We Study Billionaires - The Investor’s Podcast Network - TIP411: How the Federal Reserve Broke the American Economy w/ Christopher Leonard

Starting point is 00:00:00 You're listening to TIP. On today's episode, I sit down with investigative journalist and author Christopher Leonard. Chris wrote a New York Times bestselling book called Coke Land, which profiles billionaire Charles Koch and Coke Industries. He's also the author of a new book entitled The Lords of Easy Money, How the Federal Reserve Broke the American Economy. In this episode, we discuss the origins of Coke Industries and how Charles rose to his billionaire status, the operating system of Coke Industries known as,

Starting point is 00:00:30 market-based management, Charles Koch's legacy, and his mysterious operations behind closed doors. Then we pivot to the new book, The Origins of the Federal Reserve and How It Operates, actions taken by the Fed since the Great Financial Crisis that have resulted in a very challenging predicament for the world's economy. The untold story of Thomas Hanig, a director at the Fed, who was the sole opposing vote to the early Fed initiatives following the Great Financial Crisis, which resulted in a severely damaging reputation that Christopher aims to redeem and much, much more. The influence of the Fed is becoming more and more understood by Main Street, and it can be an endlessly fascinating discussion. That's what I found here with Christopher Leonard,

Starting point is 00:01:10 who I probably could have talked to for hours more. I especially love how he's able to weave together such a great story. I hope you enjoyed as much as I did. Here's my conversation with Christopher Leonard. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Welcome to the Investors Podcast. I am your host, Trey Lockerbie. And today I have with me author Christopher Leonard on the show.

Starting point is 00:01:53 Welcome to the show. Thanks for having me. Well, I really enjoyed your book. It's called The Lords of Easy Money. And we're going to get into that discussion around the Fed and how it operates and where it might be heading. But you've also written another book. and that was on Charles Koch and Coke Industries.

Starting point is 00:02:13 And Charles Coke, we've studied a little bit here on the show, but I'd like to kind of get your take on Charles since you did such a deep dive on him, ended up writing this book about him. It's all very fascinating. So I wanted to start there and just to learn a little bit about, first of all, what led you to want to write a book about Charles Coke. Yeah, the books are actually tied together in interesting ways. I almost consider the Lords of Easy Money as part four. of Coke land, which was a three-part book. And what, you know, what drew me to Charles Coke was initially his corporation, Coke Industries, which is the second largest privately held company in America. It's just enormous. I mean, its annual sales were bigger than

Starting point is 00:02:55 Goldman Sachs, U.S. Steel, and Facebook combined. And it's just a huge company. But what really drew me to it was how diversified it is. And it seemed like just sort of a perfect vehicle to explore what has been going on in the American economy over the last 50 years. Because inside Coke industries, you've got blue collar manufacturing, you've got raw material processing, the fossil fuels industry. You've got very high-end financial trading. Coke, you know, it's not very well known, but they've built a financial trading desk that rivals anything on Wall Street. And so that's what drew me to this company in the first place, is I just thought it be a great way to sort of do a portrait of American capitalism from 1967 to present day.

Starting point is 00:03:40 Now, it's hard to say, just judging by what you find on the internet, but it's reported that Charles Koch is estimated to be worth something over $50 billion. He's in his mid-80s now. Give us kind of an overview of where Charles started and how he was able to grow his wealth to over $50 billion in that time frame. Yeah, it's a fascinating story. Charles Koch was born in Wichita, Kansas. He was one of four sons.

Starting point is 00:04:06 And his dad, Fred Koch, was an entrepreneur, an engineer. And Fred Koch owned this company that was really an agglutination of a lot of different firms. He owned ranches. He owned engineering manufacturing facilities. He owned oil refineries. And to be honest, it was kind of a hodgepodge of industrial holdings. And I used the year 1967 because that was the year Fred Coke passed away.

Starting point is 00:04:33 And Charles Koch was 32 years old at that time and had been made president of the family company, and he quickly reshaped it and renamed it as Coke Industries. And that's really where this modern company that we have today began. And over 50 years, Charles Koch was CEO of this company and really did have unadulterated control over it and built a corporate colossus. And I think at the heart of what Charles Koch has done, what was a president of the United States, most interesting to me is that this guy is a long-term strategic thinker. And a lot of what I talk about in the book is how he fought vehemently to keep control of the firm. He's kept it private

Starting point is 00:05:16 all of these decades. He's plowed 90% or more of the profits back into the company to help it grow. And he's done all of that so he could always keep an eye on long-term strategy, you know, a horizon that's not measured in quarters or even years, but, you know, well, over many months, years or even decades. Talk to us about some of the philosophies that went into growing that business. You talk in the book about this thing called, this philosophy called market-based management. What is that exactly? And how did that come about?

Starting point is 00:05:49 It's such an interesting thing. So, you know, as I said, Charles Koch's always maintained tight control over this corporation. And one of his, I mean, I'm just going to call it one of his primary obsessions in life is writing a blueprint for how to manage a corporation. But it really does even go deeper than that. I mean, he feels like I think he's discovered a blueprint for how to run countries, nations, and societies. And it's all oriented around sort of free market beliefs, you know, competitive capitalism

Starting point is 00:06:21 beliefs. His big role models would be Friedrich Hayek, Ludwig Vos. Von Mises or von Mises, I always mispronounced that one, these Austrian economists who said that, you know, the best way to organize society is a capitalist market where you don't hold on to institutions, but there's this constant wheel of creative destruction that dissolves old institutions and replaces them with new ones. And Charles Koch wanted to kind of codify this free market view into a management manual, right? like the operating manual for Coke Industries. And that's this thing he calls market-based management. And he's been sort of refining this philosophy over the years. And if you got hired at Coke Industries today, you'd spend the first few days of your

Starting point is 00:07:08 employment going through days-long seminars on how market-based management works. And the idea is you're encoding free market laws into corporate management. What does that look like, though, exactly? What would be an example of that, I guess? It begs the question of like how effective is it, how real is it? Here's what it looks like. Let's say I get hired into Coke Industries as a commodities trader in Houston, Texas, okay? And I'm trading oil futures or oil supplies.

Starting point is 00:07:41 Within the market-based management system, I'm seen as something like a small property owner. And I'm given a certain amount of responsibility, a certain amount of money that I can trade every day. and it's trying to synthesize a market environment. So if I do well, okay, if I'm making good trades, if I've got a good insight into the market, ideally I should be gaining more and more authority, more and more responsibility or within this structure kind of more property. They think of themselves as like property owner with a growing role, you know, more money in my disposal to trade.

Starting point is 00:08:16 And, you know, that's one example of how this is supposed to work. but it's got this sort of encoded vocabulary. And it's how these people think. Like, for example, they talk about mental models, humility, and point of view. And these things kind of sound like cliches, but they have strategic and specific meaning inside Coke. Like, when I talk about my point of view, I don't just mean like Chris Leonard's thoughts, feelings and, you know, political ideology. I mean, like, this is my sharp and. analysis of where I think the market is today. That's my quote, point of view. And I'm going

Starting point is 00:08:55 to back it up with a lot of research into the fundamental factors driving the market. And I'm going to develop a view of what the world is like with the very concrete goal that I'm going to go out into the markets and trade on that point of view, which should be superior to that of my competitors. In other words, I should have a sharper, clearer understanding of how the world works. So you've got all these guys walking around, men and women, I'm sorry, all these guys and gals inside Coke industries walking around using these terms like point of view and mental model. And to me, the biggest effect of this philosophy, you know, while it is effective, I think, on the X's and O's, on the tactical reality, it's effective. But it's very powerful,

Starting point is 00:09:38 very powerful in creating a common vocabulary and the sense that people inside Coke are roe the boat in the same direction. And that's really important with a company like this, which is so diversified. You got to have people, you know, in the natural gas unit versus people who make particle board versus people who are trading commodities, all feel like they're part of a unified whole. And it seems, you know, again, like kind of a cliche, but to have everyone speaking the same language and kind of having the same point of view really helps unify the team. And I think that that's one the most powerful things of that whole philosophy. That raises the question around how unique that operating system is to Coke Industries,

Starting point is 00:10:25 meaning you would think it's been very successful for that company. Has it been adopted anywhere else that you're aware of? That's one of the interesting things. It has not zero outside adoption as far as I've been able to determine. It's not like there's this playbook getting used in different companies. And frankly, I think that's something that kind of frustrates Charles Koch. I mean, as you mentioned, he's sort of getting into the twilight of his years. You know, he's working past 20 years past the age when many people retire. And you can see he's very focused on sort of trying to package and export this philosophy. He's written at least three books, commercially published books about market-based management. But he,

Starting point is 00:11:08 first of all, it's very difficult to export Coke's secret sauce. I mean, this is a very specific company with very specific capabilities and skills that are difficult to export. Coke is extremely good processing raw material. That's kind of what's at the heart of their oil refining, their natural gas production, the nitrogen fertilizer plants, their Georgia Pacific plants. A lot of those skills and mindsets don't export to like a newspaper or a clothing retailer. But also, it's fascinating to me this dilemma that Charles Koch faces when he writes about it because secrecy is key to this corporation.

Starting point is 00:11:52 They get a lot of black eyes in the media for being this sort of opaque and secretive organization. Frankly, a lot of that's true. But it's not just because they're trying to do something nefarious. It's because, you know, the whole key to this company's success is knowing more than your competitors know about markets. So you can trade well. So you can buy and sell other companies well. And when that's your major strategy, don't show your cards, you know, secrecy is strategic. So when Charles Koch tries to write about market-based management, I can read it. I've read all of his books, frankly, several times and interviewed people in the company. You can see how he's got to kind of hold back.

Starting point is 00:12:31 He can't really talk about what they're doing because it would give away too much of their information. And so I think that's kind of hobbled his books and maybe slowed down their adoption. You have interviewed quite a few people, especially for this book, I think hundreds of employees and people close to Charles. What was your takeaway as far as what were, I guess, some of the traits that you would say created his success over the last 50 years? What have maybe the personality traits or otherwise? Relentless and obsessive drive to achieve. And that's one of the biggest mysteries to me of this guy. It's, you know, he was born quite wealthy.

Starting point is 00:13:11 He became sort of almost incomprehensibly wealthy. Like, you could never spend all the money he makes, but he still shows up at work before the sun is up many times. And this is a guy who has been just relentlessly focused on pushing and growing this company to make it as large and successful as possible. And to be truly unwavering in that mission. I mean, I think that that's the most important thing is, is, is the internal motivation, direction, and obsession on the work.

Starting point is 00:13:47 That's one of the things that hits me most. And then second, and this is a little bit more specific to Coke Industries and what they do, it's this thing of having the mind of the engineer. Charles Coke is almost dispassionate, right? He's a nice guy. He's charming. He's folksy. He makes you feel comfortable in a room.

Starting point is 00:14:08 But he's not Mr. Go out and get beers with the team. and slap you on the back kind of guy. He's analytical and again focused with this strategy that's long term. And he's really not battered by the ups and downs of markets. So I think that comes from working in the energy industry for so many decades where the volatility can just be gut-wrenching. And so, you know, for his management style, he's always focused on how this is going to benefit the company over a period of one, two, five, ten years. And if you come into the office and you've had an absolutely like catastrophic quarter. There's not going to be yelling,

Starting point is 00:14:46 slamming fists on the table. It's going to be more of like, okay, is what's going wrong a symptom of a much deeper problem? Or is this a downside in the market? Does this present us an opportunity to buy? And so I see this real kind of engineering mindset and a long-term strategy that's, I think, at the core of his success. Given that Charles Cook is not. now in his, you know, mid to late 80s, what would you say his legacy will be, and what do you think he would want his legacy to be? Okay. I mean, I feel like I can answer the latter part pretty easily. I think he wants his legacy to be, I think he wants to be seen as one of the great business figures of our era. I think he wants to be seen as one of the most successful

Starting point is 00:15:35 business people of our era. And, you know, not to be cheesy, but kind of a philosopher. King. Again, the guy has published three books about his own personal history, his management philosophy. I think he wants to be seen as a deep thinker in terms of corporate affairs. You know, the actual legacy he left behind is going to be complicated by the one topic we've not talked about, which is politics, you know. He really does think he understands the blueprint for how society should organize itself. And he hasn't been shy at all in trying to make that vision of reality. He's been very politically engaged for decades.

Starting point is 00:16:19 And that's going to be a key part of the history that's written about him. And the thing that really rises to the top on that, this isn't going to surprise any of your guests, I think, is his stance around global warming and around the fossil fuels industry, which is just key to Koch industry's long-term profitability over the decades. He's fought very, very hard against any kind of government regulation to either hinder fossil fuel emissions or put a price on carbon emissions. When the history is written, I think that will be a key part of his legacy. And also, you know, I think within the business community, his corporation will be a case study in corporate management that will probably be looked back upon for a long time. Now, you are an investigative journalist.

Starting point is 00:17:11 I'm sure part of the appeal of writing about Charles Koch had to do with some of the political aspects that he's involved in. Can you just give us an idea of, you know, maybe an example of him and his controversial way of potentially working within the shadows? Because I think it kind of ties potentially to this next subject we're going to talk about around the Fed. Yeah. It's just fascinating. I mean, Charles Koch has this, like, well-known saying that the only whale that gets harpooned is the one that comes to the surface. And it's kind of a joke in the sense that with his political team, I know I've interviewed folks up and down all the levels of his political team. They operate below the surface. And this really borrows directly from the corporate playbook I just told about of strategic secrecy. And I think Charles, Kyle's Coke has a very detailed, granular view of the machinery of government in the United States. And he's very smart about how to approach that, how to hit the pressure points, you know, where there's good opportunities to buy low, sell high, to gain a foothold to push your agenda. And by that, I mean, you know, getting out into the state government level where you can get a state seat in a state house or state senate for like $15,000 of campaign money.

Starting point is 00:18:33 So they've been very smart in taking this kind of 360 degree approach to influencing politics. And, you know, I mean, you asked about a specific story that they pushed very, very hard against the cap and trade bill to control climate emissions back in 2010. And then they've got an extraordinarily sophisticated network to do that. I mean, they would, you know, I show in the book how they they pay someone to do a study without having Coke's name on it. And then they pay their think tanks to amplify that study and go testify in front of Congress about it. And then they use material from those congressional hearings to make political ads to target vulnerable senators who are in the way of their agenda.

Starting point is 00:19:18 It's a pretty complicated machine that all works together and Coke can keep its fingerprints off of it. And it's done in my mind a remarkably effective job of pushing their agenda on Capitol Hill. Fascinating stuff. Okay, let's talk about this new book that you've written. It's a topic we talk a lot about on the show, which is the Federal Reserve and its influence. I would say, you know, going back even five, maybe 10 years ago, hardly anyone was really knowledgeable about the Fed. But I feel like it is entering the mainstream now.

Starting point is 00:19:52 I think a lot of folks are starting to become aware of their power and influence and how much markets really depend on their every move. even on Main Street. So I'm kind of curious if you had a personal experience with that or what led you to kind of investigate this aspect of the economy? This is how these two things bleed together. One of the things I love about being a reporter is you get to meet all kinds of people. I mean, I just love it. I have talked to folks totally across the political spectrum and all walks alike.

Starting point is 00:20:24 And reporting Coke Land put me into contact with some extremely interesting people. And there's this one guy I talked to who talked to me on background. So I can't like say his name. I'm not trying to be coy or anything. Super brilliant guy. And we talked for 11 hours during our first interview and, you know, to talk about asset markets. And this was back in the year 2016. And I think that this guy didn't have people to talk to about this and was just sort of happy to have an open ear. And he laid out for me what he was seeing in markets. And it blew my mind. And one headline I'll take from what he told me is that, you know, in the first century of its existence, the Federal Reserve printed about a trillion dollars. And specifically what we're

Starting point is 00:21:16 talking about is it increased the monetary base to about $900 billion. The Fed, as an institution, has one superpower, it can create new dollars out of thin air. And no one else can do that. And that's why the Fed is one of the most powerful institutions in the world. And these dollars it creates are new money, high-powered money, foundational money that we call the monetary base. To over a century, the Fed boost the monetary base slowly and incrementally to $900 billion. And then in about three and a half years after the crash of 2009, the Fed prints $3.5 trillion. In other words, it does three and a half centuries worth of money creation in about three years. So, wow, what we're talking about now is a step change, a breaking of the graph, a new era in history. And this has had

Starting point is 00:22:10 really dramatic side effects in our economy, in our financial system, in our banking system. I I mean, this money wasn't a neutral force. It really did change the shape of the American economy. And that's what got me obsessed with the Fed in 2016. I mean, I had read a lot about the Fed and its emergency rescue efforts during the crash of 08. But it's what came next. It's what came during the decade of the 2010s that I felt was not written deeply enough about. There wasn't a book about quantitative easing or seven years of zero percent interest rates. And that's the era that really fascinated me. And so that's what this book is about.

Starting point is 00:22:58 It starts when this era in my estimation really started, which was November 3rd, 2010. And then it takes us up through the present day after the COVID crash. And what you see is a system totally re-engineered by the Federal Reserve. Let's take a quick break and hear from today's sponsors. All right, I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord, and every conversation you have is with people who are actually shaping the future. That's what the Oslo Freedom Forum is.

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Starting point is 00:27:23 Back to the show. Let's talk about some of the fundamentals around the Federal Reserve, especially for those who haven't studied it. If you go on the Federal Reserve website, it says it's not, quote unquote, owned by anyone. And it's a decentralized board of governors

Starting point is 00:27:38 essentially from both public and private characteristics is what it says. So talk to us about the makeup of the Fed and how its governance actually works. The Fed is the result of a bizarre experiment of genetic engineering in government. It's part private enterprise. It's part bank. It's part government agency. And I actually, I try to walk through this history really briefly in the book.

Starting point is 00:28:06 But up until 1913, we really experimented a lot with. money. The United States was very resistant to creating a central bank. If you could have a modern industrial capitalist society without a central bank, we would have done it. There's always been this reticence in the U.S. to create something that could be so powerful as a government-run central bank. The worry was that it would displace the private market. The problem is, we had this sort of wild west of currencies. I mean, literally in the late 1800s, there were hundreds of currencies in the United States. So if I went to Oregon and stayed in a hotel, I would present a bank note from Ohio, and we would have to argue about the soundness of that currency. This led to an

Starting point is 00:28:52 era of financial instability. We had long periods of deflation. We had regular bank panics. And finally, in 1913, we established a central bank with two key jobs. One was to create a national currency called the Federal Reserve Note, otherwise known as the dollar. The second thing the Fed did was it took the role of being the lender of last resort. So if there was a bank panic, the Fed could create new money, lend it to banks that were otherwise sound that would have been hurt by the panic and stopped the panic. That's what the Fed was created to do. And it actually did a pretty exceptional job along those lines over the next century, which

Starting point is 00:29:34 we can talk about. But to your point of who owns it, who runs it, the tensions around the, the tensions around the central bank are built into the Fed. I mean, it's really a network of 12 regional banks. There's no one federal reserve bank. There are these 12 banks around the country clustered in a map that really reflects what the world look like in 1913. There are two banks in Missouri, for example, and only one really out on the West Coast in San Francisco. And the governing structure was supposed to be decentralized, like, you know, to reflect the federalist model of the United States. The regional bank presidents had authority. But then the Fed created this governing body in

Starting point is 00:30:17 D.C. Okay. This is the key headquarters of the Fed. It's in a building on the national mall called the Eccles Building. The Eccles building is not a bank. It's this home of a board of governors. And what we've seen over the decades is that power has really consolidated away from the regional banks and into the Eccles building where you've got seven governors who are selected by the president and approved by Congress who really make these key decisions about how our currency is managed and now way more than that. I mean, what the book is talking about is how the Fed has become incalculably more interventionist than it ever has been in its history and is now doing way more than just setting interest rates. But anyway, those decisions are confined now to the Board of

Starting point is 00:31:06 governors largely in D.C. And the last thing I'll say is that, you know, these governors sit on a very important committee called the Federal Open Market Committee. The FOMC is probably the most powerful body on economic affairs in the United States. Well, the book is called The Lords of Easy Money, how the Federal Reserve broke the American economy. Those are very, that's a very strong claim. And so I want to talk a lot about that and the roadmap to get there. Tell us the story of Thomas Honig. And let's start there because he had this example. He was trying to, I would say an example of rebellion. He was trying to display post the GFC. And how futile was that or how prosperous was that and how much of an impact was Thomas able to make? Let me please hasten to say,

Starting point is 00:31:59 you know, lest your listeners think I'm a bomb thrower. When I say broke the American economy, I believe the evidence is overwhelming. The Fed is dramatically widened the gap between the very richest of the rich and everybody else, which destabilizes society. The Fed's actions over the last decade have created a lot of fragility and instability in our financial system by stoking asset bubbles in corporate debt, commercial real estate bonds, stock market, you name it. We're in a real predicament because of that today. And then finally, it has simply encouraged immense amounts of indebtedness in households, corporations, and government.

Starting point is 00:32:38 So we have a lot of bills that have yet to be paid because of what's happened over the last decade. So I think a great place to start and talk about this is with this guy named Thomas Honig, who was president of the Kansas City Federal Reserve Bank. And when I got obsessed with quantitative easing, I started researching it and saw that The really pivotal vote that started all of this on November 3rd, 2010 was the vote to unleash a new and unprecedented round of money printing or quantitative easing. And the vote was 11 to 1. And so as a reporter, you're just sort of like, well, that's an interesting number. You know,

Starting point is 00:33:16 it's not six to five or three to eight. It's 11 to 1. Who was the one? Why would someone be the sole person who voted against it? And that's sort of what led me to Thomas Honig, who was the one no vote. And that's really what began the core of this book, because Thomas Haneck has been misremembered by history. He's seen as this sort of cranky dissenter, this sort of Old Testament monetary policy guy who's a quote, ultra hawk, who is against government intervention, and who voted no for the sake of voting no, and who critically was most worried at all, of all, about inflation and hyperinflation. And he was proven wrong because we never had price inflation until the year 2021. All of that is wrong. That's what shocked me. When you go back and read the actual

Starting point is 00:34:09 historical record, it tells a very different story. And luckily, we have access to the internal debates. You know, transcripts of the internal Fed debates are released after a five-year delay. So we can go back and see what people said at the time, both inside and outside the Fed. And Tom Honegg was making a very very specific argument that takes some time to unpack. But what he was saying in 2010 was, if we go down this path, if we decide to become the central force driving economic growth in America, and we decide to do it by keeping interest rates pegged at zero while pumping $3.5 trillion into the Wall Street system, we're going to create a lot of bad side effects. We're going to create asset bubbles, just like the dot-com or housing bubble that'll make

Starting point is 00:34:57 Wall Street very vulnerable to shocks and crashes. We're going to find it impossible to stop printing the money once we start. We're not going to be able to get back out of this plan. And we're going to essentially enrich the very richest of Americans, because the primary way these policies work is by stoking asset prices. And the top 1% of Americans own 30% of the assets. So he called it an allocative effect. We're going to allocate money in America toward the biggest of the big banks and the richest

Starting point is 00:35:28 of the rich Americans while creating a lot of instability. And this is an argument he made again and again and again. And you can see in terms of his dissent, he'd been at the Fed longer than anybody else during this critical period of 2010. He'd been there for 32 years, was never a dissenter. He'd cast two no votes in his entire career. And then in 2010, he casts an unbroken string of eight no votes. Well, that tells you something.

Starting point is 00:35:55 He threw his entire career on the line to try to stop this policy. And he failed entirely. But he knew he was going to fail, I think, toward the end. But he wanted to send a message to the American public to at least let them know that there had been a debate about this. And some people had tried to say no. Well, that debate is especially interesting because you touch on this in the book, how kind of, I mean, cultish it sounds at the Fed, if I can say that, meaning that they do not want debate. It's very controversial for to have a no vote, I guess. They want to be seen as this unanimous power

Starting point is 00:36:32 that is, you know, doing the right thing for society and shouldn't be questioned, so to speak. At least that's how I read it in the book. Talk about the debates that actually occurred behind doors. You got it exactly right. You know, you could say cult. You could say, cult, you could say extreme group think. This really does tell a much bigger story. You know, that that period I talked about in the 1800s, early 1900s, the politics of money and how to manage our currency was, it was a retail political issue. It's stuff people cared about. You know, when Williams Jennings Brian ran for president, he had this famous quote up on the campaign stump where he talked about you know, you shall not crucify mankind on a cross of gold. It was this line that just drew the huge

Starting point is 00:37:24 applause. That was a line about money policy. He was talking about monetary policy. That all changed, to be honest, when the Fed was created. This started this slow evolution of taking the politics of currency away from the public and putting it into the hands of a very small group of technocrats inside the Fed. And, you know, The thinking behind that wasn't like entirely crazy. The thought was the power of managing currency is so important. We can't leave it in the hands of grubby, corrupt politicians. It must be left in the hands of an institution that is insulated from the passions of politics.

Starting point is 00:38:07 So that was the idea. But what we've really seen definitely accelerated since the Greenspan era began in 1986 was that the Fed started to present itself as this sort of Olympian group, this Olympian committee of brilliant PhD economists who are not really even making policy decisions, but who are just solving math equations. That's the sort of the Greenspan mystique that I talk about in the book or the Fed-Speak phenomenon, as they call it. And Fed-Speak is just to make everything sound so impossibly complex.

Starting point is 00:38:45 complicated that anybody hearing it must instantly assume I could never understand monetary policy. Thank God we've got someone like Greenspan, Bernanke, Yellen, or Jay Powell in charge who can understand this. A key part of enforcing this view that the Fed is an Olympian group of brilliant technocrats is to have consensus and unanimity. It's very important that the votes on that committee I mentioned, the FOMC, the votes are almost always unanimous. I mean, it's a big deal when one or two people vote no on the FOMC committee. I mean, we see Supreme Court decisions all the time that are five to four, six to three, you name it. At the Fed, it's almost always 12-0, 11-1, 11-1, 10-2, and a wild outlier. This is very much done on purpose.

Starting point is 00:39:42 You know, one of the most interesting interviews I did it for the book was with a former Fed governor named Betsy Duke, who's a former Wells Fargo banker, who's a Fed governor for many years. And I mean, she just talked very candidly about how those board of governors would meet before the meeting and decide what the vote was going to be, all orchestrated by the chairman at the time, Ben Bernanke. And this is key because the governors always hold seven seats on the voting committee of the FOMC. They always have a majority. You can't vote. You can't beat the governors as well known. And so the governors would come into the meeting knowing how they were going to vote. And so at most,

Starting point is 00:40:21 you might have one cantankerous regional bank president vote no, but they're always isolated. They're always marginalized. And that's how consensus gets built at the Fed. And frankly, that's why the consequences were so significant for Tom Honek to vote no so many times. I mean, I think it's safe to say, you know, I have come to the conclusion that Tom Honig was right and that he made a principled, informed argument in his dissents. But it's also fair to say he largely threw away his reputation through this string of no vote. He certainly could kiss any job consulting for, you know, Citadel or Blackstone goodbye. I mean, he trashed his reputation in certain circles on Wall Street.

Starting point is 00:41:07 But he felt it was really important to vote no on this and to break the consensus. Well, going back to breaking the American economy, I'd like to kind of understand where you think it started to bend and break. For example, my impression is that if we go back to the Greenspan era, there was an opportunity there to raise rates that was avoided or at least ignored for too long, mainly I think because of this pressure on Greenspan, either to be a likable guy or to just be amenable. to Wall Street, but there seems to have been this missed opportunity, and that's when the bubble started to kind of escalate up the food chain, so to speak. But is that correct, in your opinion, does it go back farther than that? Where do things really start to get squirly? No, I think you've really put your finger on a very important historical moment with the Greenspan era. I do want to point out that, you know, in the book, I talk about the great inflation of the

Starting point is 00:42:08 1970s and lots of lessons we can draw from that. And that happened. There's this fantastic history, is three volume, 2000 page history behind me, like by Alan Meltzer about the Fed. And he just walks through in granular detail how during the 1960s, the Fed knew it was keeping rates too low. And it would try to raise rates a little bit to slow down inflation. But then it would face political pressure because the economy was hitting a rocky road. So it would lower interest rates again and put more money into the system. And that's what led to the great inflation in the 1970s. The Greenspan era is critical. It is the foundation of where we are today. And in my mind, one of the most important policy frameworks that happened during the Greenspan era,

Starting point is 00:42:59 this decision to focus only on price inflation. And what I'm saying here, the Fed felt that it could keep rates low as long as it desired to stoke more lending and hopefully more growth, as long as it never saw consumer prices rise too fast or too hard. And consumer prices, that's everything, you know, bread, gasoline, television sets. At the same time, the Fed and the leadership made a very concerted, a very concerted decision that they would not worry about asset price inflation or asset bubbles. And if assets were roiling and frothing and there was this irrational exuberance we've heard about, the Fed was not going to step in and try to stop that.

Starting point is 00:43:44 This was a really important policy decision. And it coincided with a very interesting period in history when we really didn't see price inflation during the 90s, during the 2000s. The Fed, if we're being honest, the Fed has no clue why we haven't seen a strong price inflation. Everybody's got their good guess as to why it never. happened. But the key is the price inflation is the one thing that could have put the brakes on the Fed's easy money policies. And so you saw Greenspan keep rates too low for too long. It led to the stock market asset bubble, which crashed. The Fed responded with more low rates in the 2000s.

Starting point is 00:44:24 It kept rates too long in the 2000s, which created the housing asset bubble, which crashed. And that brings us to 2009, kind of in the shadow of that massive financial crisis, huge, huge global crisis. And the Fed did a great job of stepping in to stop the bleeding during the financial crisis, which everyone would want it to do. It's what came next. It's what the Fed did during the recovery, during the decade of the 2010s that I argue broke the U.S. economy. So that raises this question around the governance of the Fed.

Starting point is 00:45:03 How important the actual players are, you know, we could blame Greenspan, we could blame Bernanke, Yellen, now Powell. I mean, but are these people, like, how powerful are they truly? Meaning, it seems to be, there seems to be this agenda coming from a higher power of some kind, whether it's the president or otherwise. And if it wasn't Bernanke doing X, Y, and Z, they would have voted him out and put someone else in. There's a narrative, this opinion about this. So is this an error of human judgment, or is this an era of higher power policy at play? Okay, I think there are a couple things going on.

Starting point is 00:45:44 Let's look back again to that sort of instructive example of the 1960s. When you go back and look at why the Fed kept money too easy for too long in the 60s, it was because, you know, leaders at the Federal Reserve are humans just like the rest of us. They're reading the newspapers. And when unemployment is low, citizens look to their government to do something. And we've got, you know, two engines of action on economic affairs. We've got our fiscal authorities, which would be Congress, the White House, the Department of Treasury, fiscal authorities. And then you got your monetary authorities at the Fed. You know, this is a big story to unpack, but definitely Definitely since 2009, our fiscal authorities have been on the sidelines, more or less paralyzed by dysfunction, not able to take huge action to stimulate economic growth from either a conservative angle of, you know, slashing government, slashing entitlements, slashing regulations, or from a liberal perspective of a kind of new deal where you're directly hiring workers, you're breaking up the big banks.

Starting point is 00:46:55 fiscal authorities have not been able to do anything big on either front, and that leaves the monetary authorities to kind of step in and act. So, yes, this institution is driven by humans. And I think they, well, I know, they acutely feel the pressure to do something because they're human beings too. So you've got a political bias, I'd say, toward intervention or toward exerting pressure. But then, you know, you talk about the higher power. What, you know, it's very interesting that you've got Bernanke, Yellen, and Powell, I think essentially all pursuing the same philosophy of monetary policy. And when we saw this supposed debate recently about, you know, whom Joe Biden ought to appoint

Starting point is 00:47:44 to be chairman of the Fed, Lael Brainerd of a Fed governor or Jay Powell, you know, these two people were, had zero daylight between them on core monetary policy issues. So what's going on? I think the best assessment is that easy money policies do not antagonize the most powerful institutions in the United States. And that would be the very, very large hedge funds, the very, very large private equity firms, the biggest of the big banks. If you're keeping rates low, And you're stimulating financial speculation and debt accrual and the sale of debt. You know, the people who you are not going to make mad are Jamie Diamond, you know, the head of Carlisle Group, Larry Fink, people like this are not going to take to the airwaves at CNBC and

Starting point is 00:48:45 criticize you. So there's this sort of movement in that direction, I think. It makes it a lot easier to slash interest rates, to peg interest rates at zero. The problem is, when the asset bubbles you've created inevitably crash, that's where things get heated and hectic, and there's a lot of criticism. But, you know, amazingly, during crash moments like that, everybody turns to the Fed for yet more easy money policies to help bail everybody out. the Fed is seen as a hero, and the situation repeats again. So, you know, I actually think that there are

Starting point is 00:49:24 systemic pressures that push the Fed toward easy money policies. A key, you know, the one time you saw somebody break from this was in the early 1980s, when Paul Volker, who was a Wall Street guy, came in and was chairman of the Fed, hiked interest rates from about 10% to 19% and killed inflation, destroyed an asset bubble, and sort of re-rationalize the monetary system. No one has done that since. I guess my question around the higher power also ties to this example of, you know, going back to, I think, 2015, where Jerome Powell started to take action to raise interest rates. They called it, you know, the result, a taper tantrum because the markets crashed 20, 25 percent, just from these microscopic interest rate increases. But you had Trump at the time.

Starting point is 00:50:13 on every news site available to him screaming at Jerome Powell publicly saying, our rates should be negative. Our rate should be lower. Jerome Powell should be lowering rates. And having the president on all the airwaves demanding lower interest rates and actually seeing Powell than lower rates. I mean, I was just interested, interesting to say, was this a reaction from Jerome Powell of political pressure?

Starting point is 00:50:40 Or was this something that was just made sense economically, mathematically? Well, in my view, okay, having to reported this, Donald Trump is uncouth, rude, doesn't play by the rules, says whatever he wants, tweets like crazy, goes on TV and says all kinds of crazy things, and people talk about how he bullies officials, like poor Jeff Sessions, the former, you know, Attorney General was just bullied out of a job. Jay Powell wasn't being bullied by Donald Trump. Jay Powell was being bullied by asset prices. Okay, that's what mattered to Jay Powell. That's what got his attention. And that's what ultimately caused him to do exactly what Trump wanted, which was to pivot on tightening, to stop trying to normalize the financial markets, to stop

Starting point is 00:51:28 pulling back the Fed's extraordinary stimulus, and to simply cut rates and resume the printing of money through quantitative easing. You know, if you really walk through what happened, It's such a fascinating history of the Fed trying and failing to normalize between 2015 and 2019 and then, you know, leading into the COVID crash. I think it's a myth that Jay Powell stood up to Donald Trump or in any way defended the, you know, I mean, that was a political theater. The whole thing was political theater. In fact, the Fed had been trying to.

Starting point is 00:52:10 quote, normalize. And what that means is they wanted to raise interest rates back up to a historically normal level of, let's say, 3%, you know, when you look back over the last 60 years, 3 to 4% was seen as sort of a normal interest rate. And at the same time, the Fed was trying to draw down the trillions of dollars in cash and excess cash that it had injected into the financial system. There was a lot of pressure on the Fed to do this. Incidentally, not coincidentally, A lot of this pressure came from Jay Powell, who argued vehemently when he became a governor in 2012 that the Fed needed to pull back. And the reasons are clear. Again, when you push this much money into the banking system, you are stoking asset prices. You are creating asset bubbles.

Starting point is 00:52:59 And that would be absolutely fine if you could live in that condition forever. But unfortunately, asset prices almost always converge again with the value of the asset. These bubbles crashed. And Jay Powell, when he got to the Fed in 2012, was saying, we've got to draw down these excess cash levels. We've got to raise interest rates. Or we are going to see a, quote, large and dynamic event. Economist talked for a major crash that we're not going to be able to control. The Fed had been trying to do this. They've been trying to normalize. Honestly, since about 2010, when you look at the transcripts, but in a very public way since 2014, and they were not able to do You know, the Fed said that during 2016, it was going to raise rates from zero to 1.375%.

Starting point is 00:53:45 They couldn't raise any higher than 0.5%. They were never able to truly withdraw the excess cash from the financial system through so-called quantitative tightening. All of this came to a head in late 2018. I don't know if you remember Christmas Eve, 2018, there was a stock market crash that was very bizarre because, you know, Christmas Eve is usually a pretty light trading day, the S&P was down 3% that day. And Powell pivots.

Starting point is 00:54:13 Powell pivots in January 2019 and says, we are not going to normalize. We are going to stop raising interest rates. We're going to stop drawing this excess cash out of the banking system. And then by July of 2019, J. Powell is cutting interest rates in the face of economic growth. The Washington Post reported on this really well. Heather Long, great reporter on the Fed at the time, was. pointing out how bizarre it was for the Fed to cut rates as the economy was growing. And what it shows was the Fed was trapped.

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Starting point is 00:58:14 This is a paid advertisement. All right. Back to the show. Let's talk about one other short circuit you describe in the book, which is in this chapter called the invisible bailout. And it talks about the yield curve inverting, the repo market seizing up. Walk us through that scenario. What drove us to that, that eventually, you know,

Starting point is 00:58:34 that sparked the big crash we started to see around the COVID impact in March. That's right. It's such a fascinating story. This happened in September of 2019, okay, which in retrospect was sort of as good as things we're going to get for a long time. This was a few months before the first COVID case shows up in the United States. And the Fed at this time in late 2019 was involved in the struggle I just described. They knew they needed to withdraw the excess cash from Wall Street that they had pumped in through quantitative easing. They knew they needed to raise interest rates slowly but surely up to a level of maybe three to four percent. They never got higher than two and a half percent, by the way, which is historically a very

Starting point is 00:59:19 low interest rate. So the Fed was struggling to, quote, normalize when in September, we saw a banking panic. It's very interesting. I'm sure your listeners, you know, they're enough in financial markets, they know what the repo market is. But it's a short-term loan market that's really the lifeblood of Wall Street. It's an ultra-safe overnight loan market whereby I, as a big bank, quote, loan somebody some treasury bills. They give me the corresponding same amount of cash. And then we flip back really quickly the next day. And I pay a minuscule interest rate for the, you know, the privilege of that loan. The interest rates are so low, because I'm a repo trade is supposed to be riskless, you know, the person loaning the money has hold of

Starting point is 01:00:08 these treasury bonds that are the collateral. In early September 2019, the repo market seized up. It was shocking. You know, I interviewed the top officials at the New York Federal Reserve Bank whose job it was to oversee the repo market. And, you know, Lori Logan, who is over the trading desk and John Williams, who's president of the New York Fed and the traders who worked for them, talk about being shocked in early September when repo rates start to spike. They knew there might be a little bit of increase at this time for various reasons. The short-term market rate jumps from about 2% to 10%. It can't be overstated that these are bank panic numbers.

Starting point is 01:00:50 When a repo loan costs 10%, it's a bank panic. What was so strange about this was there was no reason for a bank panic. I liken it to that sort of thing we see now in the era of global warming, the so-called sunny day flooding when a town will flood when there's no storm. It was like, why would we be seeing the repo market seize up when there's no big news on the horizon? Because back in 2008, the repo markets had spiked, but, you know, Bear Stearns had collapsed. It made sense. What was going on and what the Fed understood is that they had taken too much excess cash out of the banking system. quote, quantitatively tightened just a little bit too much. And just that little bit too much

Starting point is 01:01:34 caused the markets to seize up. And we've got to remember, there was still tremendous amounts of excess cash at this time, but it was too little to keep the system operating. And the Fed had to rush in with a bailout. First, they did hundreds of billions of dollars in repo loans, but then they unleashed quantitative easing again, which had once been an emergency program. but is now necessary for daily maintenance of the financial system, the Fed printed $400 billion in a few months to pump cash back into Wall Street. And that brought those repo prices down again. And to me, what's so telling about this story is it shows the Fed was trapped in this money printing cycle just to keep the basic bread and butter nuts and bolts of Wall Street working,

Starting point is 01:02:24 just to keep the repo market settled. And the reason I'm I call it an invisible bailout is because, you know, the Fed presented this as like a plumbing maneuver, okay, is what we had to do to keep the system flowing. But really what they were doing and the book lays out how this works is they were bailing out hedge funds who had taken on enormous, risky, highly leveraged bets called basis risk trades. And they got caught short by the repo price increase and they got bailed out by the quantitative easing. And this was standard operating procedure in late 2019. And that's before the first COVID case.

Starting point is 01:03:01 Now, my understanding is it also opened up swap lines between countries for possibly, I don't know if it's the first time, but that seems to be a normal thing nowadays as well, where you have these countries that are dollar dependent and they're short on actual dollars and needed the dollars, you know, which keeps, because this is a global effort now. We're talking a lot about the U.S., but the U.S. impacts the entire world. So when the U.S. repo market ceases up, it has implications across the world. And you had entire countries needing dollars all of a sudden overnight.

Starting point is 01:03:31 And so what are the implications of that, or is that actually a newfound release valve that's actually a benefit of some kind? Well, it's fascinating. Okay. So the swap lines really open up in March 2020 when COVID hits. I want to point out, you know, there's a great book about COVID called Shutdown by Adam And it really brings to light this was a historic generational economic catastrophe. There's no getting around that.

Starting point is 01:04:01 But we've also got to recognize this was a wave that hit financial markets that were tremendously fragile, priced to perfection and vulnerable to a shock as we just talked about. I mean, the Fed couldn't even raise interest rates. And that's why COVID hitting that market created a financial crisis that was worse than 2008. And it's amazing what happened in the market for U.S. Treasuries in March of 2020. Financial Times put it well when they said this analyst said that this wasn't supposed to be possible. The Treasury markets literally seized up. The Fed responded by executing the entire emergency playbook of 2008, 2009, basically over one weekend.

Starting point is 01:04:47 And what I'm saying is all the stuff Ben Bernanke did over about eight months the Fed did in a weekend. And a huge part of that was the swap lines you just talked about. And that's such an interesting part of this whole thing because the swap lines were barely discussed publicly when they first were initiated in 2008. And like you said, they're basically a subsidizer guaranteed loan in dollars to foreign central banks that are dollar dependent. So it means that the Fed is expending its dollar creation power to help central. central banks in Europe. And it was employed to a huge level in 2008. And then it sort of quietly died down. And then it was deployed once again very, very quickly in 2020. But even the swap lines were just the beginning of what happened in 2020. I mean, I talked about earlier how the Fed printed

Starting point is 01:05:46 300 years worth of money in a few years. In 2020, the Federal Reserve printed 300 years worth of money in about two months. And they did massive rounds of quantitative easing, which continued to this day. It has become normal operating policy. And the Fed expanded its remit dramatically. I mean, it started directly buying corporate junk debt, for example. It was one of the massive asset bubbles that the Fed had been stoking over the last decade was in corporate debt. The Fed said it was going to directly buy those kinds of loans. And, you know, when the price came to. And when the price came due for the easy money policies of the 2010s, the Fed responded literally by quadrupling down on the easy money policies. And so, you know, there was a lot of debate, a lot of controversy

Starting point is 01:06:38 over the Fed's balance sheet, which is a reflection of its intervention, how big it is. The Fed's balance sheet hit $4.5 trillion in 2014. That was a big deal, and it had never been that big. you know, now it's hovering near nine trillion. And a lot of this has been added since March of 2020. So that's where we are today as it's sort of quadrupling down on the program. So our co-host, Preston, just put out a tweet thread that we'll link to in the show notes, but it's a fairly masterful thread that outlines, I think, this sentiment that everyone seems to feel but not truly understand. And what he did is he basically outlined the top 80 percent of indices and market weighted them to show that since 2009, the markets were up

Starting point is 01:07:24 about 171 percent. But if you adjust that for the M2 money supply creation, or at least increase, it's only up 6.9 percent. Since 2009, 12 years ago, meaning that everyone is hearing that the economy is strong and that real estate is up and jobs are low, or at least they were. But the middle class is struggling to keep up. And meeting my, the best analogy I've come up with is it seems like we are a human body surviving solely on caffeine, right?

Starting point is 01:07:56 At a certain point, it breaks down without nutrition. So in your book, you call out this long crash at the end. And that's kind of what it feels like. You know, if you're crashing from this caffeine, but it's taking a very long time, you're trying to drink little bits more here and there. what do you see coming next, I guess, as far as the long crash and does it, does accelerate? Yeah. First of all, I really have to push back at that negative characterization of caffeine.

Starting point is 01:08:22 You can survive off of caffeine for a long time. And I'm kidding. 12 years, apparently. Yeah. Exactly. All right. I fully validate, by the way, the point of view reflected in that tweet thread. And exactly what you just said, this is why I wrote the book is.

Starting point is 01:08:41 I feel like what the Fed has done is critical to understanding this very bizarre economy we live in. It is like a fun house mirror in the sense that asset prices like houses are rising double-digit levels and asset prices in the stock market are rising. Corporate debt markets are breaking records right now after they almost collapsed catastrophically in 2020. So you see this froth and ferment at the same time, our real economy can only be described as limping sideways. I mean, wages have been flat for decades. Thank goodness they're rising a little bit now, but not fast enough to keep up with the price inflation that we're seeing. You know, you can go on and on about the fragility of our supply chain, which has come into direct view.

Starting point is 01:09:35 and just the falling behind of the middle class. So the Fed's policies help describe the mechanics behind this strange environment in which we find ourselves. And so what happens next? You know, the long crash I'm talking about refers to the idea that after a financial crash, you have very weak growth. And that is exactly what we were seeing in 2010 when quantitative easing really began. And, you know, rather than grow our way out of it, the Fed tried to flood the system with money to stimulate our way out of it. Ultimately, that program only encouraged stock buybacks, mergers

Starting point is 01:10:19 and acquisitions, a run in these debt markets, didn't do much for the working class. We have now doubled down on that again to avoid the catastrophe of these lower asset prices after March of 2020. So now the Fed is in a real bind. It's like getting squeezed in a vice in the sense that it keeps upping the money supply to calm down asset markets and keep asset prices high and make it look like everything's normal. And that works fine as long as you never have to pay the bill.

Starting point is 01:10:57 one of the big problems with price inflation is that it can be very destabilizing economically. It's really hard on working class people if wages don't keep up, which they're not doing today. But maybe even more worrisome is the triggering effect that price inflation could have on the Fed. In other words, price inflation is right now forcing the Fed's hand. They are going to have to tighten much more quickly than they would otherwise want to. balance sheet of $9 trillion I just talked about, or I think it's $8.8 trillion right now, you know, if you had the job of winding that down, you would want about five to 10 years to do it. You could kind of normalize over five, 10 years.

Starting point is 01:11:44 The Fed's not going to have five or 10 years. So what that means is as they raise rates, as they withdraw the excess cash from quantitative easy. We're going to have to face the reality that markets will rationally readjust themselves to a new reality of higher rates and less excess cash on Wall Street. And time and again, we've seen that that reality looks like a retreat from risk assets, a drop in the value of collateralized loan obligations, which are built on leveraged loans, and vehicles like that. Another way of putting that is a wrenching downward adjustment in asset markets. So that's the pressure where the Fed is today is how do you navigate these waters where

Starting point is 01:12:27 you're forced to raise rates, but you can't do it without crashing the economy. Now, you end the book by stating that there are a lot of bills yet to be due. We're talking about trillions now, right? Is a crash the worst thing in your opinion? And do you think there's any change in the Fed's policy once they kind of fully lose control of the narrative, especially around inflation? A crash is terrible and terrifying and awful. You know, I'm 46.

Starting point is 01:13:01 I've lived through two of these so far. Two century floods financially, one in 2008, one in 2020. It's absolutely brutal. High unemployment is absolutely brutal. And so there's nothing to be celebrated at all about the dilemma that we're in. and there's nothing easy about trying to get out of the position we're in right now. So, you know, I do think that this, yeah, hindsight is 2020, but like the Fed should have restrained itself and shown more wisdom starting in 2010. The situation wouldn't be as bad as it is today.

Starting point is 01:13:40 But that being said, there's no easy way out of this position. And to me, as a reporter, one key thing is just that people can understand how we got here. At the very least, try to work from a common set of facts to kind of understand how we got into this position, as opposed to this idea that Donald Trump bullied the Fed into doing something or now Joe Biden has ruined the economy. This is a systemic issue that's been building for a decade. And I at least want to understand how we got here. I think it's a great point about it seems to be no longer people shouldn't conflate it with a political issue. I mean, it doesn't seem to matter who's in power. This is this, like you said, a systemic issue. And my biggest takeaway from this book is what incredible foresight by Tom Honig. I mean, 10 years ago, my goodness. I mean, and what a righteous profile you display in the book to kind of give him, I guess, more credibility than, or some credibility that he seems to be due. So fantastic book. I really enjoyed it. Christopher, where can people learn more about you? Where can

Starting point is 01:14:53 they find the book and any other resources you want to share before we let you go? Well, if folks are interested, you know, I'm Googledable or Christopher Leonard.Biz is my site. And the book will be available in January from all your wonderful booksellers. Thank you so much again for coming on the show. I really enjoyed it. Okay. Thank you so much. All right, everyone, that's all we had for you this time. If you're loving the show, make sure to follow us and reach out to us on Twitter. You can find me personally at Trey Lockerby.

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We Study Billionaires - The Investor’s Podcast Network - TIP411: How the Federal Reserve Broke the American Economy w/ Christopher Leonard

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