BiggerPockets Money Podcast - 281: Former Fed President Warns Easy Money Will Bring Big Consequences for Investors w/ Tom Hoenig

Episode Date: March 7, 2022

Inflation can be a detriment to any early retirement plan. At first, you may think you only need a certain amount of money to retire, and maybe you’re adjusting for inflation when you do these calculations. But what happens when inflation runs more than triple the average or crosses into double-digit numbers. How does your investment strategy change? How does your “dream retirement” come true when it costs ten percent more than you originally accounted for? These are all questions that average Americans are asking themselves: when can I retire? Can I retire? How can I afford food or gas or pay my bills? Although we can’t solely blame high inflation on the Federal Reserve, we can see how their policies lead to the situation we’re in now. Someone who stood up against the policies of quantitative easing and massive stimulus packages, is former president of the Federal Reserve Bank of Kansas City, Tom Hoenig.  Tom was in favor of quantitative easing back at the start of the great recession, but as this power to pump more money into the economy started to get abused, he rallied against the choice of the fed. Today, Mindy and Scott use this episode to ask Tom the hard-hitting questions that average investors want answered so they can make the best financial moves possible while still building wealth.  In This Episode We Cover The rampant inflation of the 1980s and how it affects Fed policy to this day Quantitative easing explained and how it artificially inflates asset prices How asset values and price inflation go hand in hand  The goal of the Federal Reserve and how many of their policies have backfired  Whether or not the 4% rule still stands true in an inflationary environment  What a “good” unemployment rate looks like and how it maps the health of the economy How investors can prepare to take advantage of times of economic uncertainty and high inflation  And So Much More! Links from the Show BiggerPockets Money Facebook Group BiggerPockets Forums Finance Review Guest Onboarding Scott's Instagram Mindy's Twitter Apply to Be a Guest on The Money Show Podcast Talent Search! What Every Investor Should Understand About Inflation How the Unemployment Rate Affects Us All (Yes, Even the Employed) The Fed’s Doomsday Prophet Has a Dire Warning About Where We’re Headed Tom Hoenig on Wikipedia Check the full show notes here: https://biggerpockets.com/blog/money-281 Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to the Bigger Pockets Money podcast show number 281, where we interview Tom Honig, former president of the Federal Reserve Regional Bank in Kansas City, and talk about inflation, federal reserve policy, and potential rising interest rates in the coming months and years. I know it sounds weird, but I swear this is a really fun episode. And so you need to have a interest rate that promotes not a boom, not a speculative environment, not zero interest rates, but interest rates that are balanced where I as a saver get a fair return, not zero, not point two in my... I as a saver get it, and as a borrower, I can borrow money at a reasonable return

so that my investment gives me my enough money to pay back my loan and enough to get a return on my capital. Hello, hello, hello. My name is Mindy Jensen, and with me, as always, is my It's an Art, not a Science, co-host, Scott Trent. Thank you for, as always, for paintings, a wonderful picture of the podcast to come. Oh, that was good. Scott and I are here to make financial independence less scary, less just for somebody else,

to introduce you to every money's story because we truly believe financial freedom is attainable for everyone, no matter when or where you are starting. That's right. Whether you want to retire early and travel the world, going to make big-time investments in assets like real estate, start your own business, or generally understand the rules of money and the economy. We'll help you reach your financial goals and get money out of the way so you can launch yourself towards those dreams. Okay, Scott, this episode is so much fun.

Tom Hanig is, like I said before, the former president of the Federal Reserve Bank in Kansas City. He is quite the impressive, he has quite the impressive resume, and I'm so delighted to talk to him today. He is featured in a new book coming out called The Lords of Easy Money, where they talk about the effects of the Federal Reserve policy of the last 10 to 20 years with rates being so low that they have had effects on the price of assets. And I am just so delighted to talk to him. He was such an interesting person, and he had so much information. If you are living in America today, you need to listen to this episode. Yeah, I think Tom is a very special guest for us, and we're very flattered that he accepted our invitation to come on the BP Money Show podcast here,

Mindy and I actually discovered, not discovered, became aware of who he was and his importance to the economy in a general sense through an article that someone shared in our Facebook group called the Fed's Doomsday Profit has a dire warning about where we're headed. And so if you, we'll link to that in the show notes here at biggerpockets.com slash money show 281. But just thrilled to have had him come on the show. this is a true master of the economy, of all things, public financial policy, public policy, broader economic theory, those types of things. And I think it was a real privilege to get to

interview him today and learn from him. Yep. I learned a lot from him and it was just so wonderful to listen to him, explain these theories in ways that are really easy to understand. It really helps see what the thought process was behind the reason for the low interest rates that we've enjoyed for so long and more importantly to understand why those need to go away in order to help the American economy. Tax season is one of the only times all year when most people actually look at their full financial picture, including income, spending, savings, investments, the whole thing. And if you're like most folks, it can be a little eye-opening. That's why I like Monarch. It helps you see exactly where your money is going and more importantly, where your

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Kickstart your well-being journey with your first audiobook free when you sign up for a free 30-day trial at audible.com slash BP money. Tom Hanag is our guest today. He is the former president of the Federal Reserve Regional Bank in Kansas City for 20 years. And after stepping down in 2011, he became vice chairman and a member of the board of directors for the FDIC where he stayed for six years. He has a Ph.D. in economics. And I think it's pretty safe to say that he understands money and Fed policy and the general economic situation of America. So Tom, welcome to the Bigger Pockets Money podcast. I'm so excited to talk to you today. Thank you for having me. I look forward to the conversation. Hopefully I can contribute. Oh, oh, I bet you can. You're very modest. So I gave just the highlights of your career. Let's go over a little. little bit of your backstory really quickly before we get into talking about some of the things

that you are well known for. Well, I mean, you did hit the highlights. And I was in the service for a couple of years, came back to the United States in 1970, and then went right into graduate school there at Iowa State University. And I enjoyed it very much. And I actually emphasized macroeconomics and monetary money and banking. actually, and worked in that field for my PhD dissertation. And then I left there to go to the Federal Reserve Bank of Kansas City and to be a economist in their division of banking supervision and structure it was called. And in that period, worked with commercial banks, supervised some of them, reviewed merger

acquisitions and so forth and did that for a while. And then I was very, I was, by the time the crisis of the 80s came, I was an officer at the bank and worked through that, that terrible crisis. It was a collapse in asset values in agriculture, in commercial real estate, and energy for state of Oklahoma, Wyoming, Colorado. That was terrible. Commercial real estate was kind of universal problem, it also affected homeownership. So that was a very trying period. I learned a great deal from that, probably more from that than I did any PhD program in terms of how the economy works and doesn't work. And I did that until 1991, where they asked me to be president of the bank. I was honored to be selected. And

I joined the FOMC at that point and worked through a good part of what was going on in the 90s and then through the crisis of the financial, the Great Recession and the financial crisis of 2008 and 9. And so a lot of bruises from all that, but also a lot of learning exercise. You had a first row seat with that job of the Kansas City Fed for the inflation in the 70s and 80s. And, you know, sneak, you know, without giving too much away, I think a lot of the foundation for that inflation might have been set in the 60s with some Fed policy. Could you walk us through your observations as a witness and having that front row seat and what you think caused that the 70s and 80s high rates of inflation and interest rates? Well, the U.S. economy was, as they entered the 60s, it was in a recession, they eased rates. but the real thing was it was a dominant economy in the world.

And in the 60s, it took on more, if you will, programs. Number one, it decided to get involved in a war, the Vietnam War. That was a big spending requirement. It also, under President Johnson, created the Great Society program, which was a very significant expansion of support for lower income households. And that was a big spending program as well. So you had during that period a very significant expansion in spending

and in borrowing to accommodate that spending. So you had both increasing deficits and the general budget itself increasing. And at the same time, you have. had in that environment, interest rates would normally rise. So the political environment was such that there was a lot of pressure put on the Federal Reserve to print money, to help finance, if you will, the spending increase that was taking on. And when you get that combined, you get large government spending increases in debt, large increases in money. At one point, I think by the time we got to the early 70s, the money

supply of this country was growing at 13% rather than 3 or 4% that had been from an earlier time. And so you have greater increases in demand than you have supply with accompanying deficits than you get inflation. And inflation was really even in the early, very earliest part of the 70s after the 60s had kind of gone its way, you had 8% inflation. And one of the things that happened then, you know, you begin to react to that, and labor starts wanting more because they need to keep up with inflation and becomes very unsettling. And it was a tough period that we entered even as we began the decade of the 70s. And you had to deal personally with some of the ramifications of that, right?

with, you know, how did that impact bank, the valuation of assets in addition to labor and your day-to-day job? Well, what was going on in the 70s, it was really kind of a mixed bag. The administration and the Federal Reserve, when inflation got to 8%, the administration put wage and price controls on, made goods even more scarce. And so that when they took them off, inflation actually shot up. again. And the Federal Reserve in trying to fight inflation did try and kind of slow down the growth of its printing and the money. And as the economy, though, began to stall, they would back off

from doing that. They would lower rates again because they were more afraid of a recession. So you had this kind of stop go, but each time you started going again with monetary expansion, inflation got a little bit worse. And so by the end of the decade, you had very high asset inflation as well as price inflation. Now, as far as the asset inflation goes, banks were very, hadn't experienced it like this before the Great Depression. So they were making loans based on asset values. So agriculture, if you wanted to buy more land, you would borrow knowing that the price

that land would only go up. The banker would feel very comfortable because the price of land was going to go up, so they'd make a bigger loan secured by that land. You saw the same thing in energy. It went from $8 a barrel to $50 a barrel, and they said, well, it's going to be $100 a barrel. So banks were willing to lend against that on the assumption that values would only go up. And commercial real estate, they saw the increasing value of commercial real estate. And I can remember bankers saying, well, we're going to lend 100% on the construction of that new high rise because we know that it'll be worth 120% of the initial cost by a year after, very quickly after it's built, and we'll still have a very good margin on the loan.

And so we'll make a loan on that. Well, as inflation continued to increase and became price inflation of 13%, when they introduced Paul Volcker, who said, we're going to end this price inflation because it's only going to get worse, that just crushed the asset markets. It just absolutely stopped them from increasing in value because interest rates were now, not 4% or 5%, they were 20%. So commercial real estate dropped, land values, agricultural land values and other land values dropped. Oil went back down to, you know, $6, $7 a barrel. and you have this enormous implosion that hurt the entire economic system. And it was a very, very difficult, painful experience for everyone.

No one was exempted. Could you give us just a brief anecdote about interactions you might have had with banks at that point in time? Well, it was terrible. They were failing because what happened is when you have a loan and you can't cash flow it any longer because prices are falling. You're now addressing inflation. And your asset values are collapsing, so you have to charge off those losses.

And when you charge off those losses, it's against your capital that you've funded yourself with. And when that runs out, and in too many cases, it did. There was like 1,200 bank failures. There was well over, I think, 300 in the reason I was responsible for.

And so those banks are in communities. Some of those banks were fairly large. Some were community banks in rural areas, but it just totally disrupts that local economy. The most famous was, in our region at least, and probably one of the most famous in the country, was this so-called PIN Square Bank. This was a bank that was made literally billions of dollars of energy loans.

And this was a bank that was less, well less when it started than a billion dollars. And it was selling these loans to other banks around the country. So when these values collapsed, this bank ran out of capital very quickly, losses. And all these loans they had sold to other banks. Seattle Seafirst was one of them, one in Continental, Illinois, in Chicago. Then those banks also got in trouble. So you have this chain effect from that major one category that is energy lending, not agriculture, not agriculture or commercial.

It was energy. So now take that to agriculture and expand it. You could see that entire communities were brought to its knees. Unemployment rose significantly. It was a very, very difficult time for everyone. And for us, working with bankers, having to shut those banks down is really a difficult moment for everyone in that community, as well as for the FDIC who had to close those banks down. It really is heart-wrenching to see lives up in the completely. So what you're describing is happening in the 70s and into the 80s, what your saying,

saying, though, I'm hearing, I'm feeling right now as well. And you kind of predicted this starting in about 2010 with your votes against the quantitative easing. Can we talk about quantitative easing for a little bit? Sure. Quantitative easing is a concept that says the economy was recovering from this very serious crisis. And during the crisis, the central bank and the government put a good deal of money over the Federal Reserve loaned out or provided liquidity in the literally trillions of dollars during that period to stop the spread of that crisis from becoming worse. And I actually agreed with doing much of that. But in 2010, the economy was recovering. There were other global issues, but the U.S. economy was recovering.

Excuse me. And what happened was there was a very strong view that unemployment was still too high. It was over 9%. That the recovery wasn't going fast enough. and that if you then did this quantitative easing, and that is you bought trillions of dollars of assets, either government securities or mortgage-backed securities, and you put new money, called base money, into the banking system. So you would buy these assets from banks who got them from the government, that is securities,

and that would increase their accounts, and they could lend that money out, and things would be good. But the difficulty with that is you have so much demand in the economy, so much production capacity, and the Federal Reserve had decided to just flood the economy with money. And my concern was that what you're going to do in that environment is you're going to increase asset values very quickly. That money has to be deployed. you're going to move, you're going to lower interest rates to zero. We know that zero interest rates does push up asset values. If you had a government security and it went from 5% to 1%,

the value of that security would go up quite a bit. And so that was the idea to raise the asset values, both short-term and long-term and both government-type assets, but other assets as well. And that's what it did. It raised assets. But it did so for the stock market, which nearly doubled between 2010 and 2015 or 16. It did it for commercial real estate.

It did it for agricultural land again. So you were doing exactly what you did before. You were raising all these asset values. People might feel richer, but there's another side to that. It did not increase productivity in the economy. This money was such an extent of increasing this money and lowered interest rate, it encouraged speculation. It encouraged the fact that you grew the derivatives market multiples of its original size. You increased the spending on speculative investing in various assets, whether it was land or whatever.

So you were artificially giving increases in price, but you weren't investing in new plant and equipment to any great extent. You weren't making the worker more productive, so real wages stagnated. So if you were an asset holder, you were well off. You were kind of a winner. If you were a wage earner and you didn't have enough to get into the stock market or enough to buy a piece of real estate or even buy a new home because prices of housing were going up so quickly that new entrants had a greater difficulty. So what you did is you increased the divide between those.

who have, the haves, the wealthier group, upper middle class and the very wealthiest. And you didn't necessarily decrease incomes for the lower class yet because you didn't have price inflation, but they were falling farther and farther behind because their incomes weren't rising to the same extent. So you created this divide that I think people resented. People saw it. They were not oblivious to it. And you created this artificial gain. It was arbitrary. It wasn't necessarily an increase in production, an improvement in cash flow based on the increase in the production capacity of the asset, whether it was real estate or otherwise. And so you did a lot of damage to the economy. So now you come forward.

We have this terrible pandemic. We saw a decrease in supply to some extent, but even as it comes back, we did increase in government spending. We put more money in the hands of people. And the Federal Reserve accommodated that. They printed the money necessary. They bought the new debt. They increased the spending. And so now we have price inflation.

But the trouble is we have price inflation and asset inflation, and real wages are increasing not at all. As inflation is increasing faster than wage inflation, so the wage earners now actually losing. And I think that's unfortunate. And one other thing that's very important to this, we think that fiscal policy can solve the problem. But two things I would tell people, in 2008, when the crisis was there, the government's debt was about $10 trillion.

In 2015, the government's debt was $18 trillion. So the government had been spending money. People were being provided greater transfer payments, greater support by the government. By the pre-pandemic, just before the pandemic, that government debt was $24 to $25 trillion. And post-pandemic is $30 trillion. So all that debt is out there, and a good part of it is being bought by the Federal Reserve, putting more money into the economy. Not increased production, but more money into the economy. So in 2008, the Federal Reserve balance sheet was less than $1 trillion.

By 2015, it was $4.5 trillion. So over a century, the Federal Reserve had increased the so-called base money, that money it creates, by less than a trillion dollars. In the next three to four years, it increased it by another $3.5 trillion. And today, the Fed's balance sheet, not its reserve, but this balance sheet that was Four and a half trillion is now almost $9 trillion. So we're inflating the economy to a greater extent. And now that we have price inflation, not just asset inflation,

the Fed is under this very strong need, I guess, I'll call it, to begin to address the inflation problem. And I worry about what the consequences of that might be for the economy. Going back to very basics for a moment, for those listening, can you give us the 101 on price and asset inflation and what the goal of the Fed is and the basic tools that the Fed has to combat those challenges? It's a broad question, but can we get a 101 on this? Sure.

Well, inflation can be caused by various things, but fundamentally, if you are, producing more money, that is you're putting more money into the economy, than you have goods in the economy, then people will bid that money for those goods and prices rise. So in asset values, you were lending, you were providing this money to the banking system. The banking system was lending it to companies. They were lending it to hedge funds.

and those heads funds or those companies were trying to buy more goods, or since they may not feel they can get a return on investing in plan equipment, they may choose to buy another company. So rather than increase their productive capacity by investing in plan equipment, they'll just buy other companies. And therefore, raise the value of those companies. Or they'll take that money. they'll borrow more because the interest rates are now zero because you're putting so much money in the system. And when you do that, you begin to reconfigure your balance sheet. You use more debt. You buy more goods.

You leverage your company for paying out dividends, buying back your stock rather than investing in goods. Now, when you do that to such an extent, and then you have an increase in public debt, that is then used to also buy goods because the government's buying it or they're giving it to people to buy and in the pandemic, a big part of it was given to individuals as they had to deal with this terrible pandemic,

unemployment and so forth that put money in the hands of people but it didn't actually increase the amount of goods. In fact, the amount of goods may have been declining because of the reduction in manufacturing and so forth. So you're bidding more money for fewer goods, prices go up. like an auction. And therefore, you see prices rising, first in asset values over the decade,

and then in general price level. Now, its effect is to, if the wage earner isn't increasing their wages as fast as the inflation is going, you get real incomes declining. And I tell people, if you think about it, who does that affect the most? Who does an increase in inflation affect the most? The wage earner, because people who have assets, their values are going up, or so, at least for the time being, or they have higher incomes, they can withstand the higher inflation. So it's a tax. Inflation is a tax, and it's a regressive tax. It taxes everyone, poor and rich, but its impact on the middle and lower income is greater than the impact on the higher. So you further, you further divide the country between the haves and the have-nots.

And those are the, those are the very negative consequences. In your opinion, what does good look like from a Fed standpoint? Well, the mission of the Federal Reserve, and you asked me this, is that you want to promote stable long-term growth and stable prices and strong employment. So it has this very complicated multi-mission assignment. And so what looks good to the Fed is low inflation, both asset, now some people's mind just a price inflation, low price inflation and low employment.

The idea, to me, a more important goal is low inflation period, low asset inflation, low price inflation, low price inflation, stable income and real income is rising as productivity in the economy increases. And that's only possible as investment increases in the economy over time. And so you need to have a interest rate that promotes not a boom, not a speculative environment, not zero interest rates, but interest rates that are balanced where I as a saver get a fair return, not 0.2 in my... I, as a savor, get it, and as a borrower, I can borrow money at a reasonable return so that my investment gives me enough money to pay back my loan and enough to get a return on my capital.

So that would be the ideal for the Federal Reserve. But the problem is, you also want to have low employment. And trying to balance those can get difficult. because if unemployment starts to rise, there's a strong, strong effort, strong pressure on the Federal Reserve to lower interest rates to get things moving again. You can do that a little bit, but if you do it too much, which often happens, then you get inflation. If you do it too little or you tighten down too much, then you get higher unemployment. So it's this very difficult balancing act. One thing that I've said, and I think others have said,

said in the long run, low inflation, moderate interest rates, and low unemployment are supportive of one another. But in the short run, they can conflict. And that's where the difficulty of the Federal Reserve making the right decision comes into play. I love that. That's a phenomenal analysis and makes a lot of things very clear in my mind about what's going on here with this. Tax season is one of the only times all year when most people actually look at their full financial picture, including income, spending, savings, investments, the whole thing. And if you're like most folks, it can be a little eye-opening. That's why I like Monarch.

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What I personally like is that Monarch keeps you focused on achieving, not just tracking. You can see your budgets, debt payoff, savings goals, and net worth all in one place. So every decision actually moves the needle. Achieve your financial goals for good with Monarch, the all-in-one tool that makes money management simple. Use the code Pockets at Monarch.com for half off your first year. That's 50% off at Monarch.com code Pock. You just realized your business needed to hire someone yesterday.

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You get, you become the president of Kansas City's branch of the Federal Reserve in 1991. And in 2008, we have the recession. And you're aligned with Fed policy of quantitative easing. It's a tool in the arsenal and you think it's used appropriately at that point. What shifts in 2010? And you just gave us the overview of the overall economy and the expansion of the Fed balance sheet and the national debt. what are we set in the stage for here? Well, let me clarify in 2008, yes, lots of liquidity was put in.

The theory, in my mind, of central banking is you do provide the liquidity. And the idea is you provide loans or liquidity to the banks who are solvent, who are able to survive after the crisis once the markets begin to trade. again. So the central bank's role is to provide that liquidity and then back off and let the banks and the market operate. And so you pull that back out. You don't shock it out, but you pull it back out systematically. So here we are. We got through the crisis. The low point I would call is in the spring of 2009. The third quarter of 2009, we started recovery. We get into 2010. The world is, you know, struggling to recover, but it's recovering.

It is recovering. So you come to 2010, and I did not at all argue at the time to dramatically raise interest rates. But what was put forward was we need to bring another version of quantitative easing forward to bring more money into the economy, to speed the recovery, to lower interest rates to zero, to actually deliberately raise asset values, so we increase wealth. And by increasing wealth, these people will spend more money, and that will help stimulate the economy. And my concern was, from the beginning,

that when you are recovering, you want to bring things back into equilibrium. That is, you want an interest rate where the saver gets a fair return, not zero. I mean, what good gets traded successfully if you don't have a price on it. You know, it's free. Well, the market doesn't last very long.

People will stop supplying it. But here you have zero, but no one's stopping the supply because the Fed's going to do that. But the thing about it is that drives all these, you know, returns, what you get, drives it down towards zero. And therefore it encourages not just spending for goods and services, but it, it, It increases the amount of money you have for anything that appeals to you. And when it's zero and you can show a greater return on your equity by borrowing at zero and paying back your equity holders who want a higher return and buying their stock back,

or you buy at zero and buy other companies and consolidate your capacity, well, you'll do that. rather than invest, improve productivity. And when you look at that period, that's exactly what happened. We raised asset values, but the real wages didn't increase. Productivity didn't increase very much at all. It was half as much as it was during the period of the 90s after that recession. And so we were pumping money in, but we weren't actually improving the economic well-being of a, of a,

a good part of the United States population. We were making some people, asset-wise, very wealthy. We were creating and extending the divide, but we weren't increasing productivity and the real wealth of the whole nation. So when this started, having been through the 70s, having seen what they're, having studied economics and having studied monetary economics,

my concern was that we would increase asset values, we would worsen the divide, we would misallocate resources, which we did, and that the outcome in the long run would be a poorer nation. And that's what I fear has resulted. It's kind of hard to argue with you because as I'm hearing you say all of these things, I'm like, yep, yep, yep, yep. I mean, how long have we had these super low interest rates and how much has all of these assets, like how much have they increased? And I mean, it goes back even farther than 2008 and 2010. It goes back to, you know, September 11th, 2001, very soon after we dropped interest rates because of that like horrible catastrophic thing. And maybe into like 2005, 2006,

they got up. I mean, high is in air quotes because a lot of the people who are listening, aren't old enough to remember that interest rates used to be in the double digits and you used to pay 7% as like a real interest rate. And, you know, they got into, you know, the 4, 5, 6% in 2005, 2006. And now since then it's been, I mean, my mortgage is, I think, 2.75% and my bank account is 0.000,0.01%. Like, I'm not. I love your idea of paying me for my savings rate. because that's fantastic. Right. And the value of your home

has probably gone up quite a bit. Oh, which sure has. But the thing, you're right, even before 2008, I mean, part of the reason we had the crisis of 2008 was having very low interest rates prior to that. But so the argument back is, number one, Tom Honic,

we didn't have price inflation for most of the decade, 2010 to 2020. And that's all we focus on, price inflation. And therefore, you were wrong. And my argument is, well, you know, I always argued that the inflation would come later. I didn't think it would take 10 years, but it would come later. But the asset value issue was immediate and was taking place. And the speculative thrust was taking place, just as said it had before.

And so we were kind of talking past one another. I'm talking inflation broadly, both asset and price. And I used to, you know, people say that Paul Volcker said that asset and asset inflation, price inflation were first cousins. Well, I think that's the same darn thing, just expressed in a different way. And I think that's unfortunate that we focused only on price inflation. And I think I read the minutes. of the federal open market committee after I left the Fed.

And there were often referred concerns expressed that we weren't meeting our 2% inflation target. So in I think 2012 or 2013, the Federal Reserve, like other central banks, put, said, we're going to focus on price inflation. And that is going to be 2%. So we want to make sure that inflation stays right around 2%. for a host of reasons. And during this period, inflation was about 1.8%. And there was a great deal of discussion or we're not meeting our goal,

even though asset inflation was continuing to rise, and my point was 2 tenths percent difference in price inflation, that's not the issue. The issue is asset inflation. So it's how you, how you, if you will, frame the question will dictate to some extent the answer you, We'll accept. So looking forward, now that we've looked back and we've had basically 20 years of really low interest rates, what do you think is going to happen over the next few years, the next couple of decades, at kind of a high level, we've got to fix this.

We're in a crunch. So how can we fix this? And what do you think is going to happen? Well, the first thing I tell people is there's no simple solution. And here's how to think about it. We've set our economic system in the U.S. and actually globally around a market equilibrium interest rate level of close to zero. So you have this entire system, this network functioning around a base rate of zero and then a yield curve that goes up very, slowly or it's flat. So you want to move this from an environment where you have zero rates,

and now that you're being pressed with price inflation, that becomes more urgent, but you have to change that equilibrium to a new equilibrium. Well, it took us how long to get to where we are. It's going to take us a while, but it's not, it's not painless. interest rates will have to rise. We'll have to get our economy back on a equilibrium where you have savers and borrowers, shall we say, in balance rather than one subsidizing the other. And I think that's what's going to take place. And it's going to take a while to do. If you try and do it all at once, and I wish we could get it back all once, but if you do that, you're going to shock this economy into a major recession all over again. But the hard part is,

I think, and this is my opinion only, you will have to raise rates. The Fed realizes that. They're going to have to, right now, they're still expanding. They're still in a money-ease situation. They're still highly accommodated. They're still buying more government debt every month. They'll do that until March. Then the question will be, do they raise interest rates? And there's a lot of discussion. And they will have to raise interest rates. They know that. The world knows that. They're talking three. I don't know how many times, but I do know that even if they raised the rates three or four times at a quarter point, that will raise the policy rate from about 25 basis points, or of a quarter of a point, to one and a quarter percent or 120. That's still a very

accommodate a policy, one and a quarter percent. So that's, you know, that's the process. So they are going to have to raise rates. There are going to have to raise them probably at least that quickly. And then they need to communicate with the public and say, here's what we're going to do, and then we're going to wait. Because effective interest rates isn't immediate. It takes time. And one of the other errors that sometimes happens in central banks is that they get impatient. So they want to get inflation down, they want to get it taken care of. And it doesn't happen when they reach 2% or 2.5%. So they keep raising rates. And when they do that, they overshoot. So if they get to 2%, they need to wait and let it catch up. But what also happens, and this is the hardest part of all,

let's say they get to 1.5 or 1.5% or even 2% interest rates. And the economy starts to slow. unemployment starts to rise from 3.9% to 4.5%. There will be an enormous amount of pressure placed on the central bank to reverse its policy to stop increasing interest rates. That's what happened in the 70s. So then they would back off from it. The economy would pick up, it would improve, but inflation would immediately shoot back up. And then they'd tighten up again.

And then the economy, inflation was, start to get under control. And then we'd start, unemployment would start to rise. And there would be enormous amount of pressure put on. And the Fed would immediately back off. And then they would have inflation

rise, but even more than last time. And that happened through the 70s until 1979, when inflation was at 14%. So then what happened? Well, now you're really in a very

chaotic situation, a very stressful situation. When people are falling further and further behind, there's unrest, there's financial, and then even political instability. So then Paul Volcker comes in, says, we're going to beat this inflation. It's going to happen. It's going to be painful. And he raises rates, he slows the money growth, should I say, stops buying government, that until rates are 20%. People are really hurting. And this lasts for a couple of years. And then finally, inflation is brought back down.

We can begin to grow again. And interest rates are at a more, what we like to refer to as normal level, where savers and investors are in balance with one another. And so the toughest part for the Federal Reserve over the next five years, or eight years will be to keep

rates not so tight that we strangle the economy but that we slow the growth in demand relative to supply. So the supply catches up and demand slows down to where they're back in balance and we have both assets, price stability,

and price stability. But it won't come easy. It won't come quickly and it will have some pain to it. And that's where I think informing the public that will have this is the best that they can hope to do, because people will not be satisfied with that.

You will see a lot of call for more government spending, and therein lies a very difficult time, because when the government starts to borrow more, as it will, then you begin to crowd out the private sector, and interest rates should rise even more, which puts even more pressure on the central bank to buy that debt, basically help them print the money, and that means inflation will come back again. So it's such a delicate matter, and I think the Fed is far enough behind the curve now

that they're going to have to be steadfast, not choke the economy to death, but steadfast on slowing its growth, slowing the growth in the demand for goods so that the supply can catch up. And that will be the FMC's major challenge over the next half decade or more. So what I'm hearing is we're in for a period at some point, at some point, we're going to have to go in for a period of long-term rising interest rates that are going to come with pain in terms of substantially reduced returns on investments for a number of asset classes, including commercial real estate, maybe energy prices, of other, maybe different things from the, the 70s there, business and stock valuations, yada, yada, and that that might come with rising unemployment for a period of time. There might be a new normal of higher unemployment and

higher inflation for a long period of time to get this back under control, and that the best thing that the Fed can do is say, yep, that's what you're in for, guys, and we're going to hold steadfast to that, and it'll take us 10, 15 years or however long it takes to get us into a comfortable spot there. But that's what I'm hearing you say as the solution to the current situation that we're in. Hopefully not 10 or 15 years, hopefully less than that, a lot less than that. If people become convinced they are going to do this, and you said higher inflation, no, higher interest rates, and hopefully you see inflation come down steadily, maybe even sharply, depending on how convinced people are that the Fed is going to stick to their guns. But hopefully

you want inflation to come down, and you'd like to see that happen in three to four years, if not sooner. But the danger is if you don't stick with it and you back off and you start printing money again, then inflation will pick back up, and then you have to do it all over again. That's what happened in the 70s. And so what they need to do is make it clear, we're not going to strangle you. Yes, rates are going to be higher, but zero is not an equilibrium rate. It's an unstable rate.

So we're going to bring it up carefully. And we are going to see inflation. We back down to 2%. That's our goal. And we're going to keep interest rates tight enough, not so tight we strangle, but tight enough to do that, whatever that number is,

and we'll watch it carefully. And hopefully in the next two to three to four years, inflation will come back down to two. Now, the Fed thinks it'll be next year. I think that's very, I think that's unlikely, but it could come down over three or four years if they stick to the guns and people believe them

and they know they have their best interest. Now, unemployment will go up somewhat, I suspect, but hopefully not so much that we have an unstable environment. So that's really the goal that I think I would have. And I hope a goal like that. Maybe they're better, you know, their technicians are better that they can get a path that's easier, but I doubt it. As an investor, we talk about this concept called the 4% rule that says, hey, if I build a

portfolio and have a mixed stock bond portfolio, that if I get to about 25 times my spending or withdrawal just 4% of that portfolio per year, I should be able, I can call myself retired. That portfolio is very rarely likely to result in the case I'm going to run out of money. Some exceptions to that rule include 1929 with the Great Depression, and then 1965 and 1966, the years immediately preceding the period of high inflation and rising interest rates that we just talked about here. Should investors or retirees be worried, given the prognosis that you just described about their portfolios? And if so, what are some things that you would be thinking about for those types of those investors who are, looking to make sure that their money lasts.

Well, that's a, you know, that's a hard question to answer because obviously if you think inflation is going to continue, then you want to leave it in an asset whose value increases with inflation. And your challenge is to be confident that interest rates aren't going to go up so sharply that you cause asset values decline or that even if they, if they, if they did, you know, decline, but, you know, over time they rebuild, you might be okay with that. Because, you know, there's no easy answer to that, but you want something that generates income. And that would be, shall we say, inflation sensitive so that your spending power isn't, your real spending power

isn't compromised. And that's something for portfolio advisors, I think, to consider. My, my concern is, if you're in a fixed income environment and you have assets that don't generate revenues that are, shall we say, tied to inflation, or you're on a fixed pension, which even Social Security today is indexed, but if you're on a fixed pension, then your purchasing power will go away very quickly.

And that's what I would be concerned about if I were getting ready to retire and so forth. But other than that, the only advice I can give is you have to have an asset, generates a revenue that is sensitive to inflation and increases with inflation, and would recover if there is an asset shock. In other words, interest rates rise more quickly than you expected that while the asset drops for the time being, it will recover with, with the recovery of the economy down the road.

And so that's really the only choices you have at this point. And, you know, if you look at the past, even in the shock period of the 80s, where we had inflation of, you know, 14%, and we did interest rates of 20%, and the economy did go down. Over time, you know, assets that generated income did come back, and that's really you have to be thinking of the long run. Now, whatever your long

run is, if you're 75 or 80 years old, well, your long run is a little shorter than that recovery might allow for. So that's all the different. And you know, you'll be in an asset, you want to be in an asset that doesn't decline in value as quickly, whether it's some form of very short government securities, which you won't lose quite. as much value on, those are choices that people have to make as they anticipate the future, which is unknowable. That's the unfortunate part. I have another question on this front. You know, from a retirement planning perspective, for the last 50 years, rates have been generally declining, right, over that period of time.

And in a period where rates are declining, if you lend, that's very good, right? Your equity value of your bond portfolio shoots up. And that's been happening for this entire, in this entire period, right? And retirement planning hasn't been around that much longer than those 50 years in a truly meaningful sense. So, you know, I love what you're saying there about how you need something that's tied to inflation. That means, you know, having a lot of bonds in your portfolio seems like a bad bet if you think that inflation is going to increase or that rates are going to increase over time in a general sense. But it's just that hard question that people are asking themselves.

Everything you're saying makes common sense. But if I don't like bonds and stock values are overpriced because of low interest rates and real estate asset prices are really high because of low interest rates and I don't like Bitcoin, where do I go for that yield? And it sounds like you don't have that answer either other than tie it to something that is going to increase with inflation, perhaps like, like, real estate, if you can separate out the asset value, the income stream from a real estate investment might be protected over a long period of time, for example.

That's exactly right. Now, I mean, that's my point. I mean, we're in a difficult situation. We've carried on this program for over a decade. You know, every slowdown is met with a new, a larger amount of quantitative easing. we've distorted the market. And so I don't have a solution that saves everyone. And I don't think the Federal Reserve does either.

What I worry about, though, and this is the hard part thinking ahead. Do I have confidence that the Federal Reserve will pick a path of bringing this back into a 2% inflation environment? will it be able to withstand the pressure should, not necessarily it must, but should unemployment start to rise, and there's a good chance it will, will they stick to it until they get the inflation brought back, and will they also stick to it to make sure asset price inflation is stabilized so that you don't have this increasing divide between the haves and have not? And if you have confidence they will do that, then you can weather this, most of us can,

weather this, and get it back to a decent equilibrium. If, however, they, and they will be, because people don't think about it in terms of the long run, they're losing money, they're unemployed, I understand that completely, scares me to death. But if they then say, well, no, no, we'll print this money, then we have even higher inflation. People fall further behind, and you create this instability. then I think the outcomes long term, even intermediate term, are worse. So it's a huge challenge. It's a huge challenge for this country.

And I just don't see a simple solution. Maybe there's one out there, but I haven't seen it in all my years. You've mentioned unemployment rising a couple of times. And you quoted, I think, 3.9 percent. Is that what it currently is? What's a good unemployment rate or what's more of an equilibrium unemployment rate? Well, that's a very fair question. It's an estimate.

People, you know, what's the right? Zero. Well, people are changing jobs all the time. It used to be, you know, four and a half percent was about to be about right. That seemed to have the mix in the market and enough for the economy to, you know, be able to function well. People would lose their job, but they'd get rehired. So, you know, I think. think, you know, but some people think 3.9 is the right number. And that's part of the problem.

Is it the right number? Well, I don't know. And not knowing is, you know, allows for you to say it should be 3.5 or 4.5. And so what happens, though, when people become unemployed, it becomes a major issue in this country. I think if it stayed around 3.9 or 4, people would be very satisfied with that. I don't say that, knowing everyone's situation. but if it gets to 5%, 5.5%, then people will become very, very uncomfortable with it. The politicians will for sure. I think different interest groups will become less sanguine with it. And so they'll start building pressure on Congress who will build pressure on the Federal Reserve. And the Federal Reserve was designed to be semi-independent so they could withstand that pressure.

But if you're the chairman of the Federal Reserve or you're an open market committee member and you're getting the tears, if you will, from people who have been in unemployment, it's pretty hard to resist that kind of pressure. But if you don't, in the long run, there'll be more unemployed. Because if inflation gets to, you know, it's 7% now, it should come down if they follow a good path. If it gets to 8, 9%, I can assure you that in time, unemployment will rise as well. Because high inflation creates uncertainty. Uncertainty creates a holding back of investment, a holding back of building and investing,

and that creates unemployment too. So it's not necessarily one or the other. You have to get the economy back in equilibrium. with the interest rates that allow you to have growth without inflation and allow the unemployment rate to stay at a reasonable level, which probably is four and a half, maybe five percent, and be willing to live with that. So it's hard.

Yeah, what I'm hearing is it's an art, not necessarily a science in a lot of these different types of things, and that's why it's so debatable with all these things. What is the right interest rate for that equilibrium? We don't know. Maybe it's 2%, maybe it's 4%, maybe it's 3, maybe it's, I don't know. But then what's the right level of appreciation? It sounds like, in your opinion, a huge, a subtle but very powerful maneuver we could do to get that right might be something like an index instead of the CPI, something that combined that with asset prices of major

asset classes or something like that. And then the same deal has to do with unemployment with this. Right. But once you do indexing, then you start. then that affects the distribution. What you want to do is have, you know, frankly, if I were able to choose, I'd have inflation less than 2%. Because that over a generation has a big effect. But if you got it to 2%, now, you know, people know that 2% unemployment is going to be impossible to maintain.

Most people agree to that. So where the debate comes is between, you know, say three and a half, actually four percent and five percent or four percent and five and a half percent. It's not, you know, most people agree eight percent is too high in unemployment, and most people agree that two percent is too low. Most people agree even seven percent or six percent. So you get, you get an area where you can live with it, and then inflation, two percent is about where you ought to be.

I would prefer less, others prefer more, so two percent's about right. And that at least allows for certainty, it allows for confidence, it allows for innovation. And the real building of wealth, and this is a critical point, the real building of wealth, is not in printing money. It's not in the government just spending for spending sake. It's in efforts that improve productivity. So investment in plant and equipment or maybe infrastructure, right? because it improves how goods move and so forth.

So if you focus on what improves productivity and you focus on assuring price stability that allows for unemployment to remain around 4% or 4.5%, then you have an environment that is stable and in the long run prosperous and everyone gains. Not just some who happen to hold the assets, But people across the spectrum, and that's the goal. And that's hard work, right?

And so the federal policy has to, the Fed policy has to encourage that and not say, oh, great, instead of having to do all that work, here's money for free, buy a bunch of businesses, aggregate them together, and let the scale multiply your equity and speculate away. And I think the Federal Reserve, you know, I don't say that anyone that I, anyone I worked with had bad. intentions. I mean, they're always intended to help the economy improve. It's how you judge the consequences where the differences come. My judgment was the consequence over the long time would be counterproductive. Others thought it would be pro-productive. So that's where

the differences come. So the goals are the same. And you say it's art. Well, one of the difficulties is that economists think they're scientists. They build these complex models, which is fine to check with, but it is a matter of judgment, of balancing it. You can use the models, you can use the past experience, you can model it, but when it comes down to it, it is an art. It is applying the right amount of pressure or releasing the amount of pressure at the right time to allow this economy to prosper. And that's really what it's all about. Well, this has been, this has been fascinating for me. I've learned a tremendous amount here with this. And if I walk away with one thing, it's that art versus science from the Fed. I think that that's the biggest takeaway. And what should

those long-term objectives be? And I think a lot of people are going to come away a lot more informed about this stuff and have some good perspective, cautioning them. I hope so. And I hope they're able to have the pay, because it's really important for the public to have the patience to get through this. Not just the Federal Reserve. It has to be the public. The Federal Reserve has to be able to stay the course, but the public has to be willing to appoint support that effort. And hopefully that's what they'll do. Awesome. Anything else you'd like to share with us before we conclude here? I probably talk more than I should have already, so I'm good. I think we could listen to you all day, and this has been fascinating and a privilege.

Thank you very much for sharing all of this. It's been my pleasure all the way. Thank you. Yes, Tom. Thank you. No, you could, you're welcome to stay for hours. This is a lot of fun. Well, thank you.

I really appreciate your time today. Sure, sure. Okay, we'll talk to you soon. Scott, that was so much fun. I'm so delighted that we were able to talk to Tom. He was such an interesting person. What did you think of the show? I loved it.

Like, you know, in another life, I would love to have had a career like Tom. It just seems like such. a fun, not a fun, but like how to impact the society at the large scale, how to have, how to learn the ins and outs of what these things mean. What, what, you know, what a, what a guy to be the lone individual, at least within the votes that he was a part of voting no against certain things because of the strength of his convictions with that. So really a lot of admiration for, for him and his career. And then just learned a lot today about this. The frameworks around, what is inflation? Well, inflation is.

is the increase of price, the increase in the price in goods and services and assets. And there may be first cousins, but maybe really the same thing with this. And how does Fed policy contribute to income inequality in this country or wealth inequality? I mean, just so many frameworks that tie together the decisions that are being made at the highest levels in our government. And what impact that has on ordinary folks like us. and the prices and retirement theory in general. Another thing that we were, we chatted about very briefly,

and I'll say this, you know, there's nothing that Tom observed here, but I, you know, when the pandemic struck, right, I'm a rental property owner and we, you know,

the stimulus checks go out. Unemployment is, is distributed, $600 per week for the first part of that summer, then $300 a week for a very long time following that. And great. So I did not receive a stimulus check. My income was above the threshold there.

I'm very fortunate with that. But my tenants all did. And so in one way you could think, and they use that or a portion of those proceeds to pay the rent to me as the landlord and property owner. And interest rates came, you know, crashing down. And so my property portfolio, you could. argue was in some parts heavily subsidized, if not nearly guaranteed by unemployment and other government handouts. And the interest rates were very low, which increased, which I think was a big

factor in some of that 20% price appreciation that we saw nationwide in 2021. So you could argue that I'm hundreds of thousands of dollars richer and have an even more stable source of rental income as a result of that policy, while my tenants who were directly received the cash, arguably aren't that much better off than they were in the first place. And that doesn't make sense from a policy standpoint, right? You have to think, regardless of your politics, that's got to be a tough one to, that can't be the intent of the policy is to put hundreds of thousands of dollars into the property owner's pocket and give it, you know, essentially have the folks at the bottom, no better off. So something,

to noodle on there and think about. And I'll be really interested to see how the Fed does handle things going to go forward basis and how public opinion and public policy is handled over the next several years. We've got some interesting challenges in store. You know, that's an interesting point, Scott. You said, I don't think that was the intent of the policy. And it seems like a lot of what they intend doesn't actually happen in real life. So perhaps the Fed needs to start thinking about different ways that their policies can be interpreted and, I don't know, narrow down the, like really focus on what you want to have happen and what is the best way to get this result. And if that's by raising interest rates, then let's raise interest rates.

And what are all the things that could happen when we raise the interest rates? And, you know, like Tom said, let's educate the American people and let them know what is going to happen down the road. And kind of keep that. I mean, you know, it's, it seems like we're in for some tough times. And not telling people about these tough times that are coming down the road doesn't make them any less tough. Yeah. I think, you know, my biggest takeaway is one day, hopefully sooner rather than later before the damage gets even more painful, we're going to get a moderately tough minded, you know, a fed here that's going to have to make some tougher decisions.

they've made in the past because they can't continue the party forever. And we as a public need to be receptive or, you know, supportive of letting that person push that through within certain limits, right? And there's a reason why it's, it's a separate, you know, it's a separate entity from the federal government. And there's not, you know, there's that division of, of powers there. But, you know, I think that that's, that's my biggest takeaways. We're in for that at some point. Somebody's going to have to do that. And they've got to be a tough enough individual or tough enough set of leaders to go and carry that out. Yeah. Well, I hope it comes soon so that we can get back to the equilibrium that Tom was talking about.

Absolutely. Okay, Scott, should we get out of here? Let's do it. From episode 281 of the Bigger Pockets Money podcast, he is Scott Trench, and I am Mindy Jensen saying, fly high, Eagles.