Doug Nolan
May 22, 2015
The Peterson Institute for International Economics this week held it’s sixth annual “Fiscal Summit,” a wide-ranging and critical discussion of issues facing our nation. I have highlighted comments from a panel discussion, “Paying for the Past: How Will Rising Interest Costs Affect Economic Growth?,” with former Fed governor Lawrence B. Lindsey, former Dallas Fed president Richard W. Fisher and former Fed chairman Alan Greenspan (moderated by Bloomberg’s Betty Liu).
Lawrence Lindsey: “We’re delaying a normalization of rates way, way beyond what is prudent.
We have a monetary policy that’s now in place that was adopted for the crisis conditions of 2008 and 2009. This summer we’re going to be getting the seventh year of this recovery. It’s been a lousy recovery, but it’s still the seventh year of a recovery. That is totally inappropriate.
The unemployment rate is essentially at what economists call “NAIRU” [Non-Accelerating Inflation Rate of Unemployment]… When I went to school, you’d be laughed out of the classroom if you said the right interest rate when unemployment rate was five four [5.4%] was zero - it was just the most preposterous thing you could imagine. Or that the Fed should have quintupled its balance sheet in five years. We’re at the point of absurdity. Maybe it made sense when you had a crisis. It does not make sense now. At some point what is going to happen - and this gets to my eight or nine cataclysmic number [on a scale of 1 to 10] - is that we’re going to get a series of bad numbers - a little higher inflation, higher average hourly earnings or whatever - and the market is suddenly going to say, “Oh my God, they are so far behind the curve that they will never catch up.” And the market is going to force an adjustment on the Fed that will be wrenching. That’s the cataclysmic outcome. If the Fed were to get a little bit ahead of the curve - or even maybe move a little bit closer to the curve - that’s the best we can hope for - we would mitigate that. We would phase into it gradually. And that’s why so much is at stake in the monetary policy that we adopt now…
“I used to think more highly of what they were going to do. And I’ve constantly been disappointed. So I certainly think they could mitigate it if we do very modest things now. I think the Fed will say, “Oh, we’re really serious.” When I talk to my clients, the Fed has almost no credibility when it comes to a sense that they will be able to stay on top of this ticking monetary bomb. Now, my clients are all making money. They are enjoying the party while it lasts. Nobody is complaining. That’s why things [the stock market] are going up. But they also know it will end. They don’t think the Fed is going to take it seriously. And so if you have an institution that’s lost credibility in the market, when the bad number comes in the market is going to take the Fed and the Treasury curve to task in a very painful way.”
Richard W. Fisher: “I may be the only FOMC member who would quote Van Morrison and his great song “Not Feeling it Anymore.” I just want to read you a couple lyrics: “When I was high at the party everything looked good. I was seeing through rose-colored glasses and not seeing the woods for the trees. I started out in normal operation but I just ended up in doubt.” I voted against QE3. There was a reason for it. First of all we were well on our way. In March 2009 the market started to take off. They’ve tripled…”
Alan Greenspan: “We don’t have the rest of the world out there all of the sudden saying “we’re doing far better than the United States and we will effectively succeed in moving you up.” The exchange rate tells us it’s not the case. Everyone is doing worse than we are. So we’ve got all sorts of problems which says that the sooner we come to grips with this [debt] problem - and we’re going to have to come to grips with it - or the markets will do it for us. And that is not going to be a very happy experience. The longer we wait… the more difficult it’s going to be to implement it. And there’s a presumption out there that central banks can do as they see fit. The ECB has got a problem in many respects more difficult than ours. Because if the Federal Reserve were ever to go bankrupt, we have the sovereign Credit of the United States standing behind it. But who stands behind the ECB. It’s got this other monetary transaction which has not been drawn upon, but some day it will be. And the question is if there’s a run on the European Central Bank, I’m not sure where they go. So when we talked this morning about all the problems that the United States has, we can match them abroad. And that is not a good message for the United States.”
Moderator Betty Liu: “When you see a chart like that [debt] and you see the trajectory, what do you do? How do you mitigate it?”
Lindsey: “Right now we’re artificially mitigating it through Fed purchases of bonds. That is not a sustainable proposition. So one of the things we should all be concerned about is that not only will we have to pay down that debt, but ultimately the Fed is going to have to dump the debt it now has onto the market. So there’s going to be a huge amount of supply coming on which is going to push up interest rates. We talk about 2060 and 2048 and things like that - just think about 2025. It the next President, if he or she serves two terms - will be submitting the 2025 budget. Now, interest costs, healthcare costs and Social Security will be 4.6% of GDP higher under current law than they are now in that budget if we do nothing - no increasing, nothing more generous. That’s the equivalent to a 20% across the board tax increase in all taxes. So the top tax rate would have to go from 40% to 48%. The Social Security tax rate would have to go from 15.3% to 18.3%. The corporate tax rate would have to go from 35% to 42% - just to hold things even with what’s automatically going to happen. Those are not the kind of taxes the economy can afford. So taxes are not the solution. In the end, we’re going to have to begin to attack the Social Security and healthcare cost problem and that’s going to be the ultimate way of holding down the interest costs in the debt.”
Fisher: “First, a little context: I went back and looked at what our total debt was as a nation the year that Alan Greenspan was born… In 1926, our total debt was $19.6 billion. I was born in 1949 and the total debt of the US government was $253 billion. Now if you add up the numbers - in terms of what’s held by the public and the intergovernmental holdings - we’re talking a number that’s pushing $18 Trillion. It does not include these unfunded liabilities of Medicare and Medicaid and Social Security. And also it does not include - which I believe it should - the ultimate obligation of these so-called called ‘agencies’ - Freddie, Fannie and Sallie Mae. So we’re talking about very big numbers. The real issue is what does interest do - and that chart shows - we’re going to get to a point… where interest eats up certainly as much as we spend on healthcare. If you look at the CBO’s [Congressional Budget Office] numbers and you project out forward not too far, interest and healthcare costs will be well over half the budget. In Pete’s [Peterson] opening letter… he points out that interest costs will exceed R&D, education and, very importantly, as Mike Bloomberg lectured us, infrastructure. So, we’ve put ourselves in a horrific position. And getting to the Federal Reserve - and I was part of that group, Alan [Greenspan] had exited a few years earlier - we had this huge rise while I was at the Fed from $7.7 Trillion to its current level of almost $18 Trillion. So that’s 2.5 times, a compound annual growth rate of 11% just over ten years… At some point, you have to pay the piper. The real issue is what happens when interest rates go up. CBO estimates have them just increasing gradually. Well, we’ve been suppressing the yield curve. Foreign buyers have been helping us suppress the yield curve. And I think this is the ticking time bomb of all.”
Greenspan: “We’re way underestimating our debt, as of now, largely because we are not including contingent liabilities… What is the probability, in today’s environment, that JPMorgan would be allowed to default? The answer is zero or less. Now that means that that whole balance sheet is a contingent liability. To be sure, that while it’s contingent there’s not interest payments. But ultimately that overhangs the structure, because we in so many different ways have guaranteed this, that and the other thing. It’s not only Fannie and Freddie, but it’s a whole series of financial institutions. And, regrettably, it’s also non-financial institutions. I was very much concerned when we started to guarantee everyone as being too big to fail. But at least it was in the financial area. As soon as we moved over into General Motors and various other non-financial organizations, I said what is the contingent liability of the United States… What the three of us are talking about, the path we are currently on is not going to be easily resolved. It’s going to be very difficult… The sooner we get to it the better. But I see no evidence that we’re moving in that direction.”
Lindsey: “It always ends this way. If you go back and you look at Rome. You look at the Ming Dynasty or you look at Zimbabwe - it always, always, always ends this way. And the question is how can you delay it… The end game we’re all talking about here is a very unpleasant one. It means that the financial arrangement that the state has created is no longer sustainable by society. And that’s how overly indebted societies end and they move on to a new type of arrangement. So it isn’t going to be a pretty change - if we get there. And that’s why it is so urgent that we act now. It is not just a matter of numbers. It’s a matter really of political liberty. Because the government will not voluntarily let itself go out of business. It will use all of its powers - I’m not talking about just our government but any government - will use all of its powers in order to fund itself… It isn’t hard to get the math to work for America to save itself - and that’s why I’m optimistic like my colleagues here that we could do it. But we’ve got to get on the wagon and get doing it soon because time is running out.”
My thoughts: The abhorrent dilemma facing our nation is becoming increasingly difficult to evade. As such, leading policy figures are becoming more outspoken – in some cases stunningly candid. And future readers of history will be left bewildered and appalled that key issues were in fact recognized yet policymakers lacked the fortitude to confront them.
The root cause of a complex predicament is actually rather uncomplicated: it’s called inflationism. And there’s a reason why I am not the least bit optimistic. Despite centuries of history, we’ve somehow bought into the fallacy that “money printing” can resolve structural issues (financial, economic and social). In the face of overwhelming contrary evidence, central bankers and their supporters have clung to the sophistry that they can raise prices levels – in the real economy and securities markets – and that such inflation supports system growth and stability. Central banks have overpromised and have been too content to feed fanciful notions of their omnipotence and overwhelming power. Progressively bolder “activist” central bankers were afforded way too much discretion to experiment. In the end, their inflationary policies primarily inflated asset prices and securities market speculative Bubbles. And each policy error – accommodating or, worse yet, orchestrating a new Bubble – invariably led to only bigger blunders. The greater the boom and bust the more outlandish the subsequent reflationary cycle and attendant Bubbles.
For today’s readers and for the reader in 2065, it is imperative to appreciate that the Fed (and global central bankers more generally) is today trapped. Borrowing from Larry Lindsey, “We’re at the point of absurdity.” Yet normalization from absurd rates and central bank monetization is indefinitely deferred because of fears of bursting Bubbles. The great danger of central bank controlled, market-based finance has come to fruition: central bankers see no alternative than to allow Bubbles to run wild. And unhinged markets will do what unsound markets do: go to self-reinforcing precarious excess.
The nature is unclear and the course always uncertain. The end game, however, is never in doubt. Inflationism is seductive – it sets an incredibly powerful trap. And it inevitably reaches the point of no return. If only the Fed would quickly mend its ways and begin normalizing rates. I very much wish it wasn’t too late. But these global Bubbles are not going to tolerate anything like normality.
Lawrence Lindsey: “We’re delaying a normalization of rates way, way beyond what is prudent.
We have a monetary policy that’s now in place that was adopted for the crisis conditions of 2008 and 2009. This summer we’re going to be getting the seventh year of this recovery. It’s been a lousy recovery, but it’s still the seventh year of a recovery. That is totally inappropriate.
The unemployment rate is essentially at what economists call “NAIRU” [Non-Accelerating Inflation Rate of Unemployment]… When I went to school, you’d be laughed out of the classroom if you said the right interest rate when unemployment rate was five four [5.4%] was zero - it was just the most preposterous thing you could imagine. Or that the Fed should have quintupled its balance sheet in five years. We’re at the point of absurdity. Maybe it made sense when you had a crisis. It does not make sense now. At some point what is going to happen - and this gets to my eight or nine cataclysmic number [on a scale of 1 to 10] - is that we’re going to get a series of bad numbers - a little higher inflation, higher average hourly earnings or whatever - and the market is suddenly going to say, “Oh my God, they are so far behind the curve that they will never catch up.” And the market is going to force an adjustment on the Fed that will be wrenching. That’s the cataclysmic outcome. If the Fed were to get a little bit ahead of the curve - or even maybe move a little bit closer to the curve - that’s the best we can hope for - we would mitigate that. We would phase into it gradually. And that’s why so much is at stake in the monetary policy that we adopt now…
“I used to think more highly of what they were going to do. And I’ve constantly been disappointed. So I certainly think they could mitigate it if we do very modest things now. I think the Fed will say, “Oh, we’re really serious.” When I talk to my clients, the Fed has almost no credibility when it comes to a sense that they will be able to stay on top of this ticking monetary bomb. Now, my clients are all making money. They are enjoying the party while it lasts. Nobody is complaining. That’s why things [the stock market] are going up. But they also know it will end. They don’t think the Fed is going to take it seriously. And so if you have an institution that’s lost credibility in the market, when the bad number comes in the market is going to take the Fed and the Treasury curve to task in a very painful way.”
Richard W. Fisher: “I may be the only FOMC member who would quote Van Morrison and his great song “Not Feeling it Anymore.” I just want to read you a couple lyrics: “When I was high at the party everything looked good. I was seeing through rose-colored glasses and not seeing the woods for the trees. I started out in normal operation but I just ended up in doubt.” I voted against QE3. There was a reason for it. First of all we were well on our way. In March 2009 the market started to take off. They’ve tripled…”
Alan Greenspan: “We don’t have the rest of the world out there all of the sudden saying “we’re doing far better than the United States and we will effectively succeed in moving you up.” The exchange rate tells us it’s not the case. Everyone is doing worse than we are. So we’ve got all sorts of problems which says that the sooner we come to grips with this [debt] problem - and we’re going to have to come to grips with it - or the markets will do it for us. And that is not going to be a very happy experience. The longer we wait… the more difficult it’s going to be to implement it. And there’s a presumption out there that central banks can do as they see fit. The ECB has got a problem in many respects more difficult than ours. Because if the Federal Reserve were ever to go bankrupt, we have the sovereign Credit of the United States standing behind it. But who stands behind the ECB. It’s got this other monetary transaction which has not been drawn upon, but some day it will be. And the question is if there’s a run on the European Central Bank, I’m not sure where they go. So when we talked this morning about all the problems that the United States has, we can match them abroad. And that is not a good message for the United States.”
Moderator Betty Liu: “When you see a chart like that [debt] and you see the trajectory, what do you do? How do you mitigate it?”
Lindsey: “Right now we’re artificially mitigating it through Fed purchases of bonds. That is not a sustainable proposition. So one of the things we should all be concerned about is that not only will we have to pay down that debt, but ultimately the Fed is going to have to dump the debt it now has onto the market. So there’s going to be a huge amount of supply coming on which is going to push up interest rates. We talk about 2060 and 2048 and things like that - just think about 2025. It the next President, if he or she serves two terms - will be submitting the 2025 budget. Now, interest costs, healthcare costs and Social Security will be 4.6% of GDP higher under current law than they are now in that budget if we do nothing - no increasing, nothing more generous. That’s the equivalent to a 20% across the board tax increase in all taxes. So the top tax rate would have to go from 40% to 48%. The Social Security tax rate would have to go from 15.3% to 18.3%. The corporate tax rate would have to go from 35% to 42% - just to hold things even with what’s automatically going to happen. Those are not the kind of taxes the economy can afford. So taxes are not the solution. In the end, we’re going to have to begin to attack the Social Security and healthcare cost problem and that’s going to be the ultimate way of holding down the interest costs in the debt.”
Fisher: “First, a little context: I went back and looked at what our total debt was as a nation the year that Alan Greenspan was born… In 1926, our total debt was $19.6 billion. I was born in 1949 and the total debt of the US government was $253 billion. Now if you add up the numbers - in terms of what’s held by the public and the intergovernmental holdings - we’re talking a number that’s pushing $18 Trillion. It does not include these unfunded liabilities of Medicare and Medicaid and Social Security. And also it does not include - which I believe it should - the ultimate obligation of these so-called called ‘agencies’ - Freddie, Fannie and Sallie Mae. So we’re talking about very big numbers. The real issue is what does interest do - and that chart shows - we’re going to get to a point… where interest eats up certainly as much as we spend on healthcare. If you look at the CBO’s [Congressional Budget Office] numbers and you project out forward not too far, interest and healthcare costs will be well over half the budget. In Pete’s [Peterson] opening letter… he points out that interest costs will exceed R&D, education and, very importantly, as Mike Bloomberg lectured us, infrastructure. So, we’ve put ourselves in a horrific position. And getting to the Federal Reserve - and I was part of that group, Alan [Greenspan] had exited a few years earlier - we had this huge rise while I was at the Fed from $7.7 Trillion to its current level of almost $18 Trillion. So that’s 2.5 times, a compound annual growth rate of 11% just over ten years… At some point, you have to pay the piper. The real issue is what happens when interest rates go up. CBO estimates have them just increasing gradually. Well, we’ve been suppressing the yield curve. Foreign buyers have been helping us suppress the yield curve. And I think this is the ticking time bomb of all.”
Greenspan: “We’re way underestimating our debt, as of now, largely because we are not including contingent liabilities… What is the probability, in today’s environment, that JPMorgan would be allowed to default? The answer is zero or less. Now that means that that whole balance sheet is a contingent liability. To be sure, that while it’s contingent there’s not interest payments. But ultimately that overhangs the structure, because we in so many different ways have guaranteed this, that and the other thing. It’s not only Fannie and Freddie, but it’s a whole series of financial institutions. And, regrettably, it’s also non-financial institutions. I was very much concerned when we started to guarantee everyone as being too big to fail. But at least it was in the financial area. As soon as we moved over into General Motors and various other non-financial organizations, I said what is the contingent liability of the United States… What the three of us are talking about, the path we are currently on is not going to be easily resolved. It’s going to be very difficult… The sooner we get to it the better. But I see no evidence that we’re moving in that direction.”
Lindsey: “It always ends this way. If you go back and you look at Rome. You look at the Ming Dynasty or you look at Zimbabwe - it always, always, always ends this way. And the question is how can you delay it… The end game we’re all talking about here is a very unpleasant one. It means that the financial arrangement that the state has created is no longer sustainable by society. And that’s how overly indebted societies end and they move on to a new type of arrangement. So it isn’t going to be a pretty change - if we get there. And that’s why it is so urgent that we act now. It is not just a matter of numbers. It’s a matter really of political liberty. Because the government will not voluntarily let itself go out of business. It will use all of its powers - I’m not talking about just our government but any government - will use all of its powers in order to fund itself… It isn’t hard to get the math to work for America to save itself - and that’s why I’m optimistic like my colleagues here that we could do it. But we’ve got to get on the wagon and get doing it soon because time is running out.”
My thoughts: The abhorrent dilemma facing our nation is becoming increasingly difficult to evade. As such, leading policy figures are becoming more outspoken – in some cases stunningly candid. And future readers of history will be left bewildered and appalled that key issues were in fact recognized yet policymakers lacked the fortitude to confront them.
The root cause of a complex predicament is actually rather uncomplicated: it’s called inflationism. And there’s a reason why I am not the least bit optimistic. Despite centuries of history, we’ve somehow bought into the fallacy that “money printing” can resolve structural issues (financial, economic and social). In the face of overwhelming contrary evidence, central bankers and their supporters have clung to the sophistry that they can raise prices levels – in the real economy and securities markets – and that such inflation supports system growth and stability. Central banks have overpromised and have been too content to feed fanciful notions of their omnipotence and overwhelming power. Progressively bolder “activist” central bankers were afforded way too much discretion to experiment. In the end, their inflationary policies primarily inflated asset prices and securities market speculative Bubbles. And each policy error – accommodating or, worse yet, orchestrating a new Bubble – invariably led to only bigger blunders. The greater the boom and bust the more outlandish the subsequent reflationary cycle and attendant Bubbles.
For today’s readers and for the reader in 2065, it is imperative to appreciate that the Fed (and global central bankers more generally) is today trapped. Borrowing from Larry Lindsey, “We’re at the point of absurdity.” Yet normalization from absurd rates and central bank monetization is indefinitely deferred because of fears of bursting Bubbles. The great danger of central bank controlled, market-based finance has come to fruition: central bankers see no alternative than to allow Bubbles to run wild. And unhinged markets will do what unsound markets do: go to self-reinforcing precarious excess.
The nature is unclear and the course always uncertain. The end game, however, is never in doubt. Inflationism is seductive – it sets an incredibly powerful trap. And it inevitably reaches the point of no return. If only the Fed would quickly mend its ways and begin normalizing rates. I very much wish it wasn’t too late. But these global Bubbles are not going to tolerate anything like normality.
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