Author Christopher Leonard is a journalist, not an economist. Not surprisingly,
the value of The Lords of Easy Money lies mostly in its behind-the-scenes accounts
of how monetary policy was made over the last twelve years and not in its laymans
theory of how the macroeconomy works or in its narrative macroeconomic history.
Nonetheless, from talking to practitioners, Leonard has gotten hold of an important
insight. Artificially cheap credit has encouraged and financed unsustainable
investment booms: Asset inflation was the force behind the dot-com crash of
2000, the housing market crash of 2008, and the unprecedented market crash of
2020 ... The Federal Reserve can stoke asset inflation when it keeps money too
cheap for too long (p. 54). Leonard draws no direct inspiration from Austrian
business cycle theory, and indirectly indicates that his own political views are those
of a New Deal Democrat.
The book has many technical errors that will annoy specialists in monetary
economics. For example, the word dollar is not, in fact, just a slang term for American
currency (p. 4). It is neither slang (being an official term), nor specifically
American (the Spanish silver dollar long predated the U.S. dollar), nor does it designate
only currency (most dollars today are in deposit form). It is inaccurate to say
that when the Fed expands the monetary base it makes new dollars and deposits
them in the vaults of big banks (p. 6). The primary dealers from whom the Fed
makes open market purchases are not banks, and the assets that the Fed gets are
securities, not deposits. Leonard repeats the myth that Americas free banking
era was lunacy and a disaster because things cant work without a central
bank (p. 45). In fact, free banking systems without central banks have been quite
successful. In providing a potted history of the Federal Reserve Act, Leonard cites
William Greiders Secrets of the Temple rather than any works by reputable economic
historians. Assets pledged as collateral for a bank loan do not appear on the banks
books (p. 50). Banks write down the book value of bad loans, not the value of the
collateral (p. 57). Deflation of the price level is not ipso facto a suffocating death
spiral for any economy (p. 223). It can instead serve as a conduit for improving real
standards of living when driven by growing real output. Deflation was not a central
problem in 2019 (p. 237).
Leonards account shows a penchant for overstatement. Its not true that the
failure of Penn Square Bank in 1982 almost took down the entire U.S. banking
system with it (p. 63). Nor that the hedge fund Long Term Capital Management nearly destroyed the financial system when it collapsed in the late 1990s (p. 111).
Nor that there has been an epochal collapse of Americas manufacturing sector
(p. 188). Its an exaggeration to say that when Jay Powell became Fed chair, the
financial system was already falling apart (p. 231).
The books narrative shines a spotlight on Thomas Hoenig, who became president
of the Federal Reserve Bank of Kansas City, and thereby a member of the
Federal Open Market Committee, in 1991. Leonard evidently conducted lengthy
interviews with Hoenig about his experiences as a monetary policy maker. In Leonards
account, loosening by Fed Chair Alan Greenspan in 1992 marked the beginning
of a new era of easy money (p. 75). Greenspans policy of keeping interest rates
too low for too long fed the asset price inflations of the dot-com boom and then the
housing boom. Greenspan retired, and Ben Bernanke became Fed chair in 2006,
just in time for the crash of 200709. Bernanke kept the Feds interest-rate target
at near-zero long after the economy began to recover. Fearing yet another bubble,
Hoenig began to dissent in Federal Open Market Committee (FOMC) votes starting
in late 2010.
Leonard notes that Hoenig warned about the dangerous allocative effects of
0 percent interest rates (p. 27). Leonard emphasizes Hoenigs warning that when riskfree
rates are zero, in the presence of moral hazard from too-big-to-fail policies and
from a general Fed assurance that it will keep asset prices from falling (once known
as the Greenspan Put), pension funds and other financial intermediaries search
for yield by taking on more default risk. (Austrian business cycle theory emphasizes
that they also take on more duration risk and refinance risk, but Leonard does not
emphasize duration choice in investment or in funding.) Hoenig warned about the
danger of asset price bubbles. He warned about the danger of un-anchoring inflation
expectations. Ignoring his warnings, the FOMC compounded the malinvestment
effects of keeping interest rates too low for too long by promising that rates would
stay low for an extended period.
On the Federal Open Market Committee, Hoenig had support only from a few
regional reserve bank presidents: Charles Plosser of Philadelphia, Jeffrey Lacker of
Richmond, and Richard Fisher of Dallas. Hoenig faced considerable criticism from
Ben Bernanke and others on the FOMC. Leonard oddly describes this criticism by
writing (p. 17) that Hoenig was seen as something economists called a Mellonist,
a term that refers to Andrew Mellon. I have never seen or heard any economist use
the label Mellonist, although I have seen and contributed to the journal literature
on what economists do call liquidationism, the view that no action should be taken
to mitigate recessions or depressions, the view that Mellon has often been accused
of holding. According to a Google search, the only person to refer to Hoenig as a
Mellonist, other than Leonard himself, was a single pseudonymous commentator
on an economic blog in 2010. By the way: Mellon was not a liquidationist (see Lawrence H. White, Did Hayek and Robbins Deepen the Great Depression?
Journal of Money, Credit and Banking 40 (June 2008): 75168).
When Leonard looks behind the scenes at the Fed, we learn that Bernanke
counted his votes and lobbied the governors between meetings. He modified the
agenda as necessary to maintain an FOMC supermajority for his preferred policy
option, but not as far as necessary to maintain unanimity: Bernanke was willing to
accept one dissenting vote from a regional bank president, but not much more than
that (p. 129).
In mid-book the spotlight begins to switch between Hoenig and Jerome
Powell. A long detour takes us through Powells backstory. This includes his years at
the Carlyle Group, a private equity firm said to derive its profits from leveraging the
connection and influence of Washington insiders, and in particular his work leveraging
up an industrial client firm, Rexnord. The narrative then morphs into a denunciation
of leverage in general and of collateralized loan obligations, or CLOs, as a
leveraging device in particular. We return to Hoenig, who became vice chairman of
the FDIC in 2012, and his efforts to segregate exotic lines of financial deal-making at
commercial banks from the basic deposit-taking and loan-making lines. Then back to
Powell, who joins the Federal Reserve Board of Governors in 2012. Powell, although
initially giving verbal support to Hoenigs concerns about asset bubbles, never cast
a dissenting vote on the FOMC and instead started to soften his criticism. Once
he came to embrace easy money policies, Powell gained growing clout within the
Fed (p. 222).
Leonard draws attention to an invisible bailout by the Fed in 201920. In
September 2019 there was a surprising spike in repo market overnight interest rates.
Because the Feds forward guidance promised that short-term interest rates would
not rise, many hedge funds had taken to financing their operations not with long-term
loans but by borrowing massive amounts overnight, every night. A spike in
overnight rates destroyed the profitability of that approach and threatened to force
hedge funds to dump Treasuries and mortgage-backed securities on the market,
upsetting the Feds plans to keep their prices high. The Fed intervened to keep
repo rates low, first providing $75 billion in overnight loans, and soon more than
$120 billion. As Leonard notes, the Fed Put was being expanded (p. 257). Hedge
funds responded to the cheap-money program by taking on even more leverage.
In March 2020, as COVID-19 concerns hit financial markets, the Fed provided
$500 billion, then $1 trillion, to prop up Treasury bond prices.
Leonard notes that Powell was communicating throughout this period with
Treasury Secretary Steven Mnuchin. During March they spoke roughly twenty
times a day. What emerged was a complex rescue package that would include
several interlocking bailouts, each targeting different parts of the financial system
(p. 277). So much for Fed independence. So much for the traditional notion that a lender of last resorts role is to protect the payment system, not to rescue insolvent firms or segments of the financial industry. Leonard aptly quotes trader Scott
Minerd, who noted that we have now socialized credit risk.... The Fed has made it
clear that prudent investing will not be tolerated (p. 282).