The Price of Inflation, Now and in the Future

Published in The Wall Street Journal.

Your excellent editorial “Biden Has an Inflation Problem” (Aug. 12) points out that average real wages have fallen for seven months in a row. In other words, the Biden inflation has reduced the real wages of workers in every month that he has been in office. This confirms yet again that high inflation is a way of cutting wages by sneaky central-bank means.

This inflation has come as a surprise to the Federal Reserve, as it busily monetizes government debt, but it is no surprise at all. It reflects the most fundamental principle in economics: Nothing is free. You pay for monetizing government debt by taking money from the wage earners and robbing the savers.

Alex J. Pollock

R Street Institute

Expect Lower Credit Standards, More Risk From Biden Housing Authority

Published in The Wall Street Journal.

Fannie and Freddie will take orders from a ‘housing czar’ with an agenda for politicized lending.

Your editorial “A Conservative Court Awakening” (June 26) rightly says a new Biden administration Federal Housing Finance Agency (FHFA) director will “ease underwriting standards again to boost home-ownership.” But let us restate this more clearly: This director will reduce credit standards and increase risk once again to promote temporary home-ownership through low-credit-quality loans. This will revivify the notorious “originate and sell” model for such loans, so the lenders can stick the taxpayers with the credit risk. Systemic financial risk will rise.

When a regulator becomes a cheerleader, it is always bad news. Even more so in this case because the FHFA director will remain the conservator of Fannie Mae and Freddie Mac, with more power over its charges than a normal regulator. What a chance was missed by the Trump administration Treasury to designate Fannie and Freddie as the “systemically important financial institutions” they are. Then they would be subject to additional risk oversight by the Federal Reserve, instead of simply taking orders from a “housing czar” with an agenda for politicized lending.

Letter to the editor: Fed’s Inflation Genie May Deliver More Than Wanted

Published in The Wall Street Journal.

For the first four months of this year, the seasonally-adjusted consumer-price index is rising at an annualized rate of 6.2%. Without the seasonal adjustments, it is rising at 7.8%.

“The consumer-price index rose at a remarkable 4.2%,” says your editorial, “Powell Gets His Inflation Wish” (May 13). Remarkable, yes, but our current inflation problem is far worse than that 4.2%, which is bad enough. The real issue is what is happening in 2021. We need to realize that for the first four months of this year, the seasonally-adjusted consumer-price index is rising at an annual rate of 6.2%. Without the seasonal adjustments, it is rising at 7.8%. Meanwhile, house prices are inflating at 12%.

We are paying the inevitable price for the Federal Reserve’s monetization of government debt and mortgages. As for whether this is “transitory,” we may paraphrase J.M. Keynes: In the long run, everything is transitory. But now it is high time for the Fed to begin reducing its debt purchases, and to stop buying mortgages.

Letters to the Editor of Barron’s: Fed Distortion

Published in Barron’s.

Randall W. Forsyth’s column, “The Fed Might Start to Act Sooner to Head Off Housing Boom and Bust. What Could Happen,” (Up & Down Wall Street, May 21), is excellent, but he is too diplomatic when it comes to the Federal Reserve continuing to buy mortgages. Specifically, I’d rewrite two sentences.

1) “There seems little justification to stoke housing demand” should be, “There is no justification to stoke housing demand;” and 2) “The Fed might be exacerbating those problems” should be, “The Fed is exacerbating those problems.”

With the Fed’s postcrisis mortgage portfolio at $2.3 trillion (plus a lot of unamortized premium) and heading up, its distorting effects as the world’s biggest savings and loan are clear.

Inflation Is Here

Published by Barron’s.

Randall W. Forsyth (“Flood of Liquidity Is Sweetening Retirement for Stock Owners and Home Sellers,” Up & Down Wall Street, April 30) points out the rapid first-quarter growth in gross domestic product, final sales, and personal income, but oddly fails to mention that the consumer price index increased from December to March at an annualized rate of 6.8%. Inflation isn’t coming; it’s here.

It is intensely here in house prices, as he says, up in double digits (about 12%). Forsyth writes forthrightly: “The Fed keeps inflating that bubble by buying $40 billion of agency mortgage-backed securities…every month.” Yup. But why is the Federal Reserve still buying? Why is the Fed still monetizing mortgages when house prices are in runaway inflation? The answer is simple: It needs to stop.

Inflation Risk

Published in Barron’s.

To the Editor:

Regarding “Why—and How—Investors Should Gird for Inflation Risk” (The Economy, March 26), what the Federal Reserve says always reflects politics and its attempts to manipulate expectations. But being prepared for the risk of higher inflation, as Lisa Beilfuss suggests, is perfectly aligned with what the Fed is doing, namely printing money. As for the Fed’s forecasts, they are as unreliable as anybody else’s guesses about the future.

Financial Triangle

Published in Barron’s.

Henry Kaufman, as quoted by Randall W. Forsyth in “Where Wall Street’s ‘Dr. Doom’ Sees Danger Now” (Up & Down Wall Street, March 12), is so right that we have a “dangerous dependency on the Fed” and that “the central bank and the Treasury are ‘joined at the hip.’ ” Of course, a core mandate of every central bank is to finance, as needed, the government of which it is a part, although you won’t find this in the Federal Reserve’s public-relations materials. The close link of the Fed and the Treasury goes back to the Fed’s 1913 chartering act, which originally made the secretary of the Treasury automatically the chairman of the Federal Reserve Board.

But now, the joining at the hip is even tighter than Kaufman suggests, because it includes the mortgage market, too. With its $2.1 trillion and growing mortgage portfolio, the Fed owns about 20% of all residential mortgages. It buys mortgage securities with the guarantee of Fannie Mae and Freddie Mac; but with virtually no capital of their own, the value of Fannie and Freddie’s guarantees is completely dependent on the Treasury. Moreover, the Treasury is their principal owner.

Thus, the real joining at the hip is not only the Fed and the Treasury, but also the Fed and the Treasury and Fannie/Freddie—a gigantic government financial triangle.

The Coming Bailout of State Pension Plans

Published in The Wall Street Journal.

In “Prelude to a State Pension Bailout” (op-ed, March 1), Andrew C. Biggs is doubtless right that the coming bailout of hopelessly insolvent multiemployer pension plans will lead to further bailouts of other broke pension plans. These will be justified with the argument that the pensions were “promised”—but by whom? They weren’t promised by the taxpayers, only by the defaulting plans and a government insurance program that is itself insolvent. How very clever it was to set up the Pension Benefit Guaranty Corporation and promise it would never call on the taxpayers: This very same illusion created Fannie Mae and Freddie Mac and their subsequent bailout. The multiemployer pension plans are deeply in need of structural reform, and so are many public-employee pension plans, and so is the PBGC. If indeed, as Mr. Biggs argues, the political urge to bail them out is irresistible, the opportunity for reform thereby created should not be missed. The unquestionable governing principle must be that bailouts require reform: No reform, no bailout.

Given Enough Time

Published in Barron’s.

Randall W. Forsyth distorts Murphy’s celebrated law with a truncated version of it, writing “whatever can go wrong, will” (“Sometimes Things Can Go Right—and a Lot Did for the Stock Market Last Week,” Up & Down Wall Street, Oct. 11).

Although a common misquotation, this is an incomplete version. The full, correct, and much subtler statement of Murphy’s Law is, “Whatever can go wrong, will go wrong, given enough time.” It is with enough time that structural flaws in a system will necessarily emerge, and that financial vulnerabilities will burst from potential dangers to an actual bust. As properly stated, Murphy’s Law will doubtless prevail once again in finance, as in other domains.

Fund managers are the agents of shareholders

Published in the Financial Times.

“Large institutional shareholders, notably BlackRock, State Street and Vanguard, recognise that companies must serve broader social purposes,” writes Martin Lipton (Opinion, September 18). There is one big problem with this statement: these firms are not shareholders. They are mere agents for the real shareholders whose money is at risk. They are moreover agents that display all the conflicts of classic agency theory. Yet they go about calling themselves “shareholders”, pushing the personal political agendas of their executives.

What they should be doing is finding out what the real shareholders desire and voting shares accordingly as faithful agents, not pontificating about personal ideas, which are irrelevant as far as what shareholders want.

Greenland gambit finds echo in US frontier deals

Published in the Financial Times.

Theo Vermaelen’s ironic letter about the idea of purchasing Greenland (“Trump and Greenland: it’s a winner all around,” August 30) was fun, but ended with a serious point: “The current frontiers of countries are mainly the result of wars.” However, the frontiers of the United States were heavily influenced by purchases: the 1803 Louisiana Purchase of 827,000 square miles, the 1854 Gadsden Purchase of 30,000 square miles, and the 1867 Alaska Purchase of 586,000 square miles. In this context, one cannot help noticing similarities between Alaska and Greenland.

The golden 2% has created the modern world

Published in Financial Times.

Of course Vaclav Smil is correct that Moore’s Law-type growth rates of 35 per cent per year will not go on forever, however astonishing the record so far (“Infinite growth is a pipe dream”, August 9). But how about 2 per cent? Professor Smil turns up his nose at a growth rate of a mere 2 per cent real per capita per year. Yet that very 2 per cent continued over long times is the true miracle that has created the modern world. At 2 per cent compounded, in a century, people are on average seven times economically better off. So we ordinary people are seven times better off than our ancestors were as Woodrow Wilson et al negotiated the Treaty of Versailles in 1919.

This is amazing. Can we imagine that people in 2119 will again be on average seven times better off that we are today? That would be the result of the golden 2 per cent. Whether 2 per cent can continue indefinitely is a far more interesting question than whether 35 per cent can.

Power Struggle

Published by Barron’s.

To the Editor:

Discussing the tension between President Trump and Fed Chairman Powell, Steven Sears describes it as “this historically unusual relationship between two of the world’s most powerful people” (“Playing the Fed’s Next Rate Move,” July 11). But it’s not so unusual for there to be serious tension between the holders of these two high offices.

President Truman was greatly provoked when the Fed wanted to raise interest rates while he was fighting and financing the Korean War. He summoned the entire Federal Open Market Committee to the White House—and they came—to tell them what to do. But they didn’t follow his instructions. This dispute ended up with the resignation of the Fed chairman, Thomas McCabe. “McCabe was informed that his services were no longer satisfactory,” Truman later said.

President Lyndon Johnson was likewise made furious when Fed Chairman William McChesey Martin’s raised interest rates while Johnson was trying to finance both a war and big welfare programs. Johnson summoned Martin to his Texas ranch, where he pushed him around the living room, yelling in his face, “Boys are dying in Vietnam and Bill Martin doesn’t care!”

The pressure brought by President Nixon on Fed Chairman Arthur Burns is legendary. Said Nixon, “I respect [Burns’] independence. However, I hope that independently he will conclude that my views are the ones that should be followed.”

It’s hardly surprising that “two of the world’s most powerful people,” whoever holds those positions at the time, should occasionally clash.

Alex J. Pollock, R Street Institute, Washington, D.C.

Negative Interest Rates

Published in Barron’s.

In “The World Created by Upside-Down Interest Rates” (Current Yield, May 24), Jim Grant rightly observes how remarkable it is that the world’s monetary system has produced more than $10 trillion in debt with negative nominal interest rates. That would have been judged simply impossible by virtually everybody until it happened.

To understand this curious outcome, I believe we have to see it as deriving from a previous monetary event that also had no historical precedent: the world-turning-upside-down arrival of the whole global monetary system becoming based on pure fiat currencies—on the mere paper or accounting creations of central banks.

This system appeared in 1971—quite recently, historically speaking. About its prospects, Milton Friedman later wrote, “The ultimate consequences of this development are shrouded in uncertainty.” The consequences so far have included making central banks so powerful that they can render a huge swath of interest rates negative, a result certainly not foreseen.

How has the fiat system otherwise performed? Well, we have had financial crises in the 1970s, 1980s, 1990s, 2000s, and 2010s. Quite a record. The pure fiat currency, central-bank-trusting system might possibly be the least bad monetary system, but it is evidently far from perfect. Its further long-term consequences still remain “shrouded in uncertainty.” 

Echoes of the US savings and loan industry’s collapse

Published in the Financial Times.

Metro Bank has the problem so pointedly observed by the great Walter Bagehot in 1873: “Every banker knows that if he has to prove he is worthy of credit . . . in fact his credit is gone.”

Your editorial “Metro panic shows need for proactive regulation” (May 14) says “Metro’s loan book . . . is fully covered by customer deposits.” Of course, customer deposits are not inherently stable — they are inherently unstable. Their stability, as you suggest, is solely due to the guarantee provided by the government.

This fact, so humbling for bankers, has powerful effects, most strikingly shown by the collapse of the US savings and loan industry in the 1980s. Savings institutions that were irredeemably insolvent were nonetheless able to keep their deposits because they were guaranteed by a government deposit insurance fund. However, this fund, the Federal Savings and Loan Insurance Corporation, was publicly admitted to be itself broke! But the depositors correctly believed that behind it all the time was the US Treasury, as in fact it was. This allowed many insolvent S&Ls to keep funding disastrous speculations, which made the ultimate cost to the Treasury far bigger.

Inflation and the Fed

Published in Barron’s.

Forsyth suggests that a “‘complete financial externality’…would aptly describe the Great Financial Crisis of 2007-09.” I don’t think so. That crisis, like many others, was “endogenous,” as my old friend, Hy Minsky, used to say—reflecting the internal dynamics of interacting leverage, inflated asset prices, moral hazard, and risk in the financial system. Central banks are part of the system, and its internal interactions are not above the system in some celestial role. If you are prone to believe in “the control asserted by central banks over economies,” recall the hapless announcement by central banks that they had created the “Great Moderation,” which proved instead to be the Great Bubble. Widespread belief that central banks are in control may be another endogenous risk factor.

Asset Managers Should Not Vote Shares They Don’t Own

Published in The Wall Street Journal.

“Maybe it is time for the SEC to require index funds to poll their investors and vote their shares only as specifically directed,” say Phil Gramm and Michael Solon (“Enemies of the Economic Enlightenment,” op-ed, April 16). They are so right, except it is not “maybe,” it’s time, period.

Asset managers should not be able to vote the shares they do not own to pursue their political notions or business purposes. Instead, they should be able to vote only when instructed by the real owners. That means voting by the principals, not by the agents. In this way, the asset managers would be treated exactly like the broker-dealers who control huge numbers of shares registered in street name, but must ask the real owners how to vote. It is indeed high time for the SEC to fix this very troubling anomaly in corporate governance.

We can’t help feeling that we today are smarter

Published in the Financial Times.

Martin Wolf is certainly correct that “further financial crises are inevitable” (March 20). Let me add one more reason why this is so — another procyclical factor rooted in human nature. This is the intellectual egotism of the present time: the conviction we can’t help feeling that we are smarter than people in the past were, smarter than those old bankers, regulators, economists and politicians of past cycles, and that therefore we will make fewer mistakes. We aren’t and we won’t. The intellectual egotists of the future will condescendingly look back on us in their turn.

Zimbabwe Monetary Theory

Published in Barron’s.

A more instructive name for so-called Modern Monetary Theory is Zimbabwe Monetary Theory, or ZMT (“Do Budget Deficits Matter? Not to Today’s Left or Right,” Up & Down Wall Street, March 1).

It is hardly a new idea, The core issue, however, is not whether a currency is issued by fiat or instead is said to be tied to some other value. The real issue is the nature of governments and their eternal monetary temptation.

In the wake of the destruction of its old fiat currency under ZMT, Zimbabwe has not saved itself from renewed monetary debasement and confusion by trying to link to the U.S. dollar. Likewise, promising that the dollar was tied to gold under the Bretton Woods Agreement did not prevent the U.S. government from defaulting on its Bretton Woods commitments and feeding the great inflation of the 1970s.

The paradigm for government monetary behavior was perfectly explained by Max Winkler in his lively study of government defaults, Foreign Bonds: An Autopsy. In 1933, Winkler looked back a couple of millennia to a great story of Dionysius, the tyrant of Syracuse. Having gotten himself excessively in debt and being unable to pay, Dionysius ordered his subjects to turn in all their silver coins on pain of death. After collecting them, he had each one drachma coin restamped “two drachmas,” and then had no trouble paying off the debt. Dionysius, Winkler said, thereby became the father of currency devaluation. He also became the father of Zimbabwe Monetary Theory.

The end of ‘too big to fail’ remains difficult to picture

Published in the Financial Times.

If you buy shares of stock for $100 and they fall to $30, we say, “Oh well, that’s the stock market.” If you buy a bond for $100 and it ends up paying 20 cents on the dollar, we say, “Oh well, that’s the bond market.”

But if your deposits in big banks are going to pay 97 cents instead of par, that is a financial crisis, and the government must intervene to protect you.

That is why Simon Samuels is so right that “we are a long way from ending ‘too big to fail’” (“The ECB should resist the lure of bigger banks,” Jan. 31). As long as we insist that no one can lose money on bank deposits, too big to fail can never end and never will.