[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]


 
                      IMPACT OF MONETARY POLICY ON 
                      THE ECONOMY: A REGIONAL FED 
                       PERSPECTIVE ON INFLATION, 
                         UNEMPLOYMENT, AND QE3 

=======================================================================

                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON

                        DOMESTIC MONETARY POLICY

                             AND TECHNOLOGY

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                               __________

                             JULY 26, 2011

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 112-50


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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                   SPENCER BACHUS, Alabama, Chairman

JEB HENSARLING, Texas, Vice          BARNEY FRANK, Massachusetts, 
    Chairman                             Ranking Member
PETER T. KING, New York              MAXINE WATERS, California
EDWARD R. ROYCE, California          CAROLYN B. MALONEY, New York
FRANK D. LUCAS, Oklahoma             LUIS V. GUTIERREZ, Illinois
RON PAUL, Texas                      NYDIA M. VELAZQUEZ, New York
DONALD A. MANZULLO, Illinois         MELVIN L. WATT, North Carolina
WALTER B. JONES, North Carolina      GARY L. ACKERMAN, New York
JUDY BIGGERT, Illinois               BRAD SHERMAN, California
GARY G. MILLER, California           GREGORY W. MEEKS, New York
SHELLEY MOORE CAPITO, West Virginia  MICHAEL E. CAPUANO, Massachusetts
SCOTT GARRETT, New Jersey            RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas              WM. LACY CLAY, Missouri
PATRICK T. McHENRY, North Carolina   CAROLYN McCARTHY, New York
JOHN CAMPBELL, California            JOE BACA, California
MICHELE BACHMANN, Minnesota          STEPHEN F. LYNCH, Massachusetts
THADDEUS G. McCOTTER, Michigan       BRAD MILLER, North Carolina
KEVIN McCARTHY, California           DAVID SCOTT, Georgia
STEVAN PEARCE, New Mexico            AL GREEN, Texas
BILL POSEY, Florida                  EMANUEL CLEAVER, Missouri
MICHAEL G. FITZPATRICK,              GWEN MOORE, Wisconsin
    Pennsylvania                     KEITH ELLISON, Minnesota
LYNN A. WESTMORELAND, Georgia        ED PERLMUTTER, Colorado
BLAINE LUETKEMEYER, Missouri         JOE DONNELLY, Indiana
BILL HUIZENGA, Michigan              ANDRE CARSON, Indiana
SEAN P. DUFFY, Wisconsin             JAMES A. HIMES, Connecticut
NAN A. S. HAYWORTH, New York         GARY C. PETERS, Michigan
JAMES B. RENACCI, Ohio               JOHN C. CARNEY, Jr., Delaware
ROBERT HURT, Virginia
ROBERT J. DOLD, Illinois
DAVID SCHWEIKERT, Arizona
MICHAEL G. GRIMM, New York
FRANCISCO R. CANSECO, Texas
STEVE STIVERS, Ohio
STEPHEN LEE FINCHER, Tennessee

                   Larry C. Lavender, Chief of Staff
        Subcommittee on Domestic Monetary Policy and Technology

                       RON PAUL, Texas, Chairman

WALTER B. JONES, North Carolina,     WM. LACY CLAY, Missouri, Ranking 
    Vice Chairman                        Member
FRANK D. LUCAS, Oklahoma             CAROLYN B. MALONEY, New York
PATRICK T. McHENRY, North Carolina   GREGORY W. MEEKS, New York
BLAINE LUETKEMEYER, Missouri         AL GREEN, Texas
BILL HUIZENGA, Michigan              EMANUEL CLEAVER, Missouri
NAN A. S. HAYWORTH, New York         GARY C. PETERS, Michigan
DAVID SCHWEIKERT, Arizona



















                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    July 26, 2011................................................     1
Appendix:
    July 26, 2011................................................    29

                               WITNESSES
                         Tuesday, July 26, 2011

Hoenig, Dr. Thomas M., President, Federal Reserve Bank of Kansas 
  City...........................................................     6

                                APPENDIX

Prepared statements:
    Paul, Hon. Ron...............................................    30
    Hoenig, Dr. Thomas M.........................................    32


                      IMPACT OF MONETARY POLICY ON
                      THE ECONOMY: A REGIONAL FED
                       PERSPECTIVE ON INFLATION,
                         UNEMPLOYMENT, AND QE3

                              ----------                              


                         Tuesday, July 26, 2011

             U.S. House of Representatives,
                  Subcommittee on Domestic Monetary
                             Policy and Technology,
                           Committee on Financial Services,
                                                   Washington, D.C.
    The subcommittee met, pursuant to notice, at 2:12 p.m., in 
room 2128, Rayburn House Office Building, Hon. Ron Paul 
[chairman of the subcommittee] presiding.
    Members present: Representatives Paul, Jones, Lucas, 
Luetkemeyer, Huizenga, Schweikert; Clay, Maloney, and Green.
    Ex officio present: Representative Bachus.
    Chairman Paul. This hearing will come to order. Without 
objection, all members' opening statements will be made a part 
of the record.
    I want to welcome our witness today, President Hoenig.
    And I will begin the hearing with my opening statement.
    Over the years, I have been interested in the transparency 
of the Federal Reserve (the Fed), and the Fed has been 
interested in the independence of the Fed. But since I know 
what Mr. Hoenig is interested in, I think he truly represents 
the right kind of independence that I like, because he is a 
rare individual to be at the Fed, or on occasion to be a member 
of the FOMC.
    But I want to note that last year when virtually everybody 
was endorsing and welcoming QE2, he was dissenting against this 
position, I believe, about 8 times. So that to me is truly 
remarkable and shows that he is, obviously, an independent 
thinker.
    My interest, of course, in the monetary system has been 
related to the accumulation of debt. I believe they are related 
and that the size of government is indirectly affected by 
monetary policy as well. If debt can be easily monetized, the 
temptation for Congress to spend money is always there. And I 
think that is a big, big distortion.
    Mr. Hoenig has made his points made very clear, that maybe 
interest rates of 0 to 0.5 percent might be too much, and he 
actually has made statements about part of our problem prior to 
the crash of 2008 was the fact that interest rates were too low 
for too long.
    And I often think about and like to clarify and expand as 
much as possible the relationship of the problems that we have 
today to our privilege of issuing the reserve currency of the 
world.
    Obviously, nobody has quite that same benefit. And, 
therefore, our debt and our bubbles can get far more 
exaggerated than if you are an independent country and your 
debt is numbered in a currency that the world doesn't accept 
like they accept our dollars.
    So though that might be a very positive thing in the short 
run, and give us some benefits, it also may be misleading to 
us, because it is deceiving us into thinking that this process 
can go on forever.
    Today, we are in the middle of a default crisis. We are 
worrying about whether the national debt is going to be 
increased.
    And I have an opinion that once the debt gets so big, 
default is virtually impossible to stop and that the default 
that we are worrying about right now is not strange and brand 
new, because in many ways, our country has already defaulted.
    If you look at our inability to follow up on the promises 
to pay a gold certificate in the 1930s, that was a form of 
default. And then, we promised to pay foreigners gold for $35, 
and we eventually had to quit doing that.
    We promised to pay the American citizens a dollar for a 
silver certificate, and we defaulted on that. And eventually, 
those silver certificates were not worth a silver dollar, but 
they were then worth a Federal Reserve Note.
    And even in 1978, we met a major crisis. It was a dollar 
crisis, and we were not able to maintain the value of the 
dollar. And we went hat in hand to the IMF and actually got 
approximately $25 billion to $30 billion of boost to prop up 
our dollar at that time.
    So for me, that is a form of default, and I believe we have 
embarked on a system where default is going to come. And I 
think the argument and the impasse is because nobody wants to 
really admit that the default is here, and we have to face up 
to it.
    The argument is, how do we default? Are we going to quit 
sending the checks out, or are we going to do the ordinary 
thing that countries have done for years and that we 
continually do, and that is, we pay off our debt with money 
with a lot less value.
    To me, that is a default, but I see that as being unfair, 
because some people suffer more than others. And, therefore, we 
will eventually be pushed into some serious talks about 
monetary reform, which I believe are actually occurring already 
in international circles.
    But my 5 minutes has expired.
    And now, I will yield 5 minutes to Mr. Clay.
    Mr. Clay. Thank you, Mr. Chairman. And thank you for 
conducting this hearing on the impact of monetary policy and 
the state of the economy.
    The Full Employment and Balanced Growth Act of 1978, better 
known as Humphrey-Hawkins, set four benchmarks for the economy: 
full employment; growth in production; price stability; and the 
balance of trade and budget.
    The Humphrey-Hawkins Act also charges the Federal Reserve 
with a dual mandate: maintaining stable prices; and promoting 
full employment.
    According to the Department of Labor, in June, the Nation's 
unemployment rate was 9.2 percent. Over 14 million Americans 
are looking for work. Another 5 million are underemployed at 
jobs that pay much less than they previously earned, and offer 
few benefits.
    And in urban areas like the district that I represent in 
St. Louis, the unemployment rate among African Americans and 
other minorities is over 16 percent.
    The Majority party has been in power in this House for over 
200 days, and yet we have not seen one jobs bill, and America 
is still waiting.
    I am eager to hear what additional steps the Federal 
Reserve is willing to take to free up the flow of credit to 
small businesses and to encourage major banks to finally invest 
in this recovery, instead of sitting on the sidelines with 
trillions of dollars that could be creating millions of jobs.
    I also look forward to the witness' comments regarding what 
other urgent steps Congress can take to spur private sector job 
growth and restore confidence in our economic future.
    And with that, Mr. Chairman, I yield back.
    Chairman Paul. I thank the gentleman.
    Now, I yield to Mr. Luetkemeyer.
    Mr. Luetkemeyer. Thank you, Mr. Chairman. Thank you, Mr. 
Chairman, for holding this hearing today and for continuing the 
dialogue.
    I first want to recognize today's witness. President Tom 
Hoenig has been a voice for reasons and fiscal conservatism 
during a time when many of our economic policies have been 
weak.
    Tom has often been a lone dissenter who has encouraged 
sound economic principles over politically expedient ones. Our 
Nation is grateful for his service.
    President Hoenig has expressed concern over Federal Reserve 
monetary policies. Personally, I remain troubled by the 
expansionary role the Fed seems to have been championing over 
the last several years. What is more upsetting is the fact that 
we don't seem to be any closer to changing course and 
abandoning these policies, even though they don't seem to have 
worked.
    While a Federal program of quantitative easing looms, our 
economy remains stagnant. Our jobless rate continues to hover 
above 9 percent. Bank lending is still constrained. And we have 
seen little evidence of a long-term economic growth.
    Abroad, the credit markets have indicated that austere 
measures are being taken by troubled governments. We are headed 
down an identical path.
    Since 2008, the Fed has purchased several trillion dollars 
of U.S. treasuries, many of which are still held by the bank. 
We have been warned time and time again that unless we get our 
fiscal house in order, our credit rating is likely to be 
downgraded. Considering the amount of treasuries held by the 
Fed, the solvency of our central bank will undoubtedly be 
affected by this downgrade, should it occur.
    The current state of our economy, combined with the 
problems we could face in the near future, results in a recipe 
for economic distress. The Fed must begin to seriously examine 
the policies in place and plan for worst-case scenarios that 
could overwhelm our Nation in the coming months.
    Congress rarely hears from the 12 regional Fed Presidents. 
This is unfortunate, given their role as a financial regulator 
in our communities and as an independent voting member on the 
Federal Open Market Committee.
    I appreciate President Hoenig's willingness to be here 
today, and I look forward to his testimony.
    With that, Mr. Chairman, I yield back.
    Chairman Paul. I thank the gentleman.
    I now yield to Mr. Green from Texas.
    Mr. Green. Thank you, Mr. Chairman.
    And Dr. Hoenig, thank you for appearing today, sir. I trust 
that you will find our committee hospitable.
    I think that we have many concerns that we can address. 
And, of course, I am concerned about inflation, concerned about 
unemployment, concerned about the quantitative easing and the 
possibility of another round of quantitative easing.
    But I must also say to you, I still believe in America. I 
really don't want this to come across as, we have lost faith in 
the country that has produced so much for so many. America is 
still a pretty good place to live. A pretty good place to have 
your dreams, your hopes, and your aspirations fulfilled.
    So as I--I will speak for myself--make my queries and make 
my inquiries known, I don't want to give the impression that I 
no longer have faith and belief in this, the greatest country 
in the world.
    I am concerned, sir, about the widening gap, and I am not 
sure that you can address this, but if you have some 
intelligence that you will share, I would appreciate it, but 
the widening gap between what we commonly call the haves and 
the have-nots.
    That is a real concern. I have seen some information 
published indicating that Latinos, African Americans and Asians 
have had a great widening in the gap between these groups and 
some others. That concerns me.
    I am also concerned about this crisis that you have very 
little control over--you may be able to influence it, but 
little control--and that is the raising of the debt ceiling, as 
we call it. This ceiling is something that has become a crisis, 
but it really is a political problem that has somehow evolved 
into a crisis, a political problem that has evolved into an 
economic crisis, if you will, only because the politics have 
not come together appropriately.
    And I still believe that we will get it right. I think that 
there is still time for us to raise the debt ceiling.
    But these are some of the concerns that I hope you will be 
able to address today from your regional perch. I think highly 
of you, and I am interested in hearing your views. I have a lot 
of respect for you, and I thank you for appearing.
    I yield back the balance of my time, Mr. Chairman.
    Chairman Paul. I thank the gentleman.
    Now, I yield to the full committee's chairman, Mr. Bachus.
    Chairman Bachus. Thank you, Chairman Paul.
    I commend you for holding this hearing to examine the state 
of the economy from the perspective of a regional Federal 
Reserve Bank President, and I thank you for inviting Governor 
Hoenig, whom I consider to be a superb regional President.
    Tom Hoenig, or Dr. Hoenig, is the longest-serving of the 12 
Presidents of the regional Federal Reserve Banks. Perhaps 
happily for him, but sadly for many of us who admire his 
wisdom, he is soon to retire from that post.
    You will be missed.
    Dr. Hoenig has been a steadfast, independent voice among 
those in the inner circle of Federal Reserve Chairman Ben 
Bernanke, and before that, Chairman Alan Greenspan. He has been 
particularly outspoken recently in cautioning against the 
overly stimulative efforts of the Fed, including the so-called 
QE2, quantitative easing program that ended last month after 
adding an additional $600 billion in bonds onto the Fed's 
balance sheet.
    The New York Times said that Dr. Hoenig's cautious views 
were clearly shaped by having worked at the Kansas City Fed 
during the runaway inflation of the 1970s and the bank failures 
of the 1980s, and ``seem rooted in an agrarian and populist 
tradition that is mistrustful of concentrations of power.''
    I think that is a healthy fear. It is not surprising, then, 
that Dr. Hoenig has spoken forcefully on the subject of 
downsizing the biggest of the country's large banks, including 
a 2009 speech he titled, ``Too Big Has Failed.'' I can tell you 
that on this side of the aisle, many of us are in wholehearted 
agreement with you. And we have looked on with alarm as there 
has been a greater and greater concentration of ``too-big-to-
fail'' institutions.
    I mention all this not only to salute you, Dr. Hoenig, for 
your career and your, I guess, bravery in speaking out, but 
also to make a comparison between your views and the view that 
is held by some in Washington that regional Fed Presidents 
should not be allowed to vote on monetary policy moves made by 
the Federal Open Market Committee.
    Somehow, this view holds that regional Fed Presidents are 
captive of big business and the industry, and I can tell that 
you are a very good exhibit against that. In fact, I think that 
more often than not our regional banks are more attuned to Main 
Street.
    And of course, you are not the only independent thinker 
among the regional Bank Presidents, but your appearance here 
today will serve as a good rebuttal to the view that the 
Federal Reserve Bank Board of Governors in Washington, D.C., 
need less input from the regional Feds and the rest of the 
country. Actually, they need more.
    So thank you, Doctor.
    And I yield back the balance of my time.
    Chairman Paul. I thank the chairman.
    And if there are no other opening statements, we will go to 
the introduction of the witness.
    I want to welcome Dr. Thomas Hoenig, who has been the 
President of the Federal Reserve Bank of Kansas City for the 
past 20 years and is the longest-serving policymaker at the 
Fed. While a voting member of the Federal Open Market Committee 
in 2010, he voted against keeping interest rates at zero, 
casting the only ``no'' vote at all 8 FOMC meetings.
    He has been a vocal critic of the Fed's zero interest rate 
policy and QE2. He will be retiring in October, having reached 
the Fed's required retirement age of 65.
    Mr. Hoenig, you are recognized.

 STATEMENT OF DR. THOMAS M. HOENIG, PRESIDENT, FEDERAL RESERVE 
                      BANK OF KANSAS CITY

    Mr. Hoenig. Thank you, Chairman Paul, and members of the 
subcommittee. I want to thank you for this opportunity to 
discuss my views on the economy from the perspective of a 
President of the Federal Reserve Bank of Kansas City, and, as 
you said, a 20-year member of the Federal Open Market Committee 
(FOMC).
    The Federal Reserve's mandate reads: ``The Board of 
Governors of the Federal Reserve System and the Federal Open 
Market Committee shall maintain long-run growth of the monetary 
and credit aggregates commensurate with the economy's long-run 
potential to increase production, so as to promote effectively 
the goals of maximum employment, stable prices, and moderate 
long-term interest rates.''
    Within the context, then, of ``long-run,'' the role of the 
central bank is in fact to provide liquidity in a crisis and to 
create and foster an environment that supports long-run 
economic health. For that reason, as the financial crisis took 
hold in 2008, I supported the FOMC's cuts to the Federal funds 
rate that pushed the target range to 0 percent to 0.25 percent, 
as well as the other emergency liquidity actions taken to 
stanch the crisis. However, though I would support a generally 
accommodative monetary policy today, I have raised questions 
regarding the advisability of keeping the emergency monetary 
policy in place for 32 months with the promise of keeping it 
there for an extended period.
    I have several concerns with zero rates. First, a guarantee 
of zero rates affects the allocation of resources. It is 
generally accepted that no good, service or transaction trades 
efficiently at the price of zero. Credit is no exception. 
Rather, a zero-rate policy increases the risk of misallocating 
real resources, creating a new set of imbalances or possibly a 
new set of bubbles.
    For example, in the Tenth Federal Reserve District, fertile 
farmland was selling for $6,000 an acre just 2 years ago. That 
land today is selling for as much as $12,000 an acre, 
reflecting high commodity prices but also the fact that 
farmland loans increasingly carry an interest rate of far less 
than the 7.5 percent historic average for such loans. And with 
such low rates of return on financial assets, investors are 
quickly bidding up the price of farmland in search of a 
marginally better return.
    I was in the banking supervision area during the banking 
crisis of the 1980s, when the collapse of a speculative bubble 
dramatically and negatively affected the agriculture, real 
estate, and energy industries, almost simultaneously. Because 
of this bubble, in the Federal Reserve Bank of Kansas City's 
district alone, I was involved in the closing of nearly 350 
regional and community banks. Farms were lost, communities were 
devastated, and thousands of jobs were lost in the energy and 
real estate sectors. I am confident that the highly 
accommodative monetary policy of the decade of the 1970s 
contributed to this crisis.
    Another important effect of zero rates is that it 
redistributes wealth in this country from the saver to the 
debtor by pushing interest rates on deposits and other types of 
assets below what they would otherwise be. This requires savers 
and those on fixed incomes to subsidize borrowers. This may be 
necessary during a crisis in order to avoid even more dire 
outcomes, but the longer it continues, the more dramatic the 
redistribution of wealth.
    In addition, historically low rates affect the incentives 
of how the largest banks allocate assets. They can borrow for 
essentially a quarter-point and lend it back to the Federal 
Government by purchasing bonds and notes that pay about 3 
percent. It provides them a means to generate earnings and 
restore capital but it also reflects a subsidy to their 
operations. It is not the Federal Reserve's job to pave the 
yield curve with guaranteed returns for any sector of the 
economy, and we should not be guaranteeing a return for Wall 
Street or any special interest groups.
    Finally, my view is that unemployment is too high today, in 
part because interest rates were held to an artificially low 
level during the period of the early 2000s. In 2003, 
unemployment at 6.5 percent was thought to be too high. The 
Federal funds rate was continuously lowered to a level of 1 
percent in an effort to avoid deflation and to lower 
unemployment. The policy worked, but only in the short run.
    The full effect, however, was that the United States 
experienced a credit boom with consumers increasing their debt 
from 80 percent of disposable income to 125 percent. Banks 
increased their leverage ratios--asset to equity capital--from 
15-to-1 to 30-to-1. This very active credit environment 
persisted over time and contributed to the bubble in the 
housing market. In just 5 years, the housing bubble collapsed 
and asset values have fallen dramatically. The debt levels, 
however, remain, impeding our ability to recover from this 
recession. I would argue that the result of our short-run focus 
in 2003 was to contribute to 10 percent unemployment 5 years 
later.
    That said, I am not advocating for tight monetary policy. I 
am advocating that the FOMC carefully move to non-zero rates. 
This will allow the market to begin to read credit conditions 
and allocate resources according to their best use rather than 
a response to artificial incentives.
    More than a year ago, I advocated removing the ``extended 
period'' language to prepare the markets for a move to 1 
percent by the fall of 2010. Then, depending on how the economy 
performed, I would move rates back towards more historic 
levels.
    I want to see people back to work, but I want them back to 
work with some assurance of stability. I want to see our 
economy grow in a manner that encourages stable economic 
growth, stable prices, and long-run full employment. If zero 
rates could accomplish this goal, then I would support interest 
rates at zero.
    Monetary policy, though, cannot solve every problem. I 
believe we put the economy at greater risk by attempting to do 
so.
    Thank you, Mr. Chairman, and I do look forward to the 
committee's questions.
    [The prepared statement of Dr. Hoenig can be found on page 
32 of the appendix.]
    Chairman Paul. I thank you for your statement, and I would 
note that without objection, your written statement will be 
made a part of the record as well.
    Mr. Hoenig. Thank you.
    Chairman Paul. I would like now to yield to Mr. Bachus for 
any questions he would like to ask.
    Chairman Bachus. I thank the chairman.
    Dr. Hoenig, as I said in my opening statement, you have 
been firmly outspoken about monetary policy decisions.
    The Fed recently issued guidelines on how and when Federal 
Open Market Committee members should discuss or could discuss 
monetary policy decisions. Do you view this as an attempt to 
control the message or to stifle dissenting voices?
    And probably more importantly, Chairman Bernanke has 
promised a more open Fed, a more transparent Federal Reserve. 
And these guidelines, at least to me, seem a little 
inconsistent with restrictions on your ability to speak out. 
But I would like to know your views on that.
    Mr. Hoenig. I hope not. I think part of the reason for the 
guidelines are that there were instances, frankly, where I 
would wake up on a Thursday morning and find what the future 
policy might be in the Wall Street Journal, not having known 
about it. And I think I raise objections to those kind of leaks 
and ask that they be vigorously pursued, to be quite frank. So 
I hope that is the reason.
    Secondly, my approach is that I speak publicly, on the 
record. I try not to speak off the record, so that there isn't 
any confusion. And so when I come here, or wherever I go, I 
speak my views. I don't consult with the Board of Governors. I 
don't ask permission. I have until October, I realize, but I 
have never done so, and if I were staying on, I wouldn't do so 
in the future.
    So I think it is a matter of personal choice. I don't think 
any of the members should disclose confidential information or 
leak to the media in advance. I strongly object to that, and I 
would have every intention to speak on the record my views 
publicly, regardless of what that statement might otherwise 
say. And I don't think that statement prevents me from doing 
so.
    Chairman Bachus. Good, so the guidelines are more designed 
to keep unauthorized releases and releases that aren't a part 
of the public record?
    Mr. Hoenig. That is the context in which they came up.
    The fact that they are there, I think could have the effect 
of stifling some, but I think that is a matter of someone 
saying, ``I have spoken to this. This is my view,'' and show 
the leadership to speak their views.
    Chairman Bachus. Okay, good. And I am glad to hear that. I 
think that affirmation--I think Chairman Bernanke has tried to 
have a more open Fed, and I think he has been very candid with 
our committee.
    In your testimony, you used the rapid increase in farmland 
value as an example of, maybe, credit misallocation resulting 
from what you see as a too-low Federal funds rate. Do you see 
any other bubbles building?
    Mr. Hoenig. I don't--in fact, when people have asked me 
about the land, I have not said it is a bubble, but I--
    Chairman Bachus. Oh, yes.
    Mr. Hoenig. But I do say that we have conditions. We have 
created conditions. Zero interest rates, QE1, QE2 create 
conditions that are amenable to bubbles.
    And where we see asset values moving quickly, one example 
is in the farmland. I think you can see it in other areas, some 
of the bond markets and so forth. And so you have to be aware 
of that.
    I think my issue is that, when you create conditions for 
certain outcomes, they will eventually arrive unless you 
withdraw those conditions in a timely fashion. And I think that 
is really the issue at hand.
    Chairman Bachus. Okay. The Fed used to say it specifically 
did not want to use monetary policy to reduce froth in the 
markets. Chairman Greenspan said it in front of this committee 
any number of times, or made that statement.
    But is it appropriate for the Fed to avoid dealing with the 
buildup of asset bubbles but, on the other hand, conduct 
monetary policy aimed at reflating a market?
    Mr. Hoenig. I think my view is that monetary policy should 
be conducted with a long-term focus, with, if you will, 
boundaries around its discretion, and therefore should not be 
in a position of creating froth in the market any more than it 
should try and somehow pinpoint some sector of the economy that 
it thinks is too frothy, and try and adjust that.
    So, really, what you have to do is conduct monetary policy 
towards the long run. It is when you try and fine-tune monetary 
policy, direct it towards particular sectors, or to offset 
every short-term decline in the economy with extensive easing 
of monetary policy, that you create instability, as likely as 
deal with it.
    Chairman Bachus. Thank you. I will come back in the second 
round and ask other--I do want to say this, and I am just 
throwing it out for thought and not asking for a reply now. I 
have actually believed that QE2 gave the Congress an 
opportunity to--some time to move to make some long-term 
structural changes in our entitlement programs.
    It is an opportunity that, whether it was intended for that 
purpose or not, it certainly gave us an opportunity, and kept 
financing the debt at a low rate, or lower rate, maybe. But the 
Congress has squandered that opportunity, at least at this 
time.
    So I do believe that Chairman Bernanke's job has been made 
harder by the inability of this Congress to make the tough 
decisions and particularly to make needed structural changes in 
our entitlement programs. And I think we will continue to make 
problems for the Fed and probably result in inflation 
ourselves, some of our actions.
    So, thank you.
    Chairman Paul. I thank the gentleman. I yield 5 minutes to 
Mr. Green.
    Mr. Green. Thank you.
    Again, I thank you for appearing today, sir.
    Let us start with the debt ceiling. And if you could, be as 
terse as possible, because I have a couple of other questions. 
Can you give your opinion as to the consequences of our failure 
to raise the debt ceiling?
    And if you can be brief, I would appreciate it, although I 
know it is impossible on this question.
    Mr. Hoenig. The failure to address your budget issues is an 
action. It is a choice. And the consequences of doing that are 
to add to the uncertainty in the economy. So the effects will 
be, I think, in that sense, adverse.
    I think the economy would do well with addressing the 
budget crisis and the budget problems and providing more 
stability and more certainty.
    Mr. Green. In your opinion, would it be better to not raise 
the debt ceiling or to raise it and have it done in what we 
call a clean fashion--if it were those two choices?
    I know there are many others, but is it better to raise it 
and have a clean raising of the debt ceiling, as opposed to not 
raise it at all?
    Mr. Hoenig. The only answer I can give you to that is you 
really need--that is the Congress' area of responsibility--
    Mr. Green. But I am talking about the consequences.
    Mr. Hoenig. But you need to deal with it as forthrightly as 
possible.
    Mr. Green. I understand, but are the consequences more 
severe if we don't raise it than if we raise it with a clean 
ceiling?
    Mr. Hoenig. I think the consequences are there regardless. 
It is a matter of the timing of the consequences and how you 
want to accept those--
    Mr. Green. So in your opinion, it could be just as bad to 
raise the debt ceiling as we have done in the past, just have a 
clean raising of the debt ceiling. That would be just as bad as 
not raising it at all?
    Mr. Hoenig. I don't know what the consequences will be any 
more than anyone else does.
    Mr. Green. I know, but you are in the business of 
prognosticating, because that is what you do to decide whether 
you should raise it the 1 percent that you are talking about 
here.
    Mr. Hoenig. If you want my prognosis, honestly, I think 
what you need to do is address the budget crisis.
    Mr. Green. I understand, but I am not ready to go there, 
you see. I am giving you a set of circumstances and I am asking 
you, if you would, to address this set of circumstances.
    I know what you would like to do. I have been reading a 
little bit, here, and I understand your point of view. But I am 
taking you out of your comfort zone and--from time to time--
    Mr. Hoenig. But it is not mine to decide. It is yours.
    Mr. Green. I don't want you to decide. I just want you to 
tell me about consequences of not deciding.
    Mr. Hoenig. If you don't raise the ceiling immediately, 
then the Congress and whomever else has to prioritize its 
future cash flows. If you do raise it, you also will have to 
prioritize it over time. In either case, you have--
    Mr. Green. Let us go to another area, because--
    Mr. Hoenig. --you have to make choices.
    Mr. Green. I understand. My time is about up. Let me go to 
another area quickly.
    You wanted to prepare the market for a 1 percent increase 
by the fall of 2010. Is that a fair statement?
    Mr. Hoenig. Yes. And that was in an earlier part of 2010.
    Mr. Green. Okay. All right, I understand the circumstances 
were different than now. But if we had done this, we had 
prepared the market, as you had hoped we would, what were your 
thoughts in terms of what would occur?
    Mr. Hoenig. Interest rates would still be at historic low 
levels. Monetary policy would continue to be highly 
accommodative, but yet you would be off of zero. You would be 
no longer pumping enormous amounts of liquidity into the 
market.
    And the market would know. Right now, the market--what you 
are doing is you are at zero. So you are creating--the market 
is adjusting to zero, in all its allocations, in its 
investments, in its bond funds, in its land, around an 
equilibrium of zero.
    I think most people acknowledge that zero is not 
sustainable. So the longer you allow that to continue, the 
longer you allow that allocation of credit and assets around 
zero, the more fragile the equilibrium and the sharper the 
consequences when you finally do remove that zero.
    And I think, the more--
    Mr. Green. I wanted to have a quick follow up, because I 
only have 30-plus seconds.
    You do agree that we don't have as much lending now as we 
need for the economy to recover. And if we don't have that 
lending at zero, what would be the circumstance at 1 percent?
    Mr. Hoenig. I don't think that the issue around lending is 
related to the immediate policy of the Fed funds rate being 
zero. It is around the issues of the fiscal uncertainty. It is 
around the issues of whether we have a resurgence of 
manufacturing in this country that is sustainable. It is around 
the issues of how we create goods, because it is the creation 
of goods and services that brings jobs in.
    And I don't think that the marginal choice for most 
businesses around whether they would do this of zero or a half 
a percentage point or 1 percentage point is the deciding factor 
in that instance.
    Mr. Green. My time is up.
    And you have been very generous, Mr. Chairman. I thank you. 
And I will wait for a second round.
    Chairman Paul. Thank you.
    Mr. Green. And I will follow up.
    Chairman Paul. I thank the gentleman.
    I will now take my 5 minutes.
    I want to talk about the relationship of Federal Reserve 
policy and monetary policy with the debt increase. We all know 
that the Federal Reserve is the lender of last resort. The 
economy gets into trouble, liquidity dries up, the Fed is 
supposed to be there to help out.
    But could it be that this concept of lender of last resort 
contributes to the deficit problem? And what I am thinking 
about here is that politicians, we in the Congress, get 
pressure from a lot of areas to spend money. And sometimes 
spending money helps us get reelected.
    So, there are a lot of domestic needs, needs in our 
districts. And also, there is a lot of activity around the 
world, both violent and non-violent, that requires a lot of 
money.
    And in the inflationary part of the cycle when things seem 
to be going well, it is very tempting for Congress to spend a 
lot of money.
    But if the Fed is always there to keep interest rates low, 
doesn't that just encourage us? Congress generally is 
undisciplined, but doesn't the policy feed into this? Because 
if the Fed didn't do this, if they weren't our lender of last 
resort and interest rates started bumping up, we couldn't blame 
the Fed for our problems, we would have to blame ourselves--
high interest rates--because we are sucking up all the credit.
    Do you see a relationship between Fed policy and the 
encouragement or allowing Congress to spend more than they 
should be?
    Mr. Hoenig. I think there is always the danger that the 
central bank can be put in the position of buying the 
government's debt. That is why you have an independent central 
bank and why the independent central bank has to pursue long-
run monetary policy geared towards what the basic money-based 
requirements and needs are for the growth of that economy.
    And it does require not only that the Congress be 
disciplined, but that the central bank be disciplined as well 
and not allow themselves to get drawn into that, yes.
    Chairman Paul. But in a way, doesn't your testimony verify 
that maybe the Fed didn't do their job because they kept 
interest rates too low for too long, and we were part of the 
problem. So how do you protect against that, if the Fed is as 
fallible as the Congress?
    Mr. Hoenig. There is no system that is infallible. Whether 
it is the central bank doing this or the Congress doing it, 
there is no system that is infallible.
    Yes, I think that in the early part of the decade of the 
2000s--as I have said many times--the policy was kept too 
accommodative for too long. The consequence of that was to 
create a credit bubble. It affected not only the Congress, but, 
of course, the credit markets generally became very active.
    That is why we had the tremendous expansion in credit in 
housing and later the consequence. That is an area that we have 
to learn from and go forward from. I don't think it is directly 
related in terms of the Congress and the debt, but it is 
related to the economic conditions broadly and the expansion of 
monetary policy during that period. And I think we have to be 
careful and mindful of that as a central bank.
    Chairman Paul. I would agree that no system is infallible, 
but it seems like we might get better information from the 
marketplace, dealing with interest rates. Prices are very 
important in the economy, and nobody is out there advocating 
wage and price controls. We have tried it and, hopefully, they 
never bring that back again.
    But in a way, aren't we dealing with a price control and 
you are looking for the price of money, the cost of money? I 
think you talk about that, that the cost was too low. And it 
causes a misallocation of resources. So how do you know what 
the right price is?
    Mr. Hoenig. I agree that you need to have a disciplined 
monetary policy that has a range. Our long-term growth over 
this decade has been about 3 percent real growth. Our policy 
should be mindful of that as we conduct monetary policy going 
forward.
    And when we do go to zero and leave it there for an 
extended period, in reaction to a crisis, that is one thing. If 
we leave it there on a continuing basis, we do increase the 
risk that we misprice credit and misallocate resources, yes.
    Chairman Paul. It seems like it is a contest between 
confidence in the market setting the price or the interest 
rates versus somebody dealing with monetary policy. And some of 
us have come to the conclusion that we like the market to set 
that. We would like to see maybe the retirees get more for 
their CDs.
    Mr. Hoenig. Right, and I understand, but the market makes 
terrible mistakes as well. And the market is responsible 
because it gets, if you will, euphoric in a direction, creates 
its own bubble around credit, because we are a fractional 
reserve system. It crashes. The market itself isn't prefect 
either. It causes--
    Chairman Paul. My time is up, but we are going to have a 
second round, and I want to ask about the fractional reserve 
system.
    Mr. Hoenig. Okay.
    Chairman Paul. And now, I yield 5 minutes to Mr. 
Luetkemeyer.
    Mr. Luetkemeyer. Thank you, Mr. Chairman.
    And welcome to my fellow Missourian.
    Mr. Hoenig. Thank you.
    Mr. Luetkemeyer. Dr. Hoenig, it is good to have you here.
    Mr. Hoenig. Thank you.
    Mr. Luetkemeyer. Since 2008, the Fed has purchased several 
trillion dollars worth of U.S. securities, treasury bills. And 
as we have seen over in Europe, over there the countries, in 
order to get their debt sold, have had to go to some very 
austere measures, sometimes go back 2 or 3 times to review 
their plans. Every time their interest rates have gone up in 
order to be able to accommodate them.
    We are being told by the credit markets that if we don't do 
something within the next couple of weeks here, we are going to 
have our securities downgraded. How does that affect the 
solvency of the Federal Reserve to have all of those securities 
that they are holding all be downgraded suddenly?
    Mr. Hoenig. It depends on how the markets view this 
downgrade. If it is downgraded and it doesn't affect the market 
pricing on those securities, because they have confidence that 
the Congress of the United States will come to a correct 
solution on that, I don't think it will have much effect at all 
on our solvency.
    If the Congress fails to act, it will have a more lasting 
effect. But they are anticipating that the Congress will act.
    Mr. Luetkemeyer. As a former examiner, I am sure you--it 
would be interesting to have the Fed on the problem list, 
wouldn't it?
    Mr. Hoenig. Yes.
    Mr. Luetkemeyer. Along that line, though, the same thing is 
happening with the rest of the banks in this country. If, for 
instance, we did get downgraded, suddenly now those banks--so 
your local community banks got a whole fistful of U.S. 
treasuries. And now they are being downgraded, and suddenly 
that affects their capital. It affects their rating.
    How would you view that situation then--again, as a former 
examiner--the calamity that would happen to our local community 
banks?
    Mr. Hoenig. If there was a serious effect from the 
downgrade on the pricing of the bonds to where there was 
capital loss in the bank, then of course it would have negative 
effects. I think the question is whether it would be a pricing 
effect, and I think that depends very much on the actions of 
the Congress.
    Mr. Luetkemeyer. It is an action that could happen on the 
part of the credit markets to where it could be an increase in 
risk that would have to be assumed there.
    Mr. Hoenig. The failure to act is an action.
    Mr. Luetkemeyer. Okay. Thank you.
    With regards to--you mentioned a while ago--my time is 
running out here--let me get to QE3.
    We had Chairman Bernanke in here not too long ago, and he 
wouldn't say anything about QE3. But since he has been here, he 
certainly has not denied thinking about QE3. And to me, this is 
a devastating situation.
    We have had a number of economists in here since he has 
been here, and every one of them I have asked the same 
question, ``Do you see interest rates going up this fall as 
soon as QE2 stops here?'' And every one of them said ``Yes, 
unless you do a QE3, in which case you will probably have 
inflation.''
    Would you concur with that or do you have a different 
opinion on that?
    Mr. Hoenig. First of all, I am not a supporter of QE3. I 
wasn't a supporter of QE2.
    I think, by ceasing QE2, I don't know that interest rates 
necessarily will go up significantly. It depends on a whole 
host of factors in terms of how the economy is doing. It is not 
just whether you stop QE2 over time. I don't think we should 
mainly try and manage interest rates down. That is kind of the 
point of my testimony. I think there are consequences of doing 
that, that misallocate resources, and we have to be mindful of 
that.
    Mr. Luetkemeyer. Obviously, I agree with that. I am just 
going along that line of thought, that among other things, the 
Fed's job is to look long term with regards to interest rates, 
with regards to unemployment.
    And to me, this would seem to fit into a QE2, QE3. Where do 
we stop this? At some point, we have to get control of--at some 
point, the economy has to be resilient enough to stand on its 
own two feet. We have to wean them off this.
    If we are going to absorb all the debt that we are 
incurring--and every budget whether it is Democrat, Republican 
or whomever, we have debt out there. Everybody is agreeing we 
are going to have more debt. So we are going to have to have 
somebody to purchase it. And if the Fed doesn't purchase it, 
somebody else is going to have to.
    Mr. Hoenig. Correct.
    Mr. Luetkemeyer. And if we get our securities downgraded, 
risk is there, interest rates are going to necessarily go up. 
So long term, how do you manage those monies to see that you 
can minimize that? What would be your idea or a solution?
    Mr. Hoenig. I think that the mandate is a long-term 
mandate, and we need to keep that in mind. And if we do and if 
we pursue a policy that is long-run oriented towards price 
stability, then the economy--a market economy adjusts on its 
own.
    The market is not particularly brilliant, but it is harsh. 
It corrects itself when there is a misallocation. And so that 
is why monetary policy has to look to the long run, provide 
sufficient liquidity, but not try and fine-tune or manage the 
economy so that markets can in fact discipline themselves.
    So we should not be doing QE3. This is my view. There are 
plenty of excess reserves out there on the order of $2 
trillion. I think that is plenty. Let the markets begin to 
heal, and let this market of ours allocate resources in our 
economy. And we should not try and fine-tune that.
    I think when we do that, we inject instability as well, 
more likely than we do stability. So we have to be very mindful 
of that. In the short run, we can really inject instability. We 
have to have a long-run focus. And that is hard, I realize, but 
necessary.
    Mr. Luetkemeyer. Thank you for your comments.
    And thank you for your indulgence, Mr. Chairman.
    Chairman Paul. I thank the gentleman.
    I recognize Mr. Lucas for 5 minutes.
    Mr. Lucas. Thank you, Mr. Chairman.
    Doctor, as you are well aware, of course, I live in the 
great Kansas City district in western Oklahoma. And about the 
time you were out doing all that hard work in the early 1980s, 
I was a senior at Oklahoma State. And I will always think of my 
father's lecture in the spring of 1982 when I would 
occasionally go to land sales with my grandfather: ``Keep your 
hands in your pockets and your mouth shut.''
    It was wonderful advice in 1982. The reason I bring that up 
is we are now dealing with a set of circumstances here that you 
have discussed and touched around the edges that in some ways 
is reminiscent of those early 1980s. You remember, and 
sometimes there is an occasional view here that nothing is 
interconnected, that we are all little islands in the world.
    You remember when Penn Square Bank went down, an energy-
concentrated banking establishment, which then took down, 
directly or indirectly, Continental Illinois in Chicago, took 
down Seafirst in Seattle, took down two major, historic long-
term players.
    Partly that, in my opinion, and you can offer yours and I 
would be pleased to hear it, as a result of perhaps misguided 
fiscal policy by Congress and perhaps misguided monetary policy 
by the Fed in that late 1970s and early 1980s period. But it 
had a devastating consequence, and it wasn't just Oklahoma that 
imploded. We sucked people under with us.
    I guess that brings me to my real question, and whatever 
comments you would care to offer. As my colleagues have alluded 
to, with the Fed balance sheet at a little under $3 trillion 
now, and even by a Texan's definitions, Mr. Chairman, that is a 
lot of money.
    It took us 15 years to recover from the agriculture and the 
energy sector hangover from credit that started in 1982. In my 
opinion, in my quadrant, it was 1997 before the ship righted 
itself.
    Three trillion dollars is a whole lot more credit than Penn 
Square was manipulating. When the right policy decisions are 
made, how long is it going to take this credit hangover to 
clear?
    Mr. Hoenig. Let me first comment. I was on the discount 
window on Penn Square and was part of the group that 
recommended against lending against Penn Square. And I think it 
was the right decision there, although the consequences, as you 
said, were very harsh.
    Mr. Lucas. And for the record, a few officers of Penn 
Square did go to the Federal penitentiary. It was more than 
just a few bad decisions.
    Mr. Hoenig. They did. Absolutely.
    To your question of the degree of liquidity, the amount of 
time it will take to bring the liquidity off our balance sheet, 
the $3 trillion, I think, is reasonably a period of years.
    Because we have brought this on, I think if you bring it 
out too sharply, you will shock the economy. And in our last 
minutes, the Open Market Committee talked about how they would 
go about doing it in terms of rates and no longer renewing 
their debt instruments.
    But even under those, it will take years. How many years? 
It depends on how the economy does. It depends on what the 
roll-off of these instruments, the speed of the roll-off of 
these instruments and whether we choose to sell those. I don't 
know how long, other than I know it will take years, and there 
are risks to doing that.
    And that is my point about zero interest rates and creating 
what I call ``fragile equilibriums'' around this very liquid 
policy that when you finally do begin to move has a negative 
effect, a negative consequence on the economy, both nationally 
and regionally. And that does get my attention.
    Mr. Lucas. Is it a fair statement to say, Doctor, that, of 
course, we will make a decision at some point. We will, at some 
point, I hope, achieve a consensus. We have legitimate 
disagreements within the ranks of the House over what the right 
policy is.
    Mr. Hoenig. Right.
    Mr. Lucas. That is the nature of the body. But at some 
point, we will arrive at something. If we make the wrong 
decision, whatever decision we come to, are the consequences as 
frightening as I suspect they are?
    Mr. Hoenig. Any time--
    Mr. Lucas. Without commenting on any particular decision.
    Mr. Hoenig. Right, anytime you make a wrong decision, there 
are usually negative consequences. And if you make the wrong 
decision, there will be negative consequences, whatever that 
is.
    Mr. Lucas. And the financial markets are sophisticated 
enough that they will respond moment by moment with whatever 
policy decisions we make, and will, as prudent money managers, 
use what I would define from an Oklahoma perspective as 
``defensive policies'' if they need to. And that will ripple, 
too.
    Mr. Hoenig. The greater the uncertainty you create, the 
more defensive the actions will be. That much we can be sure 
of.
    Mr. Lucas. Thank you, Mr. President.
    Thank you, Mr. Chairman. I yield back the time that I have 
left.
    Chairman Paul. I thank the gentleman.
    We will go ahead and start a second round of questioning.
    If we look at the markets in the last couple of weeks, in 
light of all the conversation about whether or not the debt 
limit will be raised, my estimation or my observation is that 
the markets aren't that worried. Would you agree with that? Or 
do you think the markets are showing problems, or at least 
potential problems?
    Mr. Hoenig. To this point, I think the markets at least 
strike me as having the view that there will be a solution. And 
as long as that view is in place, they will tend to stay calm. 
If they lose that or if they begin to see more instability, 
more uncertainty around it, and therefore actions, then they 
would--as I said earlier--take more defensive actions.
    But right now, I think they have confidence in you, the 
Congress, and the President to come to some kind of agreement.
    Chairman Paul. In monetary history, it has been said that 
when countries get to a certain level of debt, they have a lot 
of trouble, and the debt eventually has to be liquidated. I 
personally think we are at that point, so there will be 
liquidation of debt.
    As a matter of fact, free market individuals recognize that 
whether it is government debt or whether it is private debt, 
liquidation actually serves a purpose in order to get back to 
square one and have economic growth again.
    When we liquidate debt, I believe I mentioned in my opening 
statement, you can do it in two different ways. You can just 
default, which great nations don't do. Small nations will. But 
we are nowhere close, I believe, to doing that. I don't believe 
that for a minute.
    But I do worry about the other part. I worry about the 
liquidation of debt, because if it is inevitable that the debt 
will be liquidated and what we do may be prolonging the agony, 
that is what I worry about, that instead of allowing the 
liquidation and rapidly getting back to square one like we did 
in 1921, that we prolong this, such as Japan did and such as we 
did in the 1930s.
    Do you agree with that? Do you have concerns that 
liquidation will come in the form of inflation? And if you want 
to prevent that, what are your other options, if we are not 
going to default on our payments, which of course, I don't 
believe we will?
    Mr. Hoenig. First of all, I agree with you. I don't think 
great nations default on their debt. Second of all, I will say 
that I agree with you also, that we have leveraged our economy.
    As I mentioned in my remarks, the consumer has raised their 
debt-to-disposable income from 80 percent to 90 percent to 125 
percent. The Federal Government has raised its debt to in gross 
numbers 100 percent of GDP. So we have increased our debt.
    My concern is that, maybe back to your earlier point, 
perhaps, but when you have that kind of debt, over time there 
is increased pressure on the central banks to help relieve that 
debt pressure by helping finance that debt.
    That puts pressure on the central bank. If they do that, it 
does risk inflationary outbreak, and then you basically repay 
your debt in cheaper dollars.
    Chairman Paul. But isn't that--
    Mr. Hoenig. That is a risk, so how do you avoid that? The 
way you avoid that is you take, either through the Congress, 
through special committees, whatever, and develop a long-run 
plan that shows the American people how we are going to deal 
with our debt, Federal and otherwise, but in the Congress, 
Federal debt, and how the debt-to-GDP ratio is going to be 
brought back down.
    And if it does that in a systematic fashion, with a strong 
binding point, then you will take care of the debt in a 
responsible way.
    Chairman Paul. But it seems to me in that attempt, the Fed 
came in and they propped up banks and corporations, that they 
were the ones that have been benefiting from this, and now they 
have been able to get back on their feet again.
    At the same time, it really didn't help the people. The 
jobs didn't come back and the people lost their houses. So it 
seems like it is a failed policy to me.
    Mr. Hoenig. I understand your point. My concern is that we 
have in this country allowed to develop ``too-big-to-fail'' 
institutions, the largest financial institutions, who bulked 
their assets, and became so important to the economy that any 
one of them that failed would bring down and risk the economy.
    The market understood that and therefore gave them an 
advantage in terms of their position in the market, lowered 
their cost of capital, and allowed them unfettered access. And 
when we allowed that part, the safety net portion of that to 
get in with the high-risk portion, the investment bank, it only 
increased that by factors.
    So we do need to address the issue of ``too-big-to-fail.'' 
We do need to think about how we separate out the safety net 
from the high risk so that the economy can function under a 
market discipline, or at least more under market discipline, 
and we would all benefit from that.
    Chairman Paul. My 5 minutes are up, and I now yield to Mr. 
Green.
    Mr. Green. Thank you, Mr. Chairman. I will be honored to 
let you have 30 seconds of my 5 minutes, if you need it.
    Let us talk for a moment about lowering the debt-to-GDP 
ratio. Do you agree that there is more than one way to do it?
    Mr. Hoenig. Of course.
    Mr. Green. Do you agree that cutting is a way to do it?
    Mr. Hoenig. You can grow your economy--
    Mr. Green. Grow the economy. You could also increase 
revenue.
    Mr. Hoenig. Of course. That is up to the Congress, how 
they--
    Mr. Green. I understand. But I just want you to be on the 
record indicating that we have more than one way to do it.
    Mr. Hoenig. Right. And every choice has a consequence.
    Mr. Green. Every choice has consequences. And not making a 
choice at all has its consequences as well.
    Mr. Hoenig. That is a choice.
    Mr. Green. Yes, sir.
    Let us move to another area. You talked about markets and 
the market being calm. You do agree that the markets, generally 
speaking, don't like big surprises. When you give the market a 
big surprise, it has a reaction to a surprise. If you lead the 
market to believe that you are going in one direction, and if 
you go in another direction, then the market responds.
    Mr. Hoenig. Correct.
    Mr. Green. I think one of the best examples of this 
occurred when we had the $700 billion TARP vote, and the market 
anticipated one thing, and when the vote went another way, we 
saw the market spiral downward. You recall that, I am sure.
    Mr. Hoenig. Sure.
    Mr. Green. So you agree that markets don't, generally 
speaking, want to be shocked with surprises.
    Mr. Hoenig. Correct.
    Mr. Green. Okay. If this is true, and you have indicated 
that the market currently believes that we are going to resolve 
this--and, by the way, I pray that we will--but you agree that 
failure to bring about the resolution that the market 
anticipates will create a reaction in the market.
    Mr. Hoenig. Sure. It certainly will. If the market is 
thinking one thing and you do something else, there will be a 
reaction.
    Mr. Green. One final question--
    Mr. Hoenig. And that also happens on Main Street.
    Mr. Green. Yes. And Home Street as well.
    Mr. Hoenig. As well.
    Mr. Green. Yes. But let us go back now to your support for 
the 0 to 0.25 target.
    Mr. Hoenig. I do not support it.
    Mr. Green. You do not support it. But in 2008, you 
supported the cut in the Federal funds rate that pushed us to 
this target range, did you not?
    Mr. Hoenig. I wasn't voting, but I am sure I would have 
supported it. Yes.
    Mr. Green. Okay. And, by the way, reasonable people can 
have opinions that differ--
    Mr. Hoenig. Absolutely.
    Mr. Green. --even on the things that you supported, true?
    Mr. Hoenig. Absolutely.
    Mr. Green. And Mr. Bernanke, whom I happen to think highly 
of and I have a great deal of respect for, and he has opinions 
that are very well-respected, and there are other members of 
the board with opinions, and you meet and you confer and you 
vote, and then you come to conclusions.
    Mr. Hoenig. Correct.
    Mr. Green. So at the time what you were trying to do was 
provide what I am going to call a soft landing. Is that a fair 
statement, that we didn't want the economy to just crash?
    Mr. Hoenig. Well--
    Mr. Green. We wanted it to land a little bit softer than if 
we had done nothing at all.
    Mr. Hoenig. ``Soft landing'' is a generous term. I think we 
did want to avoid a crash and depression, yes.
    Mr. Green. Yes, a crash and a depression.
    And if you say that you wanted to avoid it, it says to me 
that you are of the opinion that had we not acted, there could 
have been a crash and a depression.
    Mr. Hoenig. Counterfactuals are always there, and that is a 
possibility, yes.
    Mr. Green. And counterfactuals are hard to prove.
    Mr. Hoenig. Right.
    Mr. Green. But the reason you acted the way you did was 
because there was this concern--and I am being kind by saying 
``concern,'' because there are a lot of other ways to connote 
what was happening--but there were these concerns that we were 
headed for something close to a crash or a depression.
    And your actions, probably if you were to write a book, you 
would say that your actions helped to avert this, would you 
not?
    Mr. Hoenig. If you are speaking of our movement to zero 
interest rates and the liquidity we provided, yes, sir.
    Mr. Green. Yes. Yes, that liquidity was helpful.
    Mr. Hoenig. Yes.
    Mr. Green. And just as it is difficult to prove a 
counterfactual as it relates to what you did, it is equally as 
difficult to prove it with reference to what Congress has done. 
Do you agree?
    Mr. Hoenig. I assume so, yes.
    Mr. Green. Okay. All right. What I am trying to do is 
establish this, sir. People of good will, and I consider you a 
person of good will, acted at a time of crisis--
    Mr. Hoenig. Correct.
    Mr. Green. --a time when it appeared as though we were 
about to go over the edge into an abyss unlike many of us had 
seen in our lifetimes.
    And many of these things that we did, we won't be able to 
prove that we averted a great cataclysm, but we can surely 
conclude that what we did probably helped to avoid a rougher 
landing, a harder landing than we had.
    Mr. Hoenig. Right.
    Mr. Green. I want to thank you, Mr. Chairman. I will yield 
back the balance of my time.
    Chairman Paul. Thank you. I thank the gentleman.
    I will yield to Mr. Luetkemeyer.
    Mr. Luetkemeyer. Thank you, Mr. Chairman.
    Dr. Hoenig, I have been watching what is going on over in 
Europe very carefully, and it is very concerning to me. And I 
know that in discussing this issue with a couple of other Fed 
members--board members--they don't seem to be quite as 
concerned about it as I am, so maybe I am an alarmist here. I 
don't know.
    But I certainly see a contagion there that could easily 
spread to this country, especially whenever you look at our 
banks having about $1.3 trillion loaned to the various 
governments, invested in bonds of the various governments over 
there as well as, now, Dodd-Frank tying all those big banks 
together with ``too big to fail.''
    It looks like there is a lot of connectivity between all of 
these things here. And you look at a line of dominoes, and it 
looks like we are in that line of dominoes.
    So I know that the Fed has a swap line with the European 
central bank and perhaps some other reserve banks over there as 
well. And I am just wondering what your view is of that 
situation, how concerned are you?
    Mr. Hoenig. I am concerned--do you mean about the European 
situation?
    Mr. Luetkemeyer. Yes, the European situation and how it 
will affect us or what kind of exposure we might have, our 
monetary policy, how it interacts. It is kind of a big 
question, but--
    Mr. Hoenig. I understand your concern. The issues around 
those countries that keep coming up are also really around the 
banks, the European banks, because they, obviously, have 
exposure there. And that is a big part of the efforts we are 
trying to do to resolve this.
    And like the United States, as I read it--and I only know 
from what I read in the paper--they are working toward some 
kind of solution, resolution around that.
    But I think it proves to me not only in the United States, 
but internationally that we have institutions that are ``too 
big to fail.'' And that is what this is really about. We have 
taken the market discipline away. We are now working with 
institutions globally that are extremely important to those 
economies, to our economy.
    And to me, the whole issue continues to be around 
institutions that are so large that their own difficulties have 
broad effects on the economy, and that makes them ``too big to 
fail'' and therefore forces, if you will, governments to come 
in and bail them out.
    And that is really what, I think, is going on in Europe and 
that is really what has gone on in our crisis in the United 
States.
    Until we change that formula, until we break those 
institutions up into those that are under the safety net and 
those that are allowed to engage in high-risk activities, we 
will have these crises periodically into the future--not right 
away, perhaps, but in years to come.
    Mr. Luetkemeyer. And the pitfall there is that we have our 
taxpayer dollars at risk, because we are backing these ``too-
big-to-fail'' folks. Is that right?
    Mr. Hoenig. When you put a safety net over them and put the 
government's implied or explicit guarantee, the taxpayer is the 
backstop, yes.
    Mr. Luetkemeyer. In your position--and you are an 
economist, and having dealt with all of the financial things 
over the last several years, what do you see as the biggest 
concern to our economy today, whether it is international 
problems here we just discussed or oil prices or our monetary 
policy, our wars or--
    What do you see as the biggest concern and how we can go to 
it from a financial aspect there?
    Mr. Hoenig. That is a pretty important question.
    Number one, I think that as far as our financial system 
goes, I continue to believe that ``too big to fail'' is an area 
that needs to be further addressed, and these institutions need 
to have their risk better divided between what is under the 
safety net and what is not.
    Number two, I think that the budget crisis in the United 
States is important because it is drawing all of our attention 
into that. And yet the economy is in difficulty and we should 
be thinking about our policies, do we want to see if we can 
bring greater manufacturing onshore?
    In 1960, 25 percent of our GDP was contributed by 
manufacturing. Today, it is 12.5 percent. We have 14 million 
people out of work. So what is our attitude towards 
manufacturing? What is our attitude towards creating businesses 
that create things then that hire people?
    By not being able to pay attention to that in the Congress 
and elsewhere, I think we are handicapping ourselves in an 
international, global, competitive market, and we need to pay 
more attention to it so we have a brighter future. I think that 
is essential.
    Mr. Luetkemeyer. I appreciate your comments. My time is up. 
Thank you again for visiting with us today. I always enjoy 
discussing things with you. I really appreciate your 
perspective and all your hard work as well. I thank you again 
for your service, sir.
    Mr. Hoenig. Thank you, Congressman.
    Mr. Luetkemeyer. Thank you, Mr. Chairman.
    Chairman Paul. I thank the gentleman.
    I have another additional question. If you care to stick 
around, you may.
    But I am not going to let you go so easily. I need to find 
some answers. But I am very glad you are here and willing to 
take our questions.
    In your introductory statement, you mentioned that one of 
the responsibilities of the Federal Reserve was to have maximum 
employment, which sounds like a good idea, and stable prices.
    I would look around and I would say, results aren't all 
that good. When you look at stable prices of housing, you even 
brought up the subject of unstable prices in farmland. That 
quite possibly could be a bubble.
    I would think that if you looked at bonds in prices, they 
are very unstable. And who knows where that is going. If the 
market overrides, which I believe is possible, markets are 
very, very powerful. I know the Fed is very powerful, but I 
also know markets are very powerful.
    But also in your statement, I want to get back to it, we 
talked a little bit about this, and you said, ``I have several 
concerns with zero rates. First, a guarantee of zero rates 
affects the allocation of resources.''
    To me, I think that is very key and very important, because 
it really brings up the subject that the free market economists 
are very attuned to.
    Ludwig von Mises, in his ``Human Action,'' talks about this 
as the misallocations and of malinvestment, excessive debt, 
money going into the wrong sectors, like farmland maybe or 
NASDAQ bubbles and houses.
    But he took that and carried it much further. It seems like 
you have part of that philosophy, but not the full philosophy, 
but you are, I am sure, aware of what von Mises says about the 
Austrian theory of the business cycle.
    Mr. Hoenig. Sure.
    Chairman Paul. How do you look at that? Can you say 
something favorable about his approach to it? Or can you draw a 
sharp line where interest rates are harmful and know how to 
divide the two? And what is your opinion of the Austrian 
business cycle theory?
    Mr. Hoenig. I have read ``Human Action.'' I have a lot of 
respect for von Mises and I have a lot of respect for the 
Austrian school of thinking. I think it has value.
    I understand that when you overinvest, when you leave 
things artificially low and you overinvest you create a 
correction by doing that. There is an action with that.
    My view is that is why central banks have to be mindful. No 
matter what the system is, if you have markets and capitalism, 
you are going to have cycles and you are going to have crises. 
And what you want the central bank to do is address the crises 
and provide over a long period of time a base liquidity of 
money that allows your economy to grow.
    When you move beyond that, when you find the central bank 
focusing on short-term issues, trying to manage the economy, 
trying to fine-tune it, then you create, if you will, impulses 
of instability, because you are trying to take care of short-
run issues instead of looking to the long run.
    That is why when I say the duty of a central banker is to 
think long run, and that I think I am in agreement with the 
Austrian school, but I do think there is a role for central 
banks, as I have said.
    Chairman Paul. I certainly agree with your point. Once they 
overextend, they are into central economic planning, except 
many have accepted the notion that you get into central 
economic planning earlier than that, at the initial stages of 
believing that you can know what the interest rates should be.
    Maybe you can give me a quick comment on this. Do you think 
the problems in the world today--try to put that in 
perspective. I think it is a very big problem, because I don't 
think we have faced it quite the same way, because we have a 
fiat dollar standard, and we are the issuers of the reserve 
currency of the world.
    Do you think that has had an effect on what we are facing, 
the fact that we are issuing the reserve currency in the world, 
and it is much different than anything we faced before?
    Mr. Hoenig. What I think is that the fact that we are the 
reserve currency is a consequence of decades of very good 
economic policy, the fact that we have had an economy that has 
grown, become very important to the world, and therefore, its 
currency has become very important.
    I think that is a consequence, something you, as someone 
also said, you have earned. With that is carried a 
responsibility to look to long-run policy.
    And to your point, if you have a gold standard, that is a 
legitimate alternative monetary base for your economy. But it 
does not eliminate crises. There is gold hoarding, there is 
positioning, there is mercantile practices. You will have 
crises.
    So it doesn't matter if it is Congress, it doesn't matter 
if it is the central bank, it doesn't matter what the standard 
is. Good policy leads to good outcomes. Bad policy leads to bad 
outcomes. That is what you have to keep in mind.
    Chairman Paul. I would question whether we earned it or 
not. In some ways I think it was defaulted, because we were the 
standard. At least we pretended to be a good reserve standard, 
even though we weren't allowed to own gold. It was an 
international gold standard.
    And then the confidence continued, surprisingly to some 
people. So that is just a matter of an understanding or 
semantics about whether it was earned or we defaulted into it.
    But I have one more question. Because I have been 
interested in the monetary issues, I am delighted that you are 
here and so willing to visit with us.
    But last week, I learned that gold was not money. So I have 
been able to put that out of my mind. Gold is not money, so I 
am still trying to figure out what money is. And I have asked 
these questions a lot of times, I have asked the Federal 
Reserve Board Chairmen over the years. And if I asked about 
dollar policy, they would say, ``We are not in charge of dollar 
policy.''
    They are in charge of creating all this money and 
regulating interest rates, but they are not in charge of the 
dollar. The Secretary of the Treasury does that. But the 
Secretary of the Treasury doesn't give me any straight answers.
    What I need to know from you to further my education is, 
tell me what a dollar is and where can I find the definition in 
our code?
    Mr. Hoenig. The denomination is, I think--or the title was 
given back at just about the founding of our country. It was 
based on a gold standard at that time.
    But money is, as you know, a medium of exchange, deferred 
means of payment and stored value. And as long as the public 
and the world understands that the dollar that is produced by 
the central bank of the United States, the base money, and then 
credit goes on beyond that, it is money.
    As long as they take it as a medium of exchange, deferred 
payment and stored value. When that is lost, then it will no 
longer be money.
    Chairman Paul. But it is a note, it is a promise to pay. 
Actually, you are right about it being--
    Mr. Hoenig. But it fills the three functions of money.
    Gold can do the same thing. And if Congress designated that 
gold was the medium of exchange--
    Chairman Paul. This is why I am looking through the code, 
because the code, when I understand it, actually in the early 
years they wrote a dollar into the Constitution like they would 
write a yard, because everybody knew what it was, they didn't 
even define it, it was so well known. It was 371 grains of 
silver.
    But that has never been changed, as best as I can tell, and 
all of a sudden now we have a Federal Reserve Note, a promise 
to pay nothing, is now the dollar standard and we can create 
them at will out of thin air. And then sometimes people wonder 
why we have a shaky, rocky economy.
    I will keep looking for the definition of a dollar. But as 
best as I can tell, we have never said a dollar is a Federal 
Reserve Note. And the dollar under the code still says it is 
371 grains of silver.
    I yield to Mr. Luetkemeyer.
    Mr. Luetkemeyer. I just have one follow-up question on 
something the chairman asked a minute ago with regards to the 
role of currency.
    Because I think one of the consequences of us not doing 
something to resolve our debt crisis here and then be 
downgraded, it would seem to me to be a step down the path 
toward allowing ourselves to be no longer the world's reserve 
currency.
    With China sitting over on the sidelines watching us 
twiddle our thumbs and waiting for an opportunity to get in the 
game, this is an opportunity. We are stumbling here and 
allowing them to do that.
    What would be your thoughts on that comment?
    Mr. Hoenig. I do think it is a serious matter. I think the 
U.S. currency, the dollar, is the reserve currency of the world 
and will remain so for some time.
    And part of it is, what are your alternatives? You always 
have to ask the question. And the United States, for all of our 
issues and all the debate going on right now, it still has the 
deepest markets, is a market economy, has all the advantages. 
It has open capital markets. China doesn't have that. Europe 
has its issues.
    So we still are the dominant economy. However, there is 
nothing guaranteed about that. That can change based upon the 
policies we choose going forward from here, both from a fiscal 
side and from a monetary side and from basically how we choose 
to have our economy operate in terms of the private sector and 
markets.
    Those will all define the future of us as an economy and 
therefore the future of us as a nation as a reserve currency. 
It will be what we choose to do.
    Mr. Luetkemeyer. You just made the case from the standpoint 
that almost by default, we are the reserve currency, because 
China doesn't have all its ducks in a row yet to be that 
currency. Europe has its own set of problems. And so you look 
for the safest harbor, you look for the strongest economy. We 
are still there.
    But if we keep twiddling our thumbs here, it could be 
endangered from the standpoint of the world sort of looking at 
us and saying, ``Those guys can't get their act together--
    Mr. Hoenig. I agree with that.
    Mr. Luetkemeyer. --and their economy is stumbling along. 
They don't have a manufacturing base anymore, and they are 
going to import almost all the oil, which means they are going 
to be at the mercy of the oil companies and the oil cartels 
around the world.''
    And all of a sudden our economy is looked at as kind of a 
shaky thing versus a very stable thing. And now, we have those 
other folks coming in there to fill the void.
    And to me this debt debate, one of the sidelights and one 
of the side consequences is that we are going down this road, 
and nobody is thinking about allowing China to get their foot 
in the door on the world currency side.
    It is not going to happen today or tomorrow, but I have 
heard some people project that in 5 or 10 years, if we don't 
get our fiscal house in order, by that time they will be in a 
position economically where they will have resolved a lot of 
the issues that you talked about, and they may be knocking on 
the door.
    Mr. Hoenig. I agree.
    Mr. Luetkemeyer. So what do you see on the horizon for 
that?
    Mr. Hoenig. I think that the debates that are going on 
right now are about the long-run future of this country--how we 
choose to deal with our debt, how we choose to deal with our 
economy going forward. Those are the debates that are in place 
right now.
    My point is that monetary policy cannot manage the short 
run, it has to have a long-run focus also. And the Congress and 
how we choose to have our markets operate are choices that lie 
ahead of us. If we don't choose well, in a generation, I think 
the answer to that question could be different.
    So it is in our power to change this or to keep us on the 
right path, but you have to choose to do it. And these debates 
are about the long run. There is no question about it.
    Mr. Luetkemeyer. I certainly appreciate your common sense 
and intellectual approach to all of our problems, Dr. Hoenig, 
and I hope that you stay engaged in some aspect--
    Mr. Hoenig. I hope so, too.
    Mr. Luetkemeyer. --of monetary and fiscal and economic 
policy here. You are too much of a prized jewel to walk away 
from this. So thank you again for your service.
    Thank you, Mr. Chairman.
    Chairman Paul. Thank you very much.
    We are about to close, but I do have one more short 
question I think you can answer rather quickly. What would be 
the ramifications if they stripped away the voting rights of 
the regional Fed Presidents from the FOMC?
    Mr. Hoenig. The ramifications would be you would lose an 
important set of voices in the Federal Open Market Committee. 
And I think it would be a mistake.
    Right now in my region, as I deal with our board, a rancher 
from Wyoming, a bookseller in Oklahoma, a labor leader in 
Omaha--that is all input that comes into the process. I think 
you would lose that voice, and you would lose that input.
    And you can say, make them advisers. But let me just tell 
you, voting and advising are two different things, and they are 
not even close to one another.
    I would just say, since you have asked, I have been there. 
It is not democratic. It is not part of the political process. 
And my answer has been the selection of my successor will be a 
process that relies on our board, who represent, like I said, a 
grain dealer in Kansas City, an entrepreneur in Denver, a labor 
leader, a bookseller, a manufacturer, and a rancher from all 
over our region, six of our seven States.
    And they very carefully go through a search, and then it 
has to be approved by the Board of Governors, the political 
appointees.
    So, to me, that is a very democratic process. And it is in 
contrast to, if you select a Secretary of the Treasury who 
happens--if you are a Democrat and you select a former chairman 
of Goldman Sachs and you are a Republican and you select a 
chairman from Goldman Sachs, that is political, but I don't 
know that it is any more democratic than our process, and I 
don't recommend it.
    Chairman Paul. I thank you. I thank you for being here.
    The Chair notes that some members may have additional 
questions for this witness, which they may wish to submit in 
writing. Without objection, the hearing record will remain open 
for 30 days for members to submit written questions to this 
witness and to place his responses in the record.
    This hearing is now adjourned.
    [Whereupon, at 3:37 p.m., the hearing was adjourned.]















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                             July 26, 2011

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