Mr. HOENIG: ...because I don't--I don't necessarily believe in surprising people either, to a point. Then I would take the language away of highly accommodative for an extended period. Then I would move as rapidly as I--as I judge the economy could towards a 1 percent Fed funds rate, if you will, so that--and then I'd stop, and I'd see how the economy is doing, I'd watch it carefully as we move forward. And then I'd see if I could normalize it further, depending off that--how things go. Because monetary policy, it—my whole view is monetary policy can't solve everyone's problems, and the sooner that the economy and those who are involved in it understand that, the more they'll look to other types of actions like, `How do we support our manufacturing sector? How do we deal with our federal debt?' and so forth and focus on...
KUDLOW: I want to get to fiscal. I want to get to fiscal in a minute.
Mr. HOENIG: Sure. Sure.
KUDLOW: But let me just follow up. What is your economic outlook currently? You had a very soft first quarter, 1.8 percent real GDP.
Mr. HOENIG: Right.
KUDLOW: Some sluggish numbers coming out on manufacturing for the first time, of course high gasoline prices seem to have cut back on consumer spending.
Mr. HOENIG: Sure.
KUDLOW: How do you see the outlook?
Mr. HOENIG: I see that we will continue to have a modest recovery. We've had one so far, and I see it going forward because the--it's pretty striking, if you think about it, that the United States is going through a deleveraging--that is we had such a huge carry of debt that consumers, businesses, government had to--has to take on that the fact that we were able to have that debt in place, go through this terrible crisis and still have growth going forward as we deleverage is a testament to the strength of the US economy. A modest recovery, I wish it were rapid, but the fact that we have these terrible imbalances to get back in, shall we say, equilibrium, that's pretty striking how resilient this economy of ours is.
KUDLOW: If fiscal policy in Washington had slashed business tax rates or even other tax rates, would that have obviated the need for the Fed to go into QE2?
Mr. HOENIG: Again, that's a counterfactual--it's a guess. I do think that we do--I do think we have a fiscal crisis that's long term, and I hope both parties and the administration deal with that. The sooner, the better. Because I do know, as I've said before in speeches, that if you don't, then people tend, as real interest rates rise, with the carrying of the debt and the continued recovery and those real interests rise, people look to the Fed to bring interest rates down. And that's what you--that's when you begin to monetize debt, and that is a very damaging long-term effect.
KUDLOW: So OK, just to stay with that for a second. If the unthinkable happens and the debt ceiling is not increased on time and the US somehow defaults on an interest payment on treasuries or some such thing, how's that affect the Federal Reserve?
Mr. HOENIG: Well, I think that, only to the extent that it has other effects on the real economy would that put more pressure on us relative to what are you going to do about this? They tend to always turn to the Fed. And I think that would put us in a difficult situation of choice. Do we try and accommodate a carry out some way through monetary policy, the—counteract those effects?
Mr. HOENIG: And I worry about that.
KUDLOW: It's like all scenarios potentially lead to more pump priming by the Fed.
Mr. HOENIG: It tends to, when people are, if--shall we say, if they're used to that...
Mr. HOENIG: ...if they've become accustomed to that, they then turn to that automatically. And I think that can lead to some pretty difficult outcomes, especially in the long term. Because in the long term, you can then create a new set of new imbalances or you tend to change the inflation, expectations going forward, neither of which is good for the US economy, I believe.
KUDLOW: The former chairman of the Kansas City Fed's board, it's Herman Cain...
Mr. HOENIG: Mm-hmm.
KUDLOW: ...businessman Herman Cain, who's now running for president in the Republican primary, but I interviewed him a week or two ago. He would like to see the dollar re-linked to gold as per the old Bretton Woods arrangement, which died out in the early 1970s. Other people have made a similar call. Lot of people are worried about the fate of the dollar continuing to decline. Do you have a thought on re-linking the dollar to gold?
Mr. HOENIG: I've been asked that many times and I've said for some time that, you know, a gold standard is a legitimate monetary system. We've had it for generations. I don't think it's going to solve our problems because really the value of the dollar is a consequensive policy. Whether you're under the gold standard and you have the Depression or prior to that, or whether you're...(unintelligible). If you have good policy--fiscal, monetary industrial policy in the sense of a market economy, you will--your dollar will reflect that in equilibrium. If you have bad policy, fiscal, whatever, your dollar will reflect that. It's a reflection of our national policy.
KUDLOW: But how much of it can be laid at the Fed's doorstep? I mean, the dollar may be stabilizing right now. There is some speculation about that in the markets. I know you don't care to speculate. But at the end of the day, it's the Fed who controls the money supply, and the Fed who controls the interest rate, and to some extent the real interest rate. How much responsibility for the dollar is held by the Fed?
Mr. HOENIG: Well, the dollar is, like I said, affected certainly by monetary policy, but it's also affected by fiscal policy. It's also affected by what's going on in Europe or Asia. That's why I think trying to pin it on one particular thing is unwise. I think you have to look at the broad policy issues. Because let's say you went to a gold standard and that's a discipline you have. But if you don't engage in good fiscal, monetary, other policies, you're still going to have issues, whether it's the gold standard or fiat system.
KUDLOW: You're sort of the quintessential grassroots Fed guy out there in
Kansas City. You're going to retire this October, be--I guess 20 years to the day.
Mr. HOENIG: Right.
KUDLOW: Which is a great thing, great service. But let me ask you, you actually spoke to a tea party group, let's see, last September...
Mr. HOENIG: Right.
KUDLOW: ...outside of Kansas City. So far as I know, you're the only Fed representative to do so.
Mr. HOENIG: Right.
KUDLOW: So what did they tell you when you spoke to them? What did they tell you about life in general and the economy? What did they say about the Federal Reserve?
Mr. HOENIG: Well, I think the--the group that I met with were middle-class
Mr. HOENIG: They were concerned about the debt. They were concerned about monetary policy and about where interest rates were, what it meant long term, how it affected inflation, the things that you and I are concerned with. Their questions were good. They were sensible. You had, you know, you have one or two people that kind of ask an off the wall questions, but I've gotten that in the most sophisticated crowds. I was very impressed with middle America and with Heartland's representation of mid-America.
KUDLOW: Were they angry or are they still angry at things like banks in New York that are too big to fail, for example, or bailout nation that seems—I don't know that community banks are getting bailed out. That's not what the evidence shows.
Mr. HOENIG: Right.
KUDLOW: The New York banks get bailed out. What's your own feeling about too big to fail and the bailouts?
Mr. HOENIG: Well, I would first of all say the individuals in the Midwest are no different than the individuals on the East or West Coast about the fact that the largest banks were bailed out and other banks were not. They're trying to understand why that is and why that's always so necessary and what the disadvantage to that is to their community banks. That's a very reasonable reaction to that. So I think that's the most important message that we have from that.
Now my own view is that this is not capitalism. What we've done is not capital--this is not free markets.
Mr. HOENIG: This is an instance where you've given certain protections to financial institutions, and with those protections I think you have to recognize that you've incented them to engage in increasingly risk activities to return their--increase their return on equity. Why not? Your cost to capital is less, you've got protection of the safety net, you can get liquidity. And then when you do, in fact, take on too much risk and complicated transactions and derivatives and trading activities, you turn and say, `Well, I know we took our profits, but now we're going to walk away and it's yours,' that's hardly capitalism and that has to change. And I think we're a long ways from changing that.
KUDLOW: Right. So we haven't really fixed that. And so we're moving...
Mr. HOENIG: Yeah. I don't think...
KUDLOW: We're moving away from free market capitalism.
Mr. HOENIG: Right. We're moving further away from free market capitalism, because now our banks, the largest banks, are 20 percent larger than they were before the start of this crisis. We do have a new law, Dodd-Frank, that is supposed to enhance supervision. We've seen that before. Enhanced capital standards. Before we had the safety net capital standards were much higher in commercial banks in the Americas. And we have a resolution process that I can--experience suggests that on a Friday evening, and you have until Sunday to solve your problem, that you're probably going to bail them out before you resolve them.
Mr. HOENIG: And I think that's not capitalism.
KUDLOW: All right. Thomas Hoenig of the Kansas City Fed, you've given us a lot to chew on. Thank you very much, sir. Appreciate it.
Mr. HOENIG: Glad to be with you, Larry. Thank you.
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