Roadblocks to Recovery (With Apologies to W. H. Auden and Gershon Bleichröder)
February 10, 2010 Dallas, Texas
When I was told I would be introduced today by George Jones, I did not realize it would be my friend and fellow Dallas-ite George Jones.
Only days after the last presidential election, I attended a dinner with the entire cast of characters from that great drama. It was an evening dedicated to repairing wounds with the greatest salve there is: humor. One of the richest moments of the night was when President Obama looked down the table and said, "I am especially honored that Governor Palin is here. And I want to tell you, Governor, I thought you were great in '30 Rock.'" George, I thought you were great when you were married to Tammy Wynette and when you sang "We're Gonna Hold On." I still think you are great in your current incarnation as one of the leading bankers in Dallas, good husband to Miriam and a father of those beautiful children. Thank you for that introduction.
This is a Federal Reserve note—a one dollar bill. Look closely at its face. You will see that in the middle of the left side is the letter "K," surrounded by two concentric circles. The outer circle says "Federal Reserve" and "Texas." The inner circle says "Bank of" and "Dallas." "K" is the 11th letter in the alphabet—in all four corners of the face of this dollar are printed the number "11." The Federal Reserve Bank of Dallas is responsible for the administration of the Federal Reserve's operations in the 11th of 12 Federal Reserve districts set up by Congress under the Federal Reserve Act of 1913. Every one dollar bill bears the imprint of one of the Federal Reserve Banks, starting with the "A" of Boston and ending with the "L" of San Francisco. (Of course, everyone in this room knows that Dallas Fed dollars are of greater nominal value than all the others!)
As President and CEO of the Dallas Fed, I have a duty that I share with my fellow Federal Reserve Bank presidents in addition to Ben Bernanke and the four others who serve with him on the Fed's Board of Governors. Together, the 17 of us compose the Federal Open Market committee—the FOMC—where we collectively determine monetary policy. Our duty is to defend this dollar from the ravages of inflation and deflation and to conduct the monetary policy of the United States so as to encourage sustainable economic growth without sacrificing price stability.
Today, I want to talk to you about what I view as the biggest threats to carrying out that duty.
We have just come through a hellish economic downturn. We are slowly clawing our way back from the edge of what could have been a repeat of the Great Depression. I trust that history will show that the Fed acquitted itself well during this period of strife and tribulation, doing its part on the monetary front to bring us back from the brink. As the lender and liquidity-provider of last resort, we provided the means for crucial credit markets—from the interbank lending markets to money market mutual funds, asset-backed securities and commercial paper—to stay open when they suffered the financial equivalent of cardiac arrest. As was made clear in the press release after our last FOMC meeting, we have removed, or are in the process of removing on a date certain, these emergency room lifelines as the patient has stabilized. Total credit extended under all of these programs, including our regular discount window lending facility, has fallen sharply from a peak of $1.5 trillion around year-end 2008 to $110 billion last week. We performed this function of restoring these vital, short-term credit markets, I might add, at no cost to the taxpayer.
We still have an abnormally expanded balance sheet stemming from our efforts to stabilize long-term credit markets. The largest component of our holdings is the trillion-and-a-quarter dollars worth of mortgage-backed securities we will have accumulated in a purchase program that will conclude at the end of March. These purchases, combined with our purchases of long-term Treasuries and some agency debt securities, have had the effect of leaving the banking system in a flush condition, with more than $1.1 trillion of reserves now held by them in the Federal Reserve Banks. The good news is that our purchases and the associated buildup of bank reserves have led to a resumption of private credit flows and a reduction in private sector borrowing costs. But we still have work to do: As the need for monetary accommodation lessens, my colleagues and I on the FOMC must find ways to unwind the Fed's much-expanded balance sheet with the deftness to minimize credit market disruptions and the timeliness to avoid inflationary pressures. We are constantly discussing internally the ways and means to shrink our balance sheet back to historical norms, aiming to have our holdings once again consisting primarily of Treasuries needed for the regular operations we undertake as the nation's central bank. Chairman Bernanke gave a pretty thorough brief on the various tools at our disposal in the public testimony he released this morning, so I will not dwell further on this point. For those of you who are interested, we can discuss this more fully in the Q&A session following these comments.
As to the economy, there remain many roadblocks that must be overcome before we will be able to breathe easy again. Businesses must develop sufficient confidence in the future to begin expanding their order books and their payrolls. Banks must be willing and able to lend again. Consumers must regain their wherewithal and the confidence to open their pocketbooks.
To be sure, we are seeing some signs of improvement on all these fronts, however hesitant they might be in the incipient stages of a "recovery."
But there remain two significant obstacles threatening the ability of consumers and businesses to cast off their hesitancy. The first is widespread concern about our nation's fiscal predicament. The second is the risk that Congress will seek to politicize the Federal Reserve.
Over the holidays, I read a remarkable compendium of all that Winston Churchill ever said, edited by Richard Langworth and simply titled Churchill by Himself. And this past weekend, before turning on the Super Bowl to watch our New Orleans neighbors overcome the odds and trounce the Colts, I re-read some of W. H. Auden's works, including his essay "The Dyer's Hand," written in 1962. I will draw upon both here.
Langworth cites a speech given by Churchill at London's Waldorf Hotel in 1926 in which he noted that "in finance, everything that is agreeable is unsound and everything that is sound is disagreeable."
While it appears urgent, if not agreeable, to use massive public spending to stimulate an economy under duress, an economy cannot sustain long-term growth under the weight of significant fiscal burdens. At some point, what is considered a temporary economic prosthesis becomes a hindrance to the workings of the private sector.
Over the past decade—under Congresses and administrations led by both parties—discretionary spending has grown at an average real annual rate of 5 percent, outpacing the 2.6 percent annual growth rate of the overall economy during that period. And discretionary spending for fiscal 2010, excluding defense and stimulus-related items, is currently forecast to grow by 8.2 percent nominally. Add to this the rapid decline in federal tax revenue during the 2007–09 period and a flat revenue forecast for 2010, and you've got quite a fiscal pickle.
When tax receipts fall while discretionary spending soars, deficits are an expected consequence. A shortfall of nearly half a trillion dollars in fiscal 2008 was quickly supplanted in the history books by a $1.4 trillion shortfall last year—and will in turn be supplanted by a recently announced, projected $1.6 trillion shortfall in 2010. This means 40 cents of every dollar spent by the federal government during 2009 was deficit-financed, and that picture will not change much this year. If that does not rattle your bones, consider that income taxes brought in just over $1 trillion during 2009 and are expected to bring in a similar amount this year. If we wanted to raise enough revenue today to close the 2010 gap, we would have to more than double current income and corporate tax rates.
But the story does not end there. Official projections peg mid-decade deficits—say, in 2015—at half a trillion dollars annually. Remember: After this recession has ended, after many of the stimulative measures taken over the past two years have played themselves out and after economic growth has resumed, our nation's debt will continue expanding at a rate of 3 to 4 percent per annum. Even if real tax revenue grows at an eye-popping 9 percent annual rate over the next five years, as projected by the White House, deficits as a share of the economy will be higher than the historical norm—and are scheduled to remain that way as far as the eye can see.
Last year alone, the Treasury went to market to issue $2.1 trillion in debt. Estimates for this year broach $2.4 trillion. One might begin to worry that this level of financing would crowd out private-sector and other borrowers. But it hasn't—yet. In financing this massive debt issuance, we have benefitted from the need for large surplus savers, like the Chinese, to invest in deep, liquid markets. We have also benefited to a degree from the misery of others: Recent concerns about sovereign debt elsewhere—that of Greece and of some others in Europe, for example—have drawn money to the higher quality credit of the United States, keeping interest rates on Treasury debt low. As I entered this room, the 10-year Treasury was yielding 3.63 percent, a fortuitously low number.
We cannot count forever on the largess or the misfortune of others to mask our own imbalances here at home—for fiscal profligacy in Washington today hinders our ability to address fiscal challenges tomorrow.
These challenges are coming. Off balance sheet, there lie two massive, unfunded liabilities not accounted for in the "conventional budget accounting" of the federal government—most significantly, Social Security and the government obligations of current Medicare programs.
Pundits and analysts like to focus on the year in which Social Security will go permanently into the red on an annual cash flow basis—which recently was projected to occur in 2019 but could occur as early as 2016. But they largely ignore the severity of the broader problem: accumulated entitlement debt over the infinite horizon. According to our calculations at the Dallas Fed, that unfunded debt of Social Security and Medicare combined has now reached $104 trillion—trillion with a 'T'—in discounted present value. And while much attention in recent years has been devoted to Social Security, the lion's share of the total entitlement shortfall (nearly $90 trillion) actually comes from Medicare. This is a prodigious number. Others—like Pete Peterson's foundation, which uses a different time horizon in its methodology—calculate the unfunded liability at north of $40 trillion, growing by a sum of $2 trillion to $3 trillion per year. No matter. The problem is frightful, whether you take his numbers or ours.
Medicare is by far the most serious fiscal storm cloud on the horizon, and it is a storm we are poorly positioned to weather given the rapidly deteriorating medium-term deficit outlook. Yet maintaining economic growth over the long term requires us to do so.
Now, balancing the fiscal books is not the job of a central banker like me. Making Medicare and the fiscal position of our country sound again falls on the shoulders of the Congress. Only the Congress can tax and spend our monies. That is its purview, not the Federal Reserve's. The disagreeable but sound burden of bringing us back to fiscal sanity now falls on its shoulders.
If you read Sunday's New York Times, you might be given to despair, wondering whether this is indeed doable. Buried far too deep in the front section—on page 22, perhaps deliberately on the penultimate page before the obituaries—was an article titled "Spending Cuts Meet Selective Support." The subhead read "Familiar Washington Complaint: Cut the Deficit, but Not That Way." It went on to single out House and Senate members, including Republican "conservatives," who were all for cutting back on federal spending—as long as it did not occur in their districts. It vividly illustrated the struggle between national and parochial interests that results in ever darker red ink in the nation's income statement and an ever deeper hole in the nation's balance sheet. In that article, the situation was summarized perfectly by Arizona Congressman Jeff Flake, who said, "There are not enough statesmen who will stand up and say, cut it even when it is in my district."
I have not had the pleasure of meeting Congressman Flake, but I suspect—if he has a sense of humor—he might find this little vignette from England to be a nice parody of how business appears to have been conducted on the Hill.
This would all be very funny were it not so very sad. It is so easy to spend other people's money. It is, as Churchill said, so agreeable. But it is unsound. And, as the article in Sunday's Times makes clear, it is not a pleasure reserved for just one political party.
When George Shultz was director of the Office of Management and Budget, he became frustrated with the spending impulses of the Nixon administration. He reports that he called the venerable Sam Cohen—a virtual encyclopedia of budgetary history—into his office and asked, "Between you and me, Sam, is there really any difference between Republicans and Democrats when it comes to spending money?" Cohen's reply was classic: "Sir, there is only one difference: Democrats enjoy it more."
Mr. Cohen might have been a more "equal opportunity" wisecracker were he still around. Regardless, we are beyond the point of either party placing its immediate political needs ahead of the welfare of our children and successor generations.
Here is where W. H. Auden comes to mind. In "The Dyer's Hand," he wrote "in the Fifth Circle on the Mount of [Dante's] Purgatory … I suspect that the Prodigals may be almost an American colony."
I would like very much for us to prove W. H. Auden wrong. The Fifth Circle of financial purgatory must not become an American colony. Recent reports would have it that the Fifth Circle is now being populated by the Greeks and other Europeans who have taken to fiscal profligacy. Some analysts seem poised to add to that roster Japan, whose economy faces a challenging fiscal predicament given their demographic trends. I would rather they not be joined by their American counterparts. I pray the president and the Senate and the House will set aside their parochial and partisan interests, stop kicking the can down the road and get on with the disagreeable but sound business of getting us out of the financial cul-de-sac they and their predecessors have driven us into.
As bad as the situation is, I know one thing that would make it worse, and that is if the Congress took the easy way out by turning to the Fed to simply print our legislators' way out of their misery, devaluing the debt they have incurred through their spendthrift ways.
In a recent issue, The Economist magazine gently chided me for what it considered a hyperbolic reference to the fate of the Weimar Republic—a fate I referenced as a potential outcome for the U.S.A., should the Congress take to the route of politicizing the Fed. Yet the article acknowledged that in times of economic duress, there is a temptation worldwide for political authorities to compromise their central banks, the most recent case being that of Argentina. This temptation exists despite what policymakers know from history: that when fiscal authorities turn to monetary authorities to monetize their debts, the result is inevitably financial disaster.
I got a glimpse of this firsthand in the Carter administration with the ill-advised imposition of credit controls. This was but one instance in a long history that stretches from the debauching of monetary probity in ancient Rome to the inflation disaster that is now modern Zimbabwe.
If you want a primer on what can go wrong when the independence of a central bank is compromised—even in countries considered invulnerable—turn to page 88 in Liaquat Ahamed's recent book, titled Lords of Finance. He notes that, when the Reichsbank was being formed by Bismarck in 1871, Bismarck's closest confidant, Gershon Bleichröder, "warned [Bismarck] that there would be occasions when political considerations would have to override purely economic judgments and at such times too independent a central bank would be a nuisance."
It is no small wonder that the political considerations of the First World War and the impulse to override what might have been the purely economic judgments of Germany's central bank led to the hyper-inflation of the Weimar Republic and the utter destruction of the once mighty German economy. I beg to differ with Herr Bleichröder. It is more important than ever that we maintain the independence of our central bank, keeping it free from being overridden by political considerations. As the executive and legislative branches seek to navigate our economy to safe harbor, they must minimize the impulse to let political exigencies hamper the work of the Federal Reserve. If, in the process of doing what is right and proper by confining its activity to its singular purpose, the Federal Reserve becomes a "nuisance," so be it. The Fed under Paul Volcker's leadership was certainly a "nuisance." Reagan administration officials sought to reign in the Fed, and senators and congressmen on both the right and left called for Volcker's removal from office. But you would be hard-pressed to find anyone alive today who would argue the fact that the Volcker Fed pulled the nation from the precipice of economic calamity and severe inflation. Now, as then, it is important that the Federal Reserve be left to do its job and no more.
I ask you to beware of several political initiatives that threaten the Fed's independence. For example, the House of Representatives recently passed legislation that would require audits by the Government Accountability Office—not simply of the Federal Reserve's balance sheet, but also of its monetary policy decisions. The idea of expanded Fed audits was initially introduced just last February and was eventually cosponsored by well over 300 representatives, including 28 of Texas' 32 members. There are other initiatives from other House and Senate members that would make the presidents of the 12 Federal Reserve banks, or even the chairmen of their boards, subject to presidential appointment and Senate confirmation, upsetting the delicate balance forged nearly a hundred years ago between Main Street and the Washington political elite.
Independent does not mean unaccountable. We have always been subject to appropriate oversight. Since Ben Bernanke took the chair, we have ramped up our efforts to be as transparent as is prudent in the conduct of monetary policy. For example, the Fed is the only business in America that I know of that provides a public accounting of its balance sheet every week—it is called the H.4.1 release, and you may pull it up yourself on the Internet on a weekly basis. We submit a monetary policy report to the Congress twice per year, at which time our chairman makes his trek to the Hill to deliver his Humphrey–Hawkins testimony and answer questions from members of the House and Senate.
I suppose another set of eyes might provide further confidence regarding our holdings. But making the discussions held by my colleagues and me at the FOMC subject to congressional second-guessing, under the guise of auditing monetary policy deliberations, or creating a process where apolitical bank presidents have to worry about satisfying Washington powers rather than representing their districts' views—thus upsetting the delicate balance that prevails at FOMC deliberations—risks putting us on the road that leads to the fate suffered by once-great economies like pre-Weimar Germany.
A great and powerful economy cannot create the conditions for sustainable, noninflationary growth if its central bank is governed by a politicized monetary authority.
Now, let me be clear: I do not believe the Fed to be blameless in the run-up to the crisis we are now working our way out of. For quite some time, I have respectfully differed with Chairman Bernanke, saying that I felt the Fed held interest rates too low for too long in the early half of the 2000s, thus fueling reckless speculation in housing and other sectors. And I have freely admitted that a host of regulators, including those at the Federal Reserve, were caught unawares by the risk being taken by large financial institutions that later came a cropper.
This does not mean, however, that those who dwell in the political realm should try to "fix" the problem by throwing themselves into the monetary mix. We should not now politicize an institution that, in the turbulence of this period, pulled our economy back from the brink of the abyss and has now taken significant steps to repair the holes in its regulatory and supervisory apparatus. As a central bank, we had the flexibility to expand our balance sheet to shore up the financial system and put out a fire. In comparison with the Treasury, we had a greater ability to quickly lend against collateral with the flexibility that Congress granted to the central bank years ago. Our current structure gives us the ability to put out fires while remaining accountable after the fact. I would advise the Congress to leave well enough alone.
The other day, I opened a bottle of iced tea bottled by a company named, appropriately, Honest Tea. Printed in the cap was the English translation of what it said was a Chinese proverb. It read: "If we don't change the direction we are headed, we will end up where we are going." Students of history are keenly aware of the course we chart when we discuss the possibility of politicizing the Federal Reserve System, in lieu of Congress bearing down and solving its fiscal woes. It would put the United States on a road that leads directly to economic ruin.
I am tempted to end this cheery talk by saying "Have a nice day!" and walking off the stage. However, I would hate to leave this podium with your having concluded that I am just another sourpuss. It's true: Like all central bankers, I am genetically programmed to worry. But I am also a red-blooded American, as are all my colleagues at the Fed. In the end, I draw on the wisdom not just of Churchill or W. H. Auden or history as recounted by Liaquat Ahamed or the lyrics of George Jones, but on the words of someone I doubt you ever heard of: Marcus Nadler, one of the great minds of the Federal Reserve during a period when our economy endured an even greater "stress test."
To counter the intellectual paralysis and down-in-the-mouth pessimism that gripped the financial industry after the Crash of '29, Nadler put forth four simple propositions:
First, he said: You're right if you bet that the United States economy will continue to expand.
Second: You're wrong if you bet that it is going to stand still or collapse.
Third: You're wrong if you bet that any one element in our society is going to wreck the country.
And fourth: You're right if you bet that leaders in business, labor and government are sane, reasonably well-informed and decent people who can be counted on to find common ground among all their conflicting interests and work out a compromise solution to the big issues that confront them.
It may seem like the stuff of our wildest dreams to imagine our sisters and brothers in Congress finding the way to forge a solution for their woeful fiscal predicament. But I believe they can and they will. After all, one of the three great parables in the Book of Luke is that of the Prodigal Son (which, convenient for the purposes of this speech, follows the Parable of the Lost Coin): "We had to celebrate and be glad; this brother of yours … is alive again; he was lost and is found." Besides, we are Americans. Americans rise to the occasion no matter how great the challenge. We have done it time and again. We have no choice but to do it once more, now.
- Churchill by Himself: The Definitive Collection of Quotations, edited by Richard Langworth, Philadelphia: Perseus Books Group, 2008, p. 17. Langworth cites Churchill from March 15, 1926.
- According to the Peter G. Peterson Foundation's Issues website.
- "Spending Cuts Meet Selective Support," by Carl Hulse, New York Times, Feb. 7, 2010, p. A22.
- A video was shown at this point in the speech.
- The Dyer's Hand and Other Essays, by W. H. Auden, New York: Random House, 1962.
- "Policy Punchbags: From Argentina to America, Politicians Are Taking Aim," The Economist, Jan. 14, 2010.
- Lords of Finance, by Liaquat Ahamed, New York: Penguin, 2009, p. 88.
- "Confessions of a Data Dependent," speech by Richard W. Fisher, Nov. 2, 2006, and "Responding to Turbulence," speech by Richard W. Fisher, Sept. 25, 2008.
- Luke 15:31–32.
About the Author
Richard W. Fisher served as president and CEO of the Federal Reserve Bank of Dallas from April 2005 until his retirement in March 2015.