The scariest story I read over the holidays had nothing to do with winter wildfires, the COVID-flu combo or the threat of Russia invading Ukraine. It was Christopher Leonard’s superb profile in Politico of Thomas Hoenig, a retired central banker. Mr. Hoenig made a name for himself after the financial crisis of 2008, as one of the top members of the Federal Reserve who wouldn’t go along with then-Chairman Ben Bernanke’s efforts to float the economy on an ocean of money.
For this he was treated as a scaremonger, even a crank. But what if he was right?
The question is topical again because of the sudden jump in consumer prices — up by a whopping 6.8% for the year ending in November 2021 (or a still-dismaying 4.7% if you count only “core” inflation). Some mainstream economists, like Princeton’s Alan Blinder, still argue that the fundamental cause is “too much demand chasing too little supply” and that inflation will cool once pandemic-induced supply bottlenecks clear up.
Maybe that’s so, and we can all rest easy. But the people who have been telling us the inflation is “transitory” have been wrong so far. If they keep being wrong, the Fed will have little choice but to stop simply signaling its intentions and start sharply raising rates. To tame the last great inflation of the 1970s, the Fed Chair Paul Volcker raised rates to as high as 20%.
And that’s where Mr. Hoenig’s fears begin to look downright nightmarish.
That’s because of decisions made by the Fed more than a decade ago. Between 2008 and 2014, the Federal Reserve bought more than $3.5 trillion in federal securities from major banks to encourage lending and investment. “To put that in perspective,” Mr. Leonard writes, “it’s roughly triple the amount of money that the Fed created in its first 95 years of existence.” Even after this flood of money, the Fed kept interest rates low for a decade, and then pumped in $700 billion in the face of the pandemic.
Plenty of critics warned that all that money was ultimately bound to have inflationary effects. They were right — though, at least until recently, not in the way generally expected. Prices for consumer goods remained relatively stable.
But prices for assets, real and financial, soared, even after the Fed reversed course and began to reduce its holdings. Between 2011 and 2020, the average value for an acre of farmland rose by 37%, the median sales price for a house by 58%, and the Dow Jones industrial average by 147%. This was a bonanza for the savvy investor class, making it difficult for the Fed to ruin the party by raising rates. For others — savings account holders, wage-earners, renters, the young — the effects were less salutary.
Now we have an economy in which asset values keep going up because we expect them to keep going up, and in which easy money is creating speculative bubbles that seem obvious to anyone not living inside of them. Rivian Automotive, to take an example, is an electric-vehicle maker that has been losing money hand-over-fist while delivering, as of November, a grand total of 156 vehicles. That month, it went public with a market cap just shy of $100 billion, larger than Ford’s or GM’s.
Mr. Hoenig was around the last time something like this happened, in the 1970s, when easy money encouraged bankers to underwrite increasingly risky loans while relying on increasingly inflated assets, like farmland and oil wells, as collateral. That helped lead to 1,600 bank failures when the asset bubble burst after Mr. Volcker’s rate increases.
Mr. Hoenig’s warning is that we might soon be staring into the teeth of something similar. Or worse. Federal debt held by the public was roughly 24% of gross domestic product when Mr. Volcker became chair of the Fed. It was 96% in the third quarter of last year. Corporate debt of nonfinancial businesses — at around $11.4 trillion — is nearly twice what it was on the eve of the Great Recession.
If inflation persists, it won’t take much of a rate increase for the cost of servicing the debt to become ruinous for governments and businesses alike. Like an addict who can’t endure the agony of withdrawal, we could soon arrive at a moment when we will not be able to accept the price of taming inflation, and instead we’ll be tempted to inflate our way out of our debts. That won’t end well.
Even without a sharp rise in the cost of living, low rates didn’t end well politically. “Do you think that we would have had the political, shall we say turmoil, revolution, we had in 2016, had we not had this great divide created?” Mr. Hoenig asked Mr. Leonard. “Had we not had the effects of the zero interest rates that benefited some far more than others?”
Should general inflation come, that 2016 revolution will seem tame. Inflation, unchecked, has a bad way of becoming a father to political instability and extremism.
It could all still turn out all right. Inflation could moderate on its own; gentle interventions could do. But to read the profile of Mr. Hoenig is to feel the tingle of the hard, bitter, likely truth.
Bret Stephens is a columnist for The New York Times, where this originally appeared.