Inflation Is A Choice: Kevin Warsh on Fixing the Federal Reserve | Uncommon Knowledge | Peter Robinson | Hoover Institution - Uncommon Knowledge

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>> Peter Robinson (00:00):
The Federal Reserve System charged for more than a century and
now with maintaining price stability,with fighting inflation.
How's the Fed doing?
Our guest today is here to say,not as well as it should be.
Kevin Warsh on Uncommon Knowledge now.
[MUSIC]

(00:28):
Welcome to Uncommon Knowledge,I'm Peter Robinson.
A native of upstate New York, Kevin Warshearned his undergraduate degree at
Stanford and his law degree at Harvard.
Mr. Warsh spent the early years of hiscareer on Wall Street and in Washington.
In 2006,President George W Bush appointed him to
the Board of Governors of the FederalReserve, where he served until 2011.

(00:50):
Note that Mr. Warsh was on the Fedduring the financial crisis of 2008,
the worst financial crisisin more than half a century.
Mr. Warsh now divides his time betweenNew York, where he works in an investment
firm, and Stanford, where he is a fellowhere at the Hoover Institution.
Kevin, welcome back to Uncommon Knowledge.

>> Kevin Warsh (01:09):
It's great to be back.
You hid the most important thing,which is the investment firm.
I happen to work for the greatestinvestor in the history of the world,
a guy named Stan Druckenmiller.

Yeah. >> Kevin Warsh
keep that discreet, I appreciate that.
I just wanted to boast about my friend andpartner.
You keep going because I
want him to appear on the show sooner orlater.

[LAUGH] >> Peter Robinson
him up right now.
All right, Kevin,here's the first question.
Created a century and a decade ago, theFederal Reserve is the one institution in
the nation charged with maintainingthe value of our currency, the dollar.
Two quotations, the latelegendary investor Charlie Munger.
Quote, destroy the currency andGod knows what will happen.

(01:53):
Here's the second quotation.
This comes from your remarks this pastApril to an organization of bankers called
the Group of 30.
And I have plucked from it a few ofyour descriptions of the Fed today.
Institutional drift, failure to satisfyits statutory remit, contributed
to an explosion of federal spending,outsized role, and under performance.

(02:17):
Kevin Warsh,you are attacking a sacred institution,
the institution on which every oneof us depends every single day for
the integrity of the money we make andthe money we spend.
What do you think you're doing?
[LAUGH] In central banking,
we are taught to keep ourcriticisms quite closeted.

(02:40):
So I didn't do a very good job ofthat in those same remarks, Peter.
I described this as a love letter,more than a cold critique.
You might not have takenit as the love letter,
I'm not sure the current incumbent did.

I let the lovey-dovey stuff drop.

It's a love letter because the institution's as important as your
setup would suggest.
It's a love letter because ifthe institution can reform itself,
then there can be great things forthe institution and the country.
But it does mean that it's timeto get things back on track.
I should say one other thing.

(03:17):
This is our third experiment ata central bank in the United States.
And it's our third experiment,not because the first two went so well,
they went poorly.

Right. >> Kevin Warsh
like winning a third Super Bowl, Peter,where the more you get, the better.
And the first two failed because theylost the consent of the governed.
They lost their ability todeliver on what they promised.
And this isn't a history lesson, but youcan think about the Jacksonians of prior
times say that central bank seemslike they're trying to focus and
they're all preoccupied with thosespecial interests on the east coast and

(03:49):
they've lost track of what's happeningto us in the center of the country.
It's a version of what worries me today.
And so the central bank's goingon more than 100 years and
if they reform themselves,they're gonna have another great hundred.
Absent that I worry.
All right, so I wanna return to your remarks in a moment, but
first take me through.

(04:11):
I'm a layman in these matters, you'rea skilled central banker and investor.
You know this world, I don't.
So take me through, I've got a coupleof very elementary questions.
Give me a moment to set up this question.
The Federal Reserve System is establishedin 1913, possesses the power.
This may be something ofa Noble's oversimplification, but

(04:32):
it possesses the power toset interest rates and
regulate the money supply in the interestof achieving price stability.
Those are big powers.
How has it been doing?
These are remarks by Milton Friedman,
Nobel Prize winning economistMilton Friedman in 1994.
Quote, there is no institution in theUnited States that has such a high public
standing andsuch a poor record of performance.

(04:56):
The Federal Reserve beganoperations in 1914 and
presided over a doubling ofprices during World War I.
It produced a major collapse in 1921.
The major villain inthe Great Depression was unquestionably
the Federal Reserve System.
Since that time, it has presided overa doubling of prices since World War II.
It financed the inflation of the 1970s.

(05:16):
The Federal Reserve System hasdone far more harm than good, and
I have long been in favor ofabolishing it, close quote.
Kevin, why do we needthe Federal Reserve System?
None of this is new to you.
Milton Friedman was here at Stanfordwhen you were an undergraduate.

So, Milton, I was blessed to be a student of his, and when he came
here, he had a huge effect on not just me,but generations of students that followed.
I've spent some considerable time in thearchives of the Hoover Institution looking
at what Milton would say, for example,the Federal Reserve chairman.
There's a beautiful book by our ownJennifer Burns that includes some of that

(05:57):
correspondence.
But I had them search andgive me all the letters that went back and
forth between Paul Volcker andMilton Friedman, and Alan Greenspan.

Okay, so give us the dates,
Volcker is appointed Fed Chairmanby Jimmy Carter in 78, 77.

In the middle of the Carter administration,
I don't have the precise date.

And then Ronald Reagan reappoints him and
he serves until nearly the end ofthe Reagan administration, correct?

Correct. >> Peter Robinson
then Alan Greenspan succeeds him andserves until?
He serves 17 years until Ben Bernanke shows up.

In the middle of the crisis.

In 2006.

2006 preceding the crisis.

The only reason why I know that is I recall being a junior
White House staffer when I found outthat not only had Chairman Bernanke,
who had come to the White Housefrom the Federal Reserve and
was going back to serve the bigshoes of Alan Greenspan, but
he wanted me to come with him andtake his old job as Fed governor.
So I remember that.

You remember that. >> Kevin Warsh
All right, okay, Milton.

And in that correspondence of Milton,
the thing that's amazing about him is hewas constantly revisiting his priors.
He was constantly askingwhether the data and
conclusions he came to one yearwere still relevant the next,
whether his judgments on the institutionwere still relevant the next.
And in much of the correspondence duringthe Volcker years, and the Greenspan

(07:19):
years, he was quite comforted by changesin approach, by new ways of thinking about
the economy, by success that would cometo be known as the Great Moderation.
So I wouldn't say that Milton thoughtthat the Federal Reserve was a terrible
institution, he thought theyhad bad periods and good.
I can only speculate what he would sayabout the great inflation of the last
half a dozen years andhow he would have foreseen it.

(07:42):
He would have warned of it, and in alllikelihood the Fed wouldn't have listened.

All right, so one more of these elementary questions, and again,
Milton Friedman.
Milton Friedman was famous forsaying, quote,
inflation is always andeverywhere a monetary phenomenon.
Now, if inflation isa monetary phenomenon and
the Fed is in charge of the money supply.
Inflation is always the faultultimately of the Fed.

(08:09):
Why don't you describe what Paul Volckerdid when Carter appointed Volcker you'll
know this.
I'm just grasping at memories here.
When Carter pointed Volcker,
I believe we were suffering the highestinflation since the Civil War.
And by the time Paul Volcker left office,inflation was right down to 2% or
thereabouts.

Almost.

Almost 2%.
So, okay, so Milton Friedman andthe Fed is always responsible.

Yeah, so I believe what Milton and you just channeled,
which is inflation is a choice.
As you said at the beginningof this setup, inflation and
ensuring price stability was grantedto the Federal Reserve by the Congress
most recently in a review ofits statutes in the 1970s.

(08:55):
So that there would be one agencythat would be responsible for prices.
No more blaming the other guy.
We're giving the baton to you,the Central Bank.
Go after it and get it.
Now you wouldn't know from recentcommentary of the last several years that
inflation were a choice.
In fact, during the run up to the greatinflation last five or six years,
what did we hear aboutthe causes of inflation?

(09:17):
It was because of Putin in Ukraine.

Yes. >> Kevin Warsh
the pandemic and supply chains.
Well, Milton would beoutraged to hear that.
And in my own subtle way,I was troubled to hear it as well.
Those things lead to a change in prices.
After all, in market economy,the prices change in Walmart every day.
economy works.
It's not the Central Bank'srole to police those prices.
But that's not what inflation is,

(09:40):
that's a one time change inthe price level of a widget.
Inflation is what happens if that one timechange in the price level becomes self
fulfilling.
That is higher prices beget higher prices.
That means inflation ends up findingits way into every kitchen table and
every boardroom.
Because you don't know as a decision makerwhat the price level is going to be.

(10:02):
That's not about Putin and the pandemic,that's about the Federal Reserve.
That's about the Central Bank.
And I'm afraid in recent years this isprobably because central banks are part of
our culture as we do a little bit of,well, it's not my fault,
it's someone else's fault.
And I think that's what Milton wouldbe most outraged by in recent times.
The Central Bank can hit anyprice level that it wants,

(10:24):
any inflation level that it wants.
We might not like how they do it, butthe idea that is they should be blaming
someone else strikes me as quiteantithetical to good economic history.
And for the remainder of our conversation,
it's probably important, just to repeat,not only is inflation a choice,

(10:44):
but a sound dollar is also a choice,and Volcker did it.
Within living memory, it has been done.
We suffered inflation andthen the Fed got it back under control.
All right,one more of these baby questions.

If I might, so they got it back under control and
then I suspect this is a littlepsycho babble from an economist.
Then they got complacent aboutinflation being under control.
Somehow after the period of whatwe call the Great Moderation,
where prices were more or less stable fora period of more than a generation.
I think some in my professionthought this was easy and

(11:23):
in fact that it was under control becausewe had all gotten so very good at this.
We'd all gotten perhaps a littlecomplacent with this business.
But economics isn't that easy.
And it's really because ofthe most recent crises of 08 and
2020 that I suspect wetook our eye off the ball.

You've used this phrase a couple times now.
Let's just define it.
The Great Moderation is, I'm asking.
It begins by the mid 80s when Volcker andthe Fed backed,
let it be said by Ronald Reagan, when theyactually get inflation down into low,
low single digits andinflation stays right there and
the economy expands with onlya couple of quarters of recession for

(12:05):
the next quarter of a centuryuntil crisis of 2008.
Am I right about that, and
is that what you're referringto as the Great Moderation?

That's exactly right.
And we don't wanna sound as though, boy,every year was perfect and central bankers
didn't make any mistakes, but the mistakeswere relatively small and manageable.
And for viewers, I think, inflationstill this very abstract concept.
We want the change in prices tobe such that in the economy,
such that no one's talking about it.

(12:33):
That's how we know we've done our job.
And what do we know about the last five orsix years?
It's almost everythinganyone will talk about.

Right, last of my elementary questions here, gold.
President Nixon takes us offthe gold standard in 1971.
Until then, the dollar was alwaysconvertible into a fixed weight of
precious metal, for the most part, gold,and that constrained the money supply.
The journalist and investor James Grant,writing just last year,

(13:04):
the opposite of the gold standard.
What we have in place now, the opposite ofthe gold standards is really the system
in place today in the United States,one might call it the PhD standard.
It's the system of discretionarymanipulation of interest rates by
doctors of economics, close quote.
So James Grant suggests if not goldsome fixed basket of commodities.

(13:30):
Milton Friedman said about the sametime that of the quotation
I gave you where he said he long stood for
abolishing the Fed that the Fed should bereplaced with a pre-announced increase
in the money supply by a fixed sum thatwould take place each and every year.
So it was totally transparent marketsyou could plan a decade in advance.

(13:52):
And both of those are a way of sayinglet's find some objective standards here,
let's find some way of constrainingthe money supply that the markets can
know about in advance and not leaveit all to the subjective impulses.
And the group think and

(14:12):
the who really understands thateconometric latest piece of research that
takes place in the Federal Reserve Systemnow to which Kevin Warsh replies.

There is no status quo ante to return to.
I have many of our friends on the rightwho believe well let's just bring
the gold standard backthe world has moved on.
Might it have been better or worse had wemade different choices along the way but
you have to deal with what'sright in front of you,
I think that's what Orwell said.
And there has to be a third choicebetween let the machine do it and

(14:48):
let's have full discretion ofa central banker's latest whims.
I think you and I might have learnedfrom Edmund Burke of conservatism,
it's a resistance to whimsicalwe central bankers past and
present need to resist whims.
There's a way to have clarity aboutthe reaction function of Central Banks to

(15:08):
incoming information.
And if Milton were with us today Ihesitate to put words in the great man's
mouth but I think he would say that therehad been too much scientism, scholasticism
trying to make precise that which wehave still imperfect understandings of.
Most of us in economics that are it'sa better than average we try to focus to

(15:31):
the left of the decimal point,not to the right of the decimal point.
Now if we were better at our craft,if we were smarter we'd be physicists and
mathematicians and most of us that are inthis business we started in one of those
fields and then we came to economicsbecause frankly it was easier.
And so we don't have a perfectedunderstanding of how the economy works.

(15:55):
If we did, we could create the machine.
We could create the formula.
But the economy's changing every day,it's incredibly dynamic.
And so I hesitate to saywe have a perfected rule.

All right, now we'll move on to recent history,
your recent history andthe Fed's recent history.
What the financial crisis wrought.
You were on the Federal Reserve Board ofGovernors during the financial crisis of
2008, which led to the worst economiccontraction since the Great Depression and

(16:26):
unemployment in this country of 10%.

Are you drawing a causal relationship there, Peter?

[LAUGH] >> Kevin Warsh
scared where the rest is going.
You're just plain bad luck, Kevin.
The Fed responded witha number of actions, but
perhaps the most dramatic was toflood the system with liquidity.
Let me give you some sense ofthe magnitude of the Fed's action between
the first and second quarter of 2008.
The Fed's balance sheet, measure of thesupply of reserves in the banking system.

(16:55):
The balance sheet doubled in the space ofa quarter from a trillion to 2 trillion.
Now, you've written that youstrongly supported that decision.
So before we get to the QE2,
3, 4 and so forth.
Well, you'll explain yourself in a moment,but first tell me why you

(17:20):
supported that dramatic infusionof money into the markets in 2008.

Yeah, so first of all, we keep bringing up this word money.
I should say a word about that.

Please.

Milton believed, as you suggest, that monetary policy and
inflation is about money.
That is heretical in the modern academy.
That is not taught inintroductory economics.
At most of these elite universities,most came from a different school.
Not this monetary school, butmore of a Keynesian school.

(17:53):
And in that Keynesian school,money barely comes up.
In fact, if you look at the transcriptsof the Federal Reserve,
they tape most of the words that we utterinside the Federal Open Market Committee.
You're gonna have to look a longtime until you see that word money.
I think money, strangely enough,has something to do with monetary policy.
It has been absent from the discussion.

(18:13):
I think is part of the reason whythis great inflation came back.
Because while Milton himself,I don't believe,
would have held exactly to the modelhe had in his mind 30 years ago,
he would have said money hassomething to do with it.
And in the run up of the great inflationaround the time of the COVID crisis,
we saw a surge of money,
both money as best we measure it andvelocity as best we see it.

So PB equals MQ?
I'm trying to remember back nowto classes a long time ago.
I would have thought that wasbasic in discussions at the Fed.

It is non-existent in most discussions among modern economists.
Now, Milton used to say,this is the last ode to Milton.
Then we'll the current events.

All right, yes.

Milton, I was a 19 or 20 year old and
there was a small group of us aroundthe table, a little larger than this.
And I asked him some question, probablytrying to show off that I knew something
about something of which I didn't.
And he said, Kevin, the only thing weunderstand in economics is Econ 1.
Everything else is made up.
And I remember thinking, Peter,maybe the old man's losing it.

(19:21):
Maybe he sort of passed his day.
The Nobel Prize was givensome period before that.
I didn't know until the financial crisisof which you now speak that the old man
was exactly right.
No one predicted it, no one saw it.
Because all we really know abouteconomics, we teach in Econ 1.
And at least in the Econ 1,
before the schools of economic thinkingtook over at these elite departments,

(19:45):
we said that money has somethingto do with monetary policy.
And I still believe that to be true.

By the way, it occurs to me that as we sit here today,
it's getting up toward 20 yearsago that the financial crisis hit.
So why don't you take just a momentto just explain what that felt like.
You're on the phone tofriends in New York,
you're in Washington at the timeon the board of the Fed.
How bad was it?
What do we need to understandabout that crisis?

So I teach on occasion in this business school not far from where
we're taping.
And for years I would talk aboutthe global financial crisis and
they'd look at me and these studentswould have some recollection.
Now, they weren't exactly in business, butthey remember how their parents would have
come home, orthey remembered watching it on TV.
Now, when I talk of the global financialcrisis, they had heard of it, and

(20:31):
I could have easily been talkingabout the Great Depression.
So it was some time ago.
How it felt to me is, I was 35 yearsold and I had finally found myself
to this august position because ofPresident Bush and Ben Bernanke.
And I was in this beautiful office,and for about six or eight months,
life was grand.

[LAUGH] >> Kevin Warsh
put wood in the fire.
Someone else would restock thislittle pitcher of ice water and
I thought things were good.
Little did I know that wasthe calm before the storm.
I would say it in retrospect,it was scarier than it felt
at the time because we were insome ways in the bunker together.

(21:10):
While I don't know if Ben Bernankewould at all be comfortable with
what I said at the IMF G30meeting a few weeks ago,
he was a heck of a strong,good battle commander.
We were all in the bunker together and hewas very open to a small group of people
who could get around a table like this andfight about what's happening and why.

(21:32):
And he was quite open to heretical ideas.
I wonder whether there's suchpermitted heresy in the profession or
at the central bank these days.
But in the darkest days of that crisis,which maybe we get a gentleman's B for
how we handled it,we could have done more sooner.
We made plenty of mistakes.
We had some successes too.

(21:54):
The real economy was deteriorating fasterthan we had any historical reference of.
Financial markets were down 60,70% in equity prices.
And maybe most alarming,the treasury market auctions.
The auction forthe most important security in the world,
which is synonymous with the dollar.
People weren't showing up in the auctions,at least at the beginning.

(22:17):
Bid ask spreads were wide and
we were worried that the Americaneconomic was at the very cliff.
So flooding the system with liquidity,
pushing money out into the system,
was an emergency measureintended to keep the exchanges,

(22:39):
to keep the markets functioning.

Yes. >> Peter Robinson
that keeping the markets at work,keeping the markets open and
functioning, giving people enoughcurrency to be able to buy and
sell, was the best and most immediatething that anybody could do.
The markets themselves would graduallywork this through, I suppose.

(23:03):
Is that the justification?
So I'd say it goes back to first principles.

Right.

This third experiment of Central Bank, the one you referenced,
the one that we're still living in,created in 1913,
was created in 1913 in response to a panicthat had preceded it less than a decade
before Central Banks were first created.
Or this generation of central banks torespond to just this sort of situation.
A panic in the old days, what we now calla deep recession of financial crisis,

(23:32):
is when markets aren't working,when there are spreads between what buyers
are willing to pay andsellers are willing to sell.
And the job of the Central Bank isto show up with all sorts of money.
There's that dirty word again.
And get those markets to function,not to set prices, but
to make sure that buyers andsellers could clear.

(23:53):
And the central bank was there to provideliquidity when no one else would.
We were the backstop andare the backstop to the banking system,
not just in the US butin the rest of the world.
Because if we blew it, it would have beeneven worse for the rest of the world.
So that's what we did in crises.
And some of your and my friends onthe right, including at institutions,

(24:14):
we care deeply about their views, thenwere you should let the system burn down,
a phoenix will rise from the ashes.
You really have no business in doing this,that's not my view.
My view is the Central Bank wascreated to respond to panics.
We had one, we recognized it belatedly,but then we showed overwhelming force.

(24:35):
And the word you used,I think is the right word.
It was an emergency.

Right.

So you're prepared to cross more lines than you would in benign
times.
You're prepared in some sense,as Paul Volcker famously said,
then go to the veryedge of your authority.
But there was an implicit promise we madeto each other around the table that we
made to the Treasury Department,the Congress, and I would broadly say,
to the rest of the US Government.

(25:00):
When the crisis ends,we'll get out of this.
We will go back to beinga rather boring Central Bank.
That's on page B12 of the newspaper.
Six little paragraphs.
The Fed met today and they raised orcut interest rates a quarter of a point.
But from that moment until this moment,the Central Bank became front page news

(25:20):
and I will argue, played a bigger rolethan our founders would have been
comfortable with, and the founders ofa Central Bank should be comfortable with.

All right, let's go through then, from 2008 to the present.
I'm sure I'll get this wrong,so correct me.
Let me go through it quickly.
QE1, QE stands for quantitative easing,
which is a fancy way of sayingpushing money into the system.
QE1 takes place in 2008.
We've just discussed that.
The Fed's balance sheet goes from justunder a trillion to just over 2 trillion.

(25:54):
Kevin's in favor of that one.
The Fed's balance sheet risesto just under 3 trillion.
The Fed takes its balancesheet up to 4 trillion.
QE4 takes place in 2020during the COVID lockdown,
which will require a moment or two ofdiscussion because that was an emergency

(26:17):
toward the end of COVID by 2022,its balance sheet is up to 9 trillion.
Since then, the Fed has broughtit back down to 7 trillion.
But as you have noted, the Fed's balance
sheet today is almost an orderof magnitude larger than it was
when you joined the Fedwithin living memory in 2006.

(26:41):
Okay, we've discussed QE1, QE2, QE3,
the pre COVID expansionsof the money supply.

You keep printing a trillion here and a trillion there.
It's gonna catch up to you, Peter.
I mean, back in your day in Washington andin my day, various parts of the economic
institutions would spend millions onthis project or billions on that.
We are a big and strong economy.
We can tolerate these sorts of things,even if these projects aren't perfect.
But when the Federal Reserveprints trillions,

(27:15):
especially in benign times,it changes everything.
And it almost is a signal to the rest ofCongress we're doing it and so can you.
So let's just go back to the essenceof quantitative easing for a moment.
QE1, which by the way, at the time wetried to market it, this worked for
about a week as credit easing.
That was our preferred nomenclature.

(27:38):
QE sort of took off without us.
And what did we say then?
We debated internally whether to do this.
And the story goes something like this,Peter.
Secretary Paulson,he's issuing bonds on Monday and Tuesday.
What do you say we buy themon Thursday and Friday?
And I don't believe in betrayingthe confidences of those that were

(27:58):
sitting around tables.
But I recall one person saying, well,that sounds like a Ponzi scheme.
What else do you have to save usfrom the global financial crisis?
Explanations were given.
Small versions of this were done bythe bank of Japan about a decade prior,
but nothing quite like this.
And we weren't quitesure how it would work.

(28:19):
But it turns out it worked andit was radical at the time.
Now, if you turned economic textbooks,even introductory economics,
they talk about this as likestandard operating procedure.
It seemed like a roll of the dice then,but we were in roll of the dice time, so
we took it.
But that was QE1.
I supported it, and I supported it with

(28:41):
many colleagues under the view ofwe're gonna put this very dangerous,
risky stuff back behind the coveredglass until there's another crisis.
We really never did that.
So the story you are going to tell aboutthe subsequent QEs during a period that I
would say was reasonably strong growth,reasonably stable financial markets,

(29:05):
reasonable periods of stable prices,we start doing it for all seasons and
all reasons, and in so doing we raisethe bar for when another crisis hits.
Because whatever you were doingcouldn't possibly be enough.
I should only note one other thing.
You're cleansing my biography andI should be grateful I resigned.

You did?

Yeah, when QE2 was launched.

In 2010.

All right, I left in early 2011.
My colleagues, includingChairman Bernanke, who I mentioned, for
whom I had great respect as a war fighter,he and
my colleagues at the Fed decidedthat we should keep on doing it.

On what grounds?
If you could make the best argument fortheir case that you could,
what would the argument be?

So we don't see any costs.
We have found a free lunch.
Look around, asset prices are higher,markets are filled with more liquidity,
the economy is good, and, gosh, if we takeit away, we don't know what would happen.
And in some sense, they broke,in my view, the bargain that was struck.

(30:14):
Did any of us know what wouldhappen under various scenarios?
No, because again, in economics,unlike in physics,
there are no control groups,at least no very good ones.
And I should say the other thing that'sdifferent between economics and physics
and math is the atoms that we're trackingin economics, they change their minds.

(30:34):
So we don't know how individuals are goingto react to a whole range of things.
But the argument was the costs are small,the benefits are large.
Let's keep doing more of the same.

All right, QE4 takes place during COVID, Economist Paul.
I'm sure I'm gonna mispronounce this name.
Paul Sheard in 2021, quote, withgovernment suppressing economic activity
to quell the pandemic, fiscal policyneeds, he's writing during the pandemic,
needs to play a significant socialinsurance role by providing income support

(31:06):
to households and small businesses.
And the more that monetary policymakersshow their determination to achieve their
inflation target by implementingaggressive QE policies,
flooding the system with still moreliquidity, the more credibility
they will have when it comes tofighting inflation, close quote.
Kevin.

Much to unpack in that quote.

Unpack away.

So when you're in a crisis, like the 2008 crisis and
like the pandemic crisis,I used to be known for saying,
when you've seen one financial crisis,you've seen one financial crisis.
So none of them are terribly similar.
But again, if you had importedmy mind into the 2020 pandemic,
I was here in the cheap seats at Stanfordand in New York, I would have said,

(31:54):
well, this is a time wherewe have to be radical.
But the problem is between->> Peter Robinson: Another emergency.
Another emergency.

Right.

But we didn't have an emergency for
most of the decade between 2010 and 2020.
This was the time forthe Central Bank to retreat, instead,
the Central Bank stayedon the front pages.
And I should also note, during thatperiod of a relatively benign period
of relative peace andprosperity, Congress said, well,

(32:22):
if the central bank are buying allthe bonds, then we can spend trillions.
Hence the fiscal authorities, Congress andthe President decided there are very
few costs to all of this spending, becausethe Federal Reserve is subsidizing it,
because we were the most importantpurchaser of these bonds.
Then when you find your way into crisis,yes, I have sympathy for

(32:45):
my colleagues in crisisdue to crisis like things.
But if you treat every day formore than a decade like it's a crisis,
then when the actual crisis hits,you have to cross more lines.
You have to get more involvedin the private sector.
And in so doing,to go back to where you began,
you have an economic institutionthat isn't the first among equals,

(33:07):
it's the first andmost important institution in the world.
And you see administrations,Republican and Democrats.

Unelected bankers.

And you see members of Congress and importantly, you see
businesses, they now hire lobbyists togo to the Central Bank seeking relief.
This is a historical, this is, in my view,dangerous, it takes the responsibility and
accountability of fiscal policy andbrings it to the Central Bank.
And while my colleaguesare well-intentioned folks and

(33:38):
they might even make some good judgments,many of these things aren't their job.

Kevin, let me respond on behalf of the Federal Reserve.

[LAUGH] >> Peter Robinson
yes, everything you said, buthere's where we are today.
Inflation is now below 2.5%, andthe economy is growing in spite of it all.
And soinstead of chiding the Federal Reserve,
you should be saying, ladies andgentlemen, well done.

(34:07):
Mission accomplished is a very dangerous thing for
policymakers in Washington, and that wasyour attempt at mission accomplished.
Let me say this, after most crises,Peter, after the 911 Crisis,
after the Global Financial Crisis, therewere a series of after action reports,
Congressional scrutiny,Blue Ribbon Commissions.

(34:30):
How did that happen?
Well, after the Great Inflation,I'm still waiting for this.
Instead, we've cleaned up matterssomewhat, but the institution is still,
in my view, in over its skis quite a bit,and inflation is still above target.
The Fed has said are doing a bitof an after action report.

(34:50):
They're looking at their objectives,
they're going to come out withthis report this coming August.
I wonder whether their report will beup to the task of this great error.
The prices of goods andservices over the last five or
six years are up more than 30%.
Since the day before COVID,the Federal government spending is up 63%.

(35:16):
And five years ago, I don't rememberthinking this is an august, efficient,
well-run government, so
there are consequences that weshouldn't just sweep under the rug.
So I appreciate the snapshot,things are much better, but
there have been costs to this error, and
the costs are being felt by thosethat are the least well-off among us.

You've already mentioned some of this, but
I'd like to go to the the damagethe Fed has done explicitly.
The Wall Street Journal,
this is a remarkable thingon which I congratulate you.
I've never seen it before thatthe Wall Street Journal reprinted
over here under your name whileyou did it, excerpted and
rewrote your remarks for a column forthe Wall Street Journal, and

(36:02):
then printed over here the lead Op-ed inthe day's paper commenting on your speech.
A Nobel Prize is as nothing by comparisonwith appearing on both sides of
the Wall Street Journal editorial page.
So here's what the Journal said,Federal debt as a proportion
of GDP in 2006 when youjoined the Fed was about 34%.

(36:25):
Federal debt as a proportionof GDP today is about 100,
headed toward about 124%.
And the Journal quotes your speech,irresponsible spending surged,
especially in the aftermathof the pandemic,
I struggled to absolve the Fedof the nation's profligacy.
Fed leaders encouraged government spendingwhen times were tough, but didn't call for

(36:49):
fiscal discipline at the time of sustainedgrowth and full employment, close quote.
And now I'm going to turn on you, Kevin,because up until now I've been offering
one little defense afteranother of the Fed's policy.
Now I'm going to turn on you and say,the growth in Federal indebtedness,
as Niall Ferguson pointed out ina recent very arresting column,

(37:13):
there is just no history of anygovernment that finds itself paying more
on debt service than it does on defense,and remaining a great nation.
Far my friend from sounding the alarm,
you've been much too tepid inattacking the Fed, this is an outrage.

So now you have me defending the Federal Reserve.

Yes.

We've reversed rules.

I'd like to see how you handle this one.

So I believe the Federal Reserve plays this critically
important role.
I believe the Federal Reserveis up to reform,
heal thyself is an important thing forall institutions, it is not too late.
But they need to ask and answer big,hard, strategic questions,
instead of just sort of pushingthese things under the rug.

(38:02):
Congress deserves its own criticism forreckless,
irresponsible spending made more,I would say, made acceptable
because the Federal Reserve werebuying those bonds in large part.
And signaling to the world,when the Fed buys the bonds,
what are we telling the world's investors?

(38:23):
The water's warm, come on in,you should do it, too.
But plenty of blame shouldbe given to Presidents and
to Congress for pushing big spendingin periods of peace and prosperity.
But it's incredibly dangerous,I'll make one final point.
Irresponsibility runs in both directions.
The connection between fiscal spending,that is what Congress does, and

(38:47):
monetary printing,that's what the Central Bank does.
When one of them is irresponsible, theother one tends to be irresponsible too.
We tend not to see the harms thatare done immediately, there are,
as Milton famously said, long and variablelags, but there's no free lunches here.
And I'll make one broader point.
When the rest of the world, Peter, seesthe most important economic institution

(39:11):
in the world treating normal times likethey're an emergency, they do the same.
No one gives us a run forour irresponsibility.
The rest of the world believedabout the US for a long time.
Well, we don't really like how theyshow up at these meetings of the G7, or
G10, or G20, and sort of lecture us.
But before the 08 crisis,you know what they thought?

(39:32):
Well, those Americans,they might be a bit abrasive, but
they sure know how to runa banking system, until we didn't.
Then going into the COVID crisis,what did they think?
Well, those Americans, they're differentthan we are, but they do seem to
believe in Federalism, and liberty,and human agency, until we didn't.
And then, well, that Central Bank,maybe we're being too tough on them, but

(39:55):
they prevailed on andpreside over a period of stable prices for
40 years, that's pretty good,until we didn't.
When these institutions keeplosing on important things,
the rest of the world is watching, and
the rest of the world's watchingthe Central Bank as we sit here today.
And if the Central Bank can put its ownhouse in order, hide itself from the front

(40:15):
pages, encourage thereby the Congressto be more responsible on spending,
well, then this can be the shiningcity on the Hill again, can it?

Okay, so Herbert Stein used to say that if something can't go,
the late Herbert Stein, economist, and
I think he was chairman ofNixon's Council of Economic Advisors.
Is that correct?>> Kevin Warsh: Yes.
All right, I don't think he was ever on the Fed
though, was he?

Not to my knowledge.

All right, so the late economist Herbert Stein used to say,
if something can't go on forever,it won't.
Here's the question, we've beenrunning essentially a Ponzi scheme.
The treasury puts bonds up forsale, the Fed buys them.
This is as close to actuallyrunning a printing machine and

(41:00):
printing money as you could possibly get.
And yet the world still buys T bills.
In other words, why haven't world marketsdisciplined the United States of America?

So I want to be clear.

Because it looks as though Ben Bernanke was right.
It looks as though there is no price.

So that was Peter Robinson, our host,
saying that this is a Ponzi scheme.
That is not his guest.
His guest was referring to a debate wehad in a private setting about how would
this appear.
I actually do believe the US is,
I'd rather have our cards thananyone else's in the world.

Right.

I believe we are on the front end of a productivity boom.
I believe that economic growth inthe US is the most important thing and
could do a better job at defeatingthese liabilities than anything else.
Just to give one simple statistic,
the Congressional Budget Office intheir latest report, full disclosure.
I'm on a panel of economicadvisers to that office.

(42:06):
They pay no heed towhat I say necessarily.
They say that growth overthe next ten years will be 1.7 or
1.8% per year in the US, I think.

Over the next what?

Ten years.

They have no idea.
Excuse me, I'm not on your panel.
But they don't know what growth isgonna be over the next ten years.

We don't know what it'll be in the next ten minutes.

Correct.

So I agree, but
I'm willing to take the over nomatter what our government does.
It turns out that while nota birthright of the American citizenry.
We're an incredibly productive society.
Our government might be trying to fixprices because of QE over the last 15
years or so, but the Americanpeople will show a dynamism and

(42:49):
adaptability andan agency that's impressive.
If we could grow 1 percentagepoint more per year than
the Congressional Budget Office forecast,which is like most, that would yield
another four and a half trillion dollarsof revenue into the Federal Reserve.
Excuse me,into the federal government's coffers.

Right.

Well, that's a great way to defeat these liabilities.
So it isn't too late, but to your questionabout if it can't go on forever, it won't.

Where are the alarm signals in world markets?

So I would say.

Or in our own market.

We don't want to get to that tipping point where we see flashing
yellow lights and flashing red lightsagain, because this economy is even now,
I'd say the best of the lot withthe most promising moments.
We can see things thatare worrisome out there, but
I wouldn't wanna say thatthis isn't eminently fixable.

(43:43):
But the longer we kickthe can down the road,
the closer we get to the tipping point.
And the best way to avoidthe tipping point isn't to get so
close that we see it tip.

All right, so from a document published in March by
the House Budget Committee,quote, in an attempt to eradicate
inflationary pressures caused byBiden's deficit spending spree,
the Federal Reserve hiked interest rates11 times between March 2022 and July 2023.
Consequently, the averageeffective interest rate paid on

(44:15):
the national debt doubledfrom 1.7% to 3.4%.
And net interest costs rose from352 billion to 881 billion.
It's that 881 billion, which now meansthat we're paying more on debt service
than we spend on the Pentagon,which is about 800 billion and change.

(44:36):
So, Kevin, the Fed still hasa balance sheet of 7 trillion.
How does it shrink that balance sheet?
How does it claw money backin without raising it?
In other words, we have to maneuverbetween Scylla and Charybdis here.
This is a terrible pickle.
And the current members of the Fedmay say, Kevin, Kevin, yes, yes, yes.

(44:58):
Don't you understand,we're doing the best we can?
In other words,what's your agenda for reform?
That won't make matters worse.

Yes, well, this might upset part of your audience, Peter.
So this is a trigger warning, this is whatone people like you and I do on campus.
I believe this administrationinherited a mess, a fiscal and
monetary mess, and it is incumbent onthe administration to get out of it.
No one said it would be easy.
We didn't get into this mess overnight.

(45:29):
We're not gonna get out of it overnight.
To make the numbers you said somewhateasier, I think to understand,
we were paying about a billiondollars in interest expense every day.
The day before COVID we're nowpaying more than $3 billion per day
in interest expense.
None of that's going tostrengthen the military or

(45:49):
help the least well off among us.
That is being squandered away.
So what do I suggest?
As you pointed out and as you and I havediscussed, but I'm not sure the economics
profession believes this,there are two monetary policy instruments.
One is setting of interest rates.

this money we keep talking about,we call it QE,
we call it the Central Bank'sbalance sheet.
If we would run the printing pressa little quieter, we could then have
lower interest rates because what we'redoing right now is we have all this
money that's being flooded into the systemwhich causes inflation to be above target.

(46:30):
That's the $7 trillion balancesheet you're talking about.
An order of magnitude largethan when I joined the Fed.
And at the same time you have anothermonetary policy instrument and
that's interest rates.
They don't work perfectly together.
They're not perfect substitutes for each.
But they're both monetary policy and
too many that are in the centralbanking business say no,

(46:51):
no, no, that balance sheet hasnothing to do with monetary policy.
Well, if it did when you were growing it,it should have something to do with
the conduct of monetary policy whenit's going the other direction.
I think we have to be honestabout these two instruments and
because I believe that growing the realeconomy is the more important piece for

(47:13):
revenue, for fairness,for efficiency and growth.
Because you have higher inflationcaused by the bigger balance sheet,
we wanna shrink that.
We can't do it overnight.
We want the Treasury Department and theFederal Reserve to come to some accord,
much like the treasury andthe Federal Reserve came to in 1951.

(47:34):
Who responsible for what?
Who's going to be managing interest rates?
The Federal Reserve.
Who's going to behandling fiscal accounts?
The Treasury Department.
We have blurred these linesabout who's responsible.
And when a President comes to power, hisTreasury Secretary should be responsible
for as the fiscal authority instead ofblurring that over to the Federal Reserve,

(47:57):
which only brings politicsto the Federal Reserve.
And I would say interruptstheir normal ordinary course.
In my judgment, we should be shrinkingthe Central Bank balance sheet,
taking the Fed out of these marketsunless and until there's a crisis.
And in so doing,you'd have less inflation that way.
You andI might call that a practical monetarism.

(48:20):
I think that's what our intellectualheirs might be thinking about,
intellectual teachersmight be thinking about.
And in so doing, you might actuallybe able to pull off lower interest
rates which matter more to the realeconomy than the balance sheet.
All right, Kevin, let me ask you,

(48:41):
in closing here,about two visions of the country.
And let me set this up with,again, a couple of quotations.
Here's you, Kevin Warsh.
This is beginning with the greatmoderation, so beginning in the mid 80s.
For about 40 years, Americans scarcelythought about changes in the price level.

(49:06):
Things were working the way they should.
We could take it forgranted because intelligent, hardworking
people permitted the rest of the countryto get on with its business, correct?
All right, here is former fedChairman Alan Greenspan testifying on
the financial crisis of 2008before Congressman Henry Waxman.
Greenspan, I made a mistake inpresuming that the self-interests

(49:30):
of organizations, specifically banks,were such that they were
best capable of protecting theirown shareholders and equity.
Coming from Alan Greenspan, who beganhis career as an Ayn Rand fan and
was as deep a believer in free marketsas you could ever encounter anywhere in
America in the 20th or21st centuries, that's a statement.

(49:53):
Waxman says, in other words,
you found that your free marketideology was not working.
Greenspan, that's precisely the reasonI was shocked because I have been
going on for 40 years with veryconsiderable evidence that it was working.
Okay, so here's one vision.

(50:14):
Beginning withFed Chairman Paul Volcker and
President Reagan back in the 1980s,we achieved low inflation, sound dollar,
overall federal spending is lowenough to permit the economy to grow.
Indeed, it grows fasterthan the Federal spending.
We've got, as George W Bush comes intooffice, and before new wars take place,

(50:35):
as he comes into office, we'reactually running projected to run for
a couple of years.
We ran or projected to run a surplus,but it's over.
The financial crisis changed the world,the COVID lockdown.
We have over a decade now offiscal irresponsibility and
market distorting easy money.

(50:57):
And now you have market professionalssuch as James Grant and
Ray Dalio casting doubt onthe whole monetary system and
young entrepreneurs buying Bitcoinbecause they no longer trust the dollar.
Kevin, something basic is over andit's irreparable.
What do you make of that vision?

That's outrageous.

Really? >> Kevin Warsh
The country is not a quitter.
The country is on the verge ofa productivity boom, in my view,
that makes that productivity boom thatyou knew when you were sitting in
the Oval Office,helping as a scribe to the President,
that's gonna make the 1980s looklike we can do it all over again.

(51:41):
More than AI, so give me your vision.
Give me your vision of what can happenif we don't continue screwing it up.

Our government has done its level best now for
more than 15 years trying to screwaround and do harm to this economy and
we have failed miserably,in spite of our best efforts,
to undermine the United States andits role in the world.
The 21st century can be America's century.
We have real rivals, a G2 rivalry,much like you once knew,

(52:11):
with the Soviets onthe other side of the world.
We have to take it very seriously.
But, boy, I'd much ratherhave our cards than theirs.
The broad conduct of public policydoesn't have to be perfect.
You and I could envision, with colleaguesaround here, what would make for
perfect trade policy, orregulatory policy, or tax policy.

(52:31):
But of course,perfection's not the necessary ingredient.
We just need to make policya little better than it is,
move it directionally back towardssomething that makes good sense in
monetary and fiscal policy,and the US economy will boom.
Now, there's a tendency amongsome of our peers to say, well,
we should just do what Reagan did,but those days are behind us.

(52:54):
Hayek, I think famously said,the job of people like you and
me is to take the ideas from the past andto restate them and
rethink them in the mindsof a new generation, and so
it's not going back to Reaganism.
It's a new set of economic policiesin a new world that can drive

(53:16):
the American spirit, that can driveindividual liberty and freedom.
And importantly, they need institutionslike the Federal Reserve to be
restored to what they once were, whichis important institutions that are on
the sidelines most of the time andcan come in in exigent circumstances.

(53:36):
And in so doing,we'll have more fiscal responsibility,
we'll have higher economic growth, andthis new generation of technologies,
I believe started here, andthe US Will be a huge beneficiary.
It's not preordained,it's not a birthright, but
I believe it's not only possible,but likely.

Two last questions, summary questions.
The Fed does not need to be ripped up.
It doesn't need to be smashed and rebuilt.
It just needs to correct itspresent course a few degrees.
The aircraft carrier takesa while to adjust, but
a few degrees will do the trick,have I got that right?

Right, I think you do.
The Fed doesn't need a revolution.
It's had a revolution in the last decade.
What it needs is somedegree of restoration.
I know you're not a golfer, but
I learned this from a famous golfcourse architect named Gil Hanse.
When he looks at these golf courses andhe tries to think about how do I make them

(54:39):
great again, he says that he is inspiredby their past but not bound by it.
Faithful to what the architectsof that golf course,
in this case the Central Bank,had in mind.
Faithful to it, butdon't have to literally recreate it.
Again, this is just like we can't goback to Reagan regulatory policies,

(55:00):
or Reagan fiscal or tax policies.
We can't go back toReagan monetary policies.
We can look back to an institution andtry to restore its best elements and
keep in mind how the world is changing.
You made reference to Bitcoin,and I thought I heard a little
bit of condescension that peopleare buying bitcoin in these things.

But doesn't it?
Charlie Munger, this is two orthree years before he died,
Charlie Munger attacked Bitcoin.
He called it evil, in part because itwould begin to undermine the Fed's ability
to manage the economy.

Or it could provide market discipline, or
it could tell the world thatthings need to be fixed.

Bitcoin does not make you nervous?

Bitcoin does not make me nervous.
I can hearken back to a dinnerI had here in 2011 with someone
who is another guest on your show,I won't say his name.
Okay, I just did, Mark Andreessen,who showed me the white paper.
That was the original white paper.

(56:01):
I wish I had understood as clearly ashe did how transformative Bitcoin and
this new technology would be.
Bitcoin doesn't trouble me.
I think of it as an important assetthat can help inform policymakers
when they're doing things right and wrong.
It is not a substitute to the dollar.
I think it can often be a verygood policeman for policy.

(56:24):
And if I were to speak more broadlyto what did Charlie Munger and
others perhaps have in mind.
There is a proliferation of securitiesthat go under all sorts of names.
Many, if not most of them are not worthwhat they're might be being traded for.
So what did Charlie say, andmaybe his pal Warren say,

(56:45):
there's the innovators,the imitators and the incompetence.
They're real innovators that are happeningin and around that new technology.
And what I would try toimpart towards businesses and
bankers is that the underlying technologythat Mark showed me in that white paper,
or tried to show me in that white paper,it's just software.

(57:07):
It's just the newest, coolest softwarethat will provide us an ability to do
things that we couldnever have done before.
Can the software be used forgood and evil?
Yes, both like all software.
So I don't cast aspersions like that.
If there's a final point, it's thesetechnologies are being built here.
I don't just mean on Stanford campus.

(57:28):
I believe in the United States and
the world's most talented engineersfrom China and Europe and
everywhere they come to the United Stateseven now to try to build this stuff.
And my view is by building it here,that gives us an opportunity to be more
productive and create somethingvery special over the next decade.

Last question, Kevin, last question.
You back in Manhattan, you work with oneof the great investors of the last half
century, Stanley Druckenmiller,and you're known as a macro house.
You're looking at large global trends.
So you see, and I know you see in detailbecause I know that you've been to
China over and over again to investigatematters on the ground in China.

(58:11):
There we have China, which sinceroughly the very late 70s has lifted
hundreds of millions of people outof poverty, built a modern economy.
We now see growth in India,more openness to markets in India.
It's lagging China, but it's coming on.
We even see, I say even because formany decade, decade after decade,

(58:34):
these were viewed as trouble spots.
But in sub Saharan Africa, there are signsof real economic growth in Nigeria and
Kenya, among other places.
Looking at all of that,aware of all of that,
Kevin Warsh is still longthe United States of America.

Absolutely, I'll say a couple things if I can-

Of course,
you know that.

The US is the innovator of almost all of these technologies.
Now might they be used in other places,absolutely.
The most talented people inthe world still wanna come here.
The most talented people that are inthe United States wanna build here.
Economic policy, I believe,

(59:21):
is trending in a better direction overthe last half year than it has been.
Economic policy isn't perfect andit never will be.
But the American people are ready tobe liberated from the shackles they've
been under.
For all the policies that have beendiscussed around this table and others.

(59:41):
We haven't mentioned the regulatorytax that has really done great
harm to the US economic growth overthe course of the last decade.
That tax is coming off, I believe,
in part we've talked aboutthis productivity revolution.
We talked in some sense about technology.

(01:00:01):
But I think that humans are underrated,American humans in particular, and
their ability to adapt to new technologiesand thrive, I think, is very real.
This might sound Pollyannish to some ofyour listeners, but what we used to call
the micro foundations of macroeconomics,which I will broadly translate in

(01:00:24):
another trigger word, the cultureof what's happening in the society.
The willingness to take risks, fail, andtake risks again they are still happening
in the United Statesmore than anywhere else.
They're not happening in France andGermany at this rate.
They're not happening inChina at this rate because of
their own governance issues.

(01:00:45):
And it's an incredibly exciting timeas we take that regulatory tax away,
as we restore some economicpolicies that could,
that have worked better before,as we're reforming institutions right now.
I'm willing to take the upsideof economic growth here, and
I'm willing to bet that the Central Bankfixes matters that are broken,

(01:01:08):
achieves price stability yet again.
And the rest of the world mightnot love us, but once again,
they're gonna look at the US and say, inspite of some of the things we don't like,
their economy is growing faster, andthat's where we wanna send our capital.

>> Peter Robinson (01:01:23):
Kevin Warsh, thank you.

>> Kevin Warsh (01:01:25):
Thank you, Peter.
Honored to be back on the show.

>> Peter Robinson (01:01:28):
For Uncommon Knowledge, the Hoover Institution and Fox Nation,
I'm Peter Robinson.
[MUSIC]

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