let's buy as I can. And that puts more upward pressure on housing prices themselves. And I expect that to continue, especially given the fact that the Federal Reserve has lowered interest rates and the anticipation that they will lower interest rates further. I think the housing market and the stock market are prime candidates for increased asset inflation.
Kelly Scanlon:
As inflationary pressures continue to affect the real estate market as you just suggested, what does the lack of affordable housing, people turning perhaps to rentals, which of course rents are going up too because of the demand, but what does that bode for long-term for the American economy? I mean, for the longest time there, everybody's dream so to speak, or goal is probably a better word, was to buy a house. That was a symbol of wealth in America. You had an asset as you keep saying. What happens?
Tom Hoenig:
Well, and people are aware of this. I mean the American dream, homeownership is a part of that. But it has been, I think, adversely affected by some of the Fed's actions and certainly by the government's actions that have caused asset prices to increase. But I would tell you the main issue right now is supply of housing. Right. So there are not enough houses out there. And because of that and because of lower interest rates, you've increased demand. So the housing issue requires attention to the supply factors. So there are housing restrictions, there are issues with building permits, there are areas that become more difficult to get permits to build on. That's really the issue. And I think that's where the Congress and others need to pay more attention.
Kelly Scanlon:
Some of the things that you just mentioned seem to point to perhaps an issue at the local government level with building permits and things like that.
Tom Hoenig:
Local government is extremely important in this area and understandably. So if you're a local government and you have people who have homes, they don't want new development going up and spoiling their view or changing the neighborhood or whatever it takes. And so they put more restrictions in place and they want to make sure that everything stays the same. Well, that's fine to a point, but to the extent that it limits housing around the United States, perhaps not as much in Kansas City, who knows. But certainly in other parts of the country, the local governments are restricting entry, especially on the West Coast and East Coast. And so that means housing is limited. So all can happen as the price goes up and lower interest rates, while helpful won't solve the problem. And I think subsidies will shift, but not really solve the housing problem,-
Kelly Scanlon:
Which is a shortage.
Tom Hoenig:
Which is a shortage of housing.
Kelly Scanlon:
Based on the trends that you've observed, some of the things we've talked about today, what are some of the potential challenges and some of the opportunities that you see for the US economy, especially in the short term?
Tom Hoenig:
Well, we've talked about many of the challenges, and so let me start with the opportunities. I think the United States still is, without question, the strongest industrial country in the world. I think it has a good investment environment for the most part. We talked about housing, not so much. But otherwise, we're a leader in technology and we are going to capitalize on that. We are also are very strong in manufacturing. Now not, some manufacturing, but the more sophisticated manufacturing. We have the technology, we have the skills. Those are real opportunities going forward for us. And I think if our Congress comes together, which is a big, if I understand, the opportunities I think are almost limitless. We talk about artificial intelligence, that's one area, but just investments in technology overall. Investments in sophisticated manufacturing are ours to win.
We are the envy of the world. So that I think is something that we have to be mindful of and keep in front of us in an optimistic tone. But in doing that, to me that says we have an opportunity then to address our challenges. We have an opportunity to address our national debt problem. We have an opportunity to provide a more stable environment for our employment growth in the future. And it means we have a opportunity to provide for more stable interest rates so that people can make good decisions about their future investments. Those are the opportunities to deal not only with winning but with addressing current problems so that we can win in the long run.
Kelly Scanlon:
You mentioned AI and technological advancements. How are technological advancements affecting monetary policy?
Tom Hoenig:
Well, I think it affects it in some ways in terms of the so-called transmission mechanism. If those technology is less interest-sensitive would mean the technology can go faster than the Fed anticipated. I think that may be its main benefit of allowing say, a decrease in interest rates to go through the economy more quickly rather than more slowly. The Fed has to acknowledge that, has to be prepared for it. And that's where its research I think needs to be focused. But I think therein lies what I call managing the monetary policy more successfully. Assuming that monetary policy understands that it cannot be the printing press for the government's spending and debt accumulation. That has to be taken away and they have to make that clear to Congress so that Congress acts more responsibly.
Kelly Scanlon:
So I've interviewed you a few times now and every time I've asked you the questions that I'm about to ask you, but it's been four years since the last time we talked, and I'm curious to see if your answers changed. You were the president of the Federal Reserve Bank of Kansas City for 20 years, and during that time you served both Democratic and Republican administrations. With a partisan mood of our country, which I was going to say today, but it's been a while now. What do you see as successful tactics for moving things forward economically, but also just as the country in general to be able to take advantage of those opportunities that you just described?
Tom Hoenig:
Very good question. The first thing in my mind is Congress does have to put his house in order. It is unfortunately dysfunctional. It needs to put the country first. Now I realize there are going to be differences. And so for example, as we address the debt, let's think about that. Some members think the only way to do it is to reduce spending. Other members think the only way to do it is to increase taxes. All right, so let's find out where there is a common ground we can find, compromise we're willing to make and address that problem in the best interest of the country. We're not doing that right now.
Now we have in the past. We've had a Republican Congress in the middle of the 90s with a Democratic administration. We actually were able to balance the budget, believe it or not, in four years. So it's number one doable, but you have to want to do it. The second thing is the Central Bank of the United States has to stick with its primary mission. It cannot be the market maker for the government's debt. It has to make that clear. Its mandate is clear, to promote a maximum employment, stable prices, and long-run moderate interest rates. I understand that mandate or those multiple mandates, but they require then that you don't use QE on an ongoing basis.
Kelly Scanlon:
Quantitative easing. Yeah.
Tom Hoenig:
Quantitative easing on an ongoing basis. Use it only in the emergencies, and then you take it out of practice and you make it clear to Congress, you're not the market maker for issuing debt. It's their responsibility and Treasury's. That means you put more pressure on them to act responsibly and to compromise and you do your job and let them do their job. And I think we'll all be better served for it in the long run. And that's really my message to them. Politics is always part of life and it affects the Fed, but you have to rise above that for the good of the nation.
Kelly Scanlon:
Tom, your answer really hasn't changed a whole lot. Maybe a few of the numbers, but it really has not changed. But yeah. No, thank you. We really appreciate you taking the time to come and provide some of these insights to us over and above what we hear in the media to get it straight from you. Really appreciate you taking the time to do that. Thank you.
Tom Hoenig:
My pleasure. And thank you for the opportunity.
Joe Close:
This is Joe Close, President of Country Club Bank. Thank you to Tom Honig for being our guest on this episode of Banking on KC. As a retired KC Fed chair, vice chair of the FDIC, early bank examiner, and current Senior Fellow of the Mercatus Center, Tom has amassed a lifetime of economic knowledge, which he applied to our current economic situation. Tom delved into the complexities of economic policies and their implications for stability and growth, discussing how monetary policy decisions can impact inflation, asset values, and overall economic climate. At Country Club Bank, we are grateful to Tom for sharing his insights and we are dedicated to supporting a robust local economy where businesses and individuals can prosper. Through our commitment to strong relationships and sustainable practices, we actively contribute to enhancing the financial well-being and prosperity of the Kansas City community. Thanks for tuning in this week. We're banking on you Kansas City. Country Club Bank member FDIC.