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

THE PRICE OF MONEY: CONSEQUENCES
OF THE FEDERAL RESERVE'S ZERO
INTEREST RATE POLICY

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

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

SECOND SESSION

__________

SEPTEMBER 21, 2012

__________

Printed for the use of the Committee on Financial Services

Serial No. 112-160

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76-130 WASHINGTON : 2012
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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
KEVIN McCARTHY, California BRAD MILLER, North Carolina
STEVAN PEARCE, New Mexico DAVID SCOTT, Georgia
BILL POSEY, Florida AL GREEN, Texas
MICHAEL G. FITZPATRICK, EMANUEL CLEAVER, Missouri
Pennsylvania GWEN MOORE, Wisconsin
LYNN A. WESTMORELAND, Georgia KEITH ELLISON, Minnesota
BLAINE LUETKEMEYER, Missouri ED PERLMUTTER, Colorado
BILL HUIZENGA, Michigan JOE DONNELLY, Indiana
SEAN P. DUFFY, Wisconsin ANDRE CARSON, Indiana
NAN A. S. HAYWORTH, New York JAMES A. HIMES, Connecticut
JAMES B. RENACCI, Ohio GARY C. PETERS, Michigan
ROBERT HURT, Virginia JOHN C. CARNEY, Jr., Delaware
ROBERT J. DOLD, Illinois
DAVID SCHWEIKERT, Arizona
MICHAEL G. GRIMM, New York
FRANCISCO R. CANSECO, Texas
STEVE STIVERS, Ohio
STEPHEN LEE FINCHER, Tennessee
FRANK C. GUINTA, New Hampshire

James H. Clinger, Staff Director and Chief Counsel
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

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Page
Hearing held on:
September 21, 2012........................................... 1
Appendix:
September 21, 2012........................................... 19

WITNESSES
Friday, September 21, 2012

Grant, James, Editor, Grant's Interest Rate Observer............. 5
Lehrman, Lewis E., Chairman, The Lehrman Institute............... 6

APPENDIX

Prepared statements:
Paul, Hon. Ron............................................... 20
Grant, James................................................. 22
Lehrman, Lewis E............................................. 27

THE PRICE OF MONEY: CONSEQUENCES
OF THE FEDERAL RESERVE'S ZERO
INTEREST RATE POLICY

----------

Friday, September 21, 2012

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 9:33 a.m., in
room 2128, Rayburn House Office Building, Hon. Ron Paul
[chairman of the subcommittee] presiding.
Members present: Representatives Paul, Jones, Lucas,
Luetkemeyer, Huizenga, and Schweikert.
Chairman Paul. This hearing will come to order. And without
objection, all Members' opening statements will be made a part
of the record.
I want to welcome our two witnesses here today, and I will
now recognize myself for 5 minutes to make an opening
statement.
Today, we are emphasizing the importance of interest rates.
In a free market, interest rates are crucial. It is a crucial
bit of information that tells a lot of people what to do,
whether it is the investors, the savers, the spenders,
consumers, whatever.
But once it is interfered with and interest rates are
artificial, it tends to mess things up.
We talk a lot about monetary policy and the soundness of
the dollar and the spending and monetizing of debt. Today, we
are more or less concentrating on that aspect of monetary
policy that deals with interest rates--how important is it--and
has that whole emphasis on interest rates and this concession
through the Federal Reserve (the Fed) that they have a duty and
sometimes an unregulated duty to pretend they know what the
interest rates should be.
This opens up a lot of questions. Who benefits and who
suffers from this? Has it done any good? Is it a worthy effort
even to try to pretend that we know what interest rates should
be? And figure out exactly how much difficulty it has caused.
From my viewpoint, I think that, from the viewpoint of the
marketplace--just as all prices, I want the market to set these
prices. And we have been living now with a Federal Reserve for
100 years, and early on, they were manipulating interest rates.
It is hard to manipulate the supply of money or be the
lender of last resort without getting involved in interest
rates. And it is usually done with either trying to prevent a
problem or to solve a problem.
But if we look at history, especially in our last 100
years, we have had a lot of ups and downs. It hasn't been
smooth sailing. The Federal Reserve is supposed to be providing
for a sound dollar and making sure that prices are stable and
that there is high employment.
And yet the results that we see today, because they have
pursued this almost obsession on believing that they can leap
over into a central economic planning through the manipulation
of money and credit, and in particular interest rates, we have
ended up with some pretty poor results.
So I am working under the assumption that we are in a
period of time probably unparalleled in our history, possibly
unparalleled in the history of the world, because we have never
had quite the global economy involved like we have today and we
have never had a single fiat currency for 30, 40 years being
used as the reserve currency of the world. So I think the
distortions now are so great.
And if it is indeed true that the concentration on interest
rates might be the culprit, it would be good to get it exposed,
so that when the time comes when it becomes an absolute
necessity to try to correct this problem, we might be able to
put a better system together.
So I am delighted today that we have been able to bring two
individuals who are very well-versed on this subject to talk
about this, and other members of the committee, to emphasize
the importance of price fixing of money.
Some people don't like to call it price fixing and they
refer to it as something in interest. But in a way, it is easy
to understand it is a price fixing.
Price fixing is bad when we have wage and price controls.
Not many people are advocating wage and price controls at the
moment, even though there is a lot of that going on in a subtle
way, if money is one-half, the currency is one-half of every
transaction and you have some price fixing involved in the
price of money, it can be a fairly significant event that
should be exposed, and we certainly ought to recognize that as
we move into that period of time when there is a necessity for
monetary reform.
So I am delighted that we have had this opportunity to
further this discussion.
I would now like to yield 5 minutes to the gentleman from
North Carolina, Walter Jones.
Mr. Jones. Mr. Chairman, thank you. And I won't take but 1
or 2 minutes. I want to thank you again for your national
leadership on this area of monetary policy and concerns of
where this country is going.
And to our witnesses today, thank you very much. I look
forward to listening to your comments.
I don't think there is a better time, when we are going
home for the next 5 weeks, all of us in the United States
Congress, to be with the people. And knowing that I am from
eastern North Carolina and the concern about the actions of the
Federal Reserve, I think the topic today is absolutely
fascinating and critical.
So I just want to say to you, Mr. Chairman, thank you very
much for holding this hearing, and I look forward to listening
to the witnesses and thank them for being here. And just thank
you for your service to our Nation.
I yield back.
Chairman Paul. I thank the gentleman.
I now yield time to Mr. Lucas from Oklahoma.
Mr. Lucas. Thank you, Mr. Chairman. And as all of the
hearings that you have called in your tenure as a subcommittee
chairman reflect, this is an important subject matter and
something on which we all need to focus. Perhaps not quite as
exciting to the membership, as one can tell, as it should be,
but nonetheless it cuts to the very basis of how our free
market system works in this country.
That said, let me reminisce for just a moment, since this
session of Congress is beginning to wind down, and there is
always a possibility this might be the last hearing of this
subcommittee. I suspect we might be around after Election Day,
but a lame duck session is to be avoided if it is humanly
possible.
I would just simply note that--having sat next to you on
this dais on the full committee and served on your subcommittee
for almost a decade now--we have had many a good policy
discussion, and not just monetary policy, but we have discussed
the intricacies of farm policy, agricultural economics.
It might surprise some of you to know that Dr. Paul and I,
while we agree on many, many, many things, we are not exactly
in sync on agricultural economics. But we have had some lovely,
very thoughtful, to-the-point discussions, and you have opened
my mind in an area or two, and I appreciate that. And I hope
perhaps even on an occasion or two, I have offered a thought
for you to think about. But you have just been a pleasure.
And if Congress is about free elections, and an open and
thoughtful debate process where policies can be formulated in
the best interest of the country, then I think you have done
more than your part, and we will all be ever so appreciative of
that for many, many years to come.
And with that, thank you, Mr. Chairman.
Chairman Paul. I thank the gentleman.
And now, I yield time to Mr. Luetkemeyer from Missouri.
Mr. Luetkemeyer. Thank you, Mr. Chairman. I add my
congratulations and empathies from Chairman Lucas as well. It
has been an honor to serve with you these past 2 years.
The subject we have today I think is extremely important
from the standpoint that the Fed continues to tinker around
with our economy through the money supply, and, from all things
that I see, it is having minimal success. I am concerned about
the direction that they are going, the situation that they are
putting us in.
If you look at the global situation, other entities,
central banks around the world, they are struggling. And is
this the proper path to take? I don't know, I am not an
economist, and I think there is a general disagreement even
with good economists on whether it is a good policy or a bad
policy.
But I think that the discussion is pertinent, extremely
important to today's economic welfare from the standpoint that
we are in an economic stagnation period here, and how we get
out of this is everybody's concern.
And I think monetary policy by the Fed and their money-
supply policy is an extremely important subject to discuss.
So with that, I thank you for the subject today, Mr.
Chairman, and I yield back.
Chairman Paul. I thank the gentleman.
Now, I yield time to Mr. Schweikert from Arizona.
Mr. Schweikert. Thank you, Mr. Chairman. I will be very
quick.
You do realize that you letting me on this subcommittee has
really screwed up my subjects of reading over the last 2 years.
All of a sudden, I find myself reading more about monetary
policy than I ever thought I would want to touch. And I have
learned a lot. I have also worked through a series of things
that I realize are just sort of complete folklore out there.
And, Mr. Chairman, I am hoping also in our testimony and in
some of the discussion, I am one of those who is absolutely
fixated on the concept that interest rates ultimately are the
pricing of risk and where interest rates and capital flows, and
then that interest rate charged to where that capital flowed is
sort of an allocation and a management of risk.
Do you end up moving large amounts of capital, or even
sometimes, us as individuals, capital to places that it
shouldn't be because it is misallocated and mispriced? And what
are the ultimate consequences for what we have done here when
we have basically destroyed what should have been the
historical pricing mechanism or risk mitigation, risk analysis
system, which is interest rates and our economy.
And with that, Mr. Chairman, I look forward to the
testimony.
Chairman Paul. I thank the gentleman.
We will now proceed to our witnesses.
First, Mr. James Grant is a noted investor and founder and
editor of Grant's Interest Rate Observer, a widely circulated
bimonthly newsletter on finance that accurately foresaw the
financial crisis.
A former columnist from Barron's, he is the author of five
books on finance and financial history. Mr. Grant has appeared
on television programs such as ``60 Minutes'' and ``The Charlie
Rose Show'' to share his expert knowledge of finance, and his
journalism has been featured in numerous publications,
including The Wall Street Journal, the Financial Times, and
Foreign Affairs.
Second, Mr. Lewis Lehrman is a senior partner of the
investment firm L.E. Lehrman & Co., and is chairman of the
Lehrman Institute, a public policy organization he founded in
1972, where he heads up the Gold Standard Now Project.
As a member of President Ronald Reagan's Gold Commission,
Mr. Lehrman helped write the Commission's minority report
entitled, ``The Case for Gold.''
Over the years, he has written widely about economic and
monetary policies and has been featured in Harper's, The
Washington Post, and The New York Times, among others.
Without objection, your written statements will be made a
part of the record. You will each now be recognized for a 5-
minute summary of your testimony.
Mr. Grant?

STATEMENT OF JAMES GRANT, EDITOR, GRANT'S INTEREST RATE
OBSERVER

Mr. Grant. Mr. Chairman, and members of the subcommittee,
good morning. It is an honor and a pleasure, and may I
underscore honor to be here.
The price mechanism is our indispensable contrivance, and
without it, the store shelves would be stocked with things we
don't want, if they would be stocked at all. Our economy is
wondrously complex, and what coordinates the moving parts is
Adam Smith's invisible hand.
For a superb critique of the perils of price control, look
no further than Ben Bernanke's own lectures last March to the
students of George Washington University. ``As you know,'' the
chairman reminded his charges, ``prices are the thermostat of
an economy; they are the mechanism by which an economy
functions. So putting controls on wages and prices,'' here Mr.
Bernanke was referring to the disastrous Nixon experiment of
the early 1970s, ``meant that there were all kinds of shortages
and other problems throughout the economy.''
Yet this same observant critic is today leading the Fed in
a policy of financial price control, to call the thing by its
name. Interest rates are, after all, prices. They convey
information, or are intended to. Market-determined interest
rates are the prices that balance the supply of savings with
the demand for savings.
These, however, are not our interest rates. Actually, we
hardly have any. They are so small you can hardly see them.
They are tiny. Today, the Federal Reserve imposes interest
rates, and those rates it does not impose, it heavily
influences.
Mr. Bernanke's bank fixes at zero percent the basic money
market interest rates called the Federal funds rate that
manipulates the alignment of rates over time, the yield curve,
and it has its fingerprints all over the relationship between
government yields on the one hand, and the yields attached to
private claims on the other.
The Federal Reserve has decreed that ultra-low interest
rates are a necessary if not sufficient condition for economic
recovery. It says that miniature interest rates will boost
hiring and another aspiration of the central bank, keep
consumer prices rising by just enough; ``a decent minimum, say,
of 2 percent a year,'' so says the Fed.
Now, every market intervention has consequences, but not
necessarily the consequences that the intervening authority
intended. In the nature of things, there can be no predicting
exactly what will come of today's radical and indeed
unprecedented monetary policies.
Mr. Bernanke himself makes no bones about it in his widely
scrutinized speech at Jackson Hole, Wyoming, on August 31st. He
used the phrase, ``learning by doing.'' Indubitably the Fed is
doing, nobody can doubt its manic energies, but it seems not to
be learning.
Artificially low interest rates must inevitably subsidize
speculation at the expense of saving. It must raise up the
prices of stocks and commodities, but only temporarily. It must
enrich the asset holders and inadvertently punish the wage
earner. It must advantage one class of financial institutions--
say, banks--over another--say, life insurance companies. It
must disturb the currency markets, and therefore interfere with
international trade, and it must conflate our understanding of
the strength of the Treasury's own finances.
This year, in the just-ending fiscal year--or the soon to
end--the interest cost in the debt will run to an estimated
$125 billion. That happens to be slightly lower than the outlay
the Treasury bore in 2006 when the debt was 58 percent smaller
than it is today, but when the average interest rate was a
towering 4.8 percent as opposed to the current average of 2.1
percent.
Ultra-low rates flatter the Nation's credit profile, yet
that credit profile remains the same.
Mr. Chairman, millions of Americans are earning nothing on
their savings. Having nowhere else to turn, they are investing
in richly priced corporate debt, some of that speculative
grade. The Fed author of this interest-rate famine of ours has
inadvertently created a paradox that would be funny if it
weren't dangerous.
Mr. Bernanke's bank has created a high-yield bond market,
junk bonds to the cognoscenti, but a market lacking one
customary attribute of high-yield security. That is, the Fed
has created a high-yield bond market without the yield.
I thank you.
[The prepared statement of Mr. Grant can be found on page
22 of the appendix.]
Chairman Paul. Mr. Lehrman, go ahead.

STATEMENT OF LEWIS E. LEHRMAN, CHAIRMAN, THE LEHRMAN INSTITUTE

Mr. Lehrman. So, Mr. Grant and I like to switch one
sentence to express how much we honor the extraordinary record
of the chairman in his 30 years plus, perhaps, service in the
Congress. It has been a heroic effort on behalf of the
authentic Constitution, and on behalf of the liberties which we
have inherited from our forefathers, and of course, for sound
money.
Now, Mr. Grant is about six feet, five inches tall. I am
only five feet, 10 inches tall, and he determined the protocol
of our presentation. So, he established that he would focus on
the problem, and I should spend a moment or two on the
solution.
Indeed, Jim has described the consequences of Federal
Reserve quantitative easing and interest rate manipulation and
suppression.
From Mr. Grant's analysis, one concludes that the Fed's
unlimited power to purchase Treasury debt and financial market
securities not only funds the Treasury deficit with newly
printed money, but the Fed's market intervention process also
makes of the financial class a special interest group of
privileged investors and speculators, because of their special
access to subsidized funds at near zero interest rates, while
middle-income families depend upon their credit card balances
and pay upwards of 20 percent or more.
A well-connected financial class subsidized by the Federal
Reserve is a crucial cause of increasing inequality of wealth
in America. In this regard, I would cite only one fact for the
Monetary Policy Subcommittee to contemplate. Since the
termination of dollar convertibility to gold in 1971, a mere
generation, the financial sector has doubled in size as a share
of the American economy, but the manufacturing sector has been
cut in half.
Only comprehensive reform of the Fed and termination of the
Reserve currency role of the dollar will arrest this trend. For
example in 2002, Mr. Bernanke described the Fed's extraordinary
power to create new money and credit in our present financial
regime of inconvertible paper money and inconvertible bank
deposit money.
I quote Mr. Bernanke, ``Under a fiat paper-money system, a
government, the central bank in cooperation with other
agencies, should always be able to generate increased nominal
spending and inflation. Even when the short-term nominal
interest rate is at zero, the U.S. Government has a
technology,'' Bernanke continues, ``called a printing press, or
today its electronic equivalent that allows it to produce as
many U.S. dollars as it wishes at essentially no cost.''
Reading this, I don't know whether to laugh or to cry. In
effect, as James Grant wrote elsewhere, ``The Fed is not only
the American central bank, but with this exalted power to print
money, the Fed is now the government's central planner.''
During the Volcker years, from 1979 to 1987, Fed interest
rate manipulation was justified as the means to end inflation.
By 1994, employment as a Fed target had all but disappeared
from the minutes of Fed meetings.
Now, in 2012, despite inflation being again on the rise,
employment is as a practical matter the sole target of
quantitative easing. The Fed and its apologists in the media
and the academy justify quantitative easing and its unlimited
scope and duration as the way to restore economic growth--
surely, an extra-Constitutional form of fiscal spending through
Federal Reserve capital allocation reserved for the Congress of
the United States.
But as soon as one examines that Federal Reserve balance
sheet, which if I may say so, few politicians do, one sees that
the Fed primarily buys Treasury securities and mortgage-backed
securities. In effect, a subsidy by which to finance the
government deficit, and to refinance bank balance sheets that
is to say the promotion of more financial and consumption
sector growth. In a word, quantitative easing is the most
pernicious form of trickle-down economics.
Now, the problem of the American economy is neither under-
consumption nor is it under-banking. The problem is the lack of
rapidly growing investment in domestic production and
manufacturing.
The investment is the necessary means by which to enable
our producers to lead in both domestic and global markets. It
is rapidly increasing investment and production growth which
begets employment growth and with it healthy unsubsidized
consumption growth, not by means of transfer payments.
It is a truth of economic theory and practice that rising
personal and family real income grows from increasing per
capita investment in innovative businesses; new plant, new
equipment. So the question is, in reforming the Fed, how can
our runaway central bank be harnessed by the financial markets
to target the goal of economic growth through increased
productive investment, not the promotion of consumption and
Treasury deficit financing by means of interest rate
manipulation and quantitative easing?
The answer, I believe, is transparent. The Congress of the
United States has the exclusive constitutional power under
Article I, Sections 8 and 10, not only to establish the
definition of the dollar, but Congress also has the power to
define by statute the eligible collateral that the Federal
Reserve may buy and hold against the issue of new money and
credit.
Thus, a simple congressional statute defining sound
commercial loans as the primary eligible collateral for
discounts and new credit from the Fed would have two primary
defects. First, it should rule out Fed purchases of Treasuries,
thus requiring the government to finance its deficits not with
newly printed Fed money, but instead in the open market away
from the banks.
Second, the Fed would then become a growth-oriented central
bank by which to finance productive business loans, encouraging
thereby commercial banks themselves to make banks to solvent
businesses in order to sustain economic and employment growth.
Now, why is this the case? Commercial banks would focus on
production and commercial loans because solvent loans, instead
of Treasury debt, could then be used by commercial banks as the
primary eligible collateral by which to secure credit from the
Fed as the lender of last resort. In a word, Treasury subsidies
by the Fed should be displaced by productive business loans
oriented toward economic and employment growth.
Mr. Chairman, this simple proposed reform of Fed operations
was the very monetary policy insisted upon by Carter Glass, a
leading Democrat who was the chief sponsor of the Federal
Reserve Act of 1913. The congressional legislative leaders who
created, indeed founded, the Federal Reserve System of 1913
designed the Fed by law to enable steady commercial investment
and employment growth.
The Federal Reserve Act was also designed explicitly to
uphold and maintain dollar convertible to gold in order to
maintain a reasonably stable general price level. Now, such a
congressional Federal Reserve reform today, consistent with the
original Federal Reserve Act, would require no further
legislative mandate to sustain employment growth and to rule
out systemic inflation and deflation.
Just a word more--so today, the Fed reiterates at every
meeting that it, the central bank, must manage and manipulate
interest rates to fulfill a congressional mandate to maintain
reasonable price stability and reasonably full employment. But
the best way to do this is to remobilize the express intent and
the techniques of the original Federal Reserve Act, namely the
statutory requirement that the Fed uphold the classical gold
standard and, as was intended by the original Federal Reserve
Act, to substitute commercial market credit for Treasury debt
as the primary eligible collateral for bank loans from the
lender of last resort, the Federal Reserve System.
Mr. Chairman, may I say with respect, Congress has
defaulted to the Federal Reserve System its sole and solemn
constitutional authority to define and to regulate the value of
the dollar and to define the vital economic use of eligible
collateral by which to obtain productive business loans from
the Federal Reserve System. It does not have to be this way.
Thank you very much.
[The prepared statement of Mr. Lehrman can be found on page
27 of the appendix.]
Chairman Paul. Thank you.
We will go into the questioning session right now. I yield
myself 5 minutes.
I want to ask both of you the same question. In 1979, and
the 1980s, we had a bit of a crisis, quite different than we
have today because interest rates were very, very high and even
made higher. At that time, as I recall, not too many people
were happy and claiming they were getting benefits from the
higher interest rates. I don't think the markets--the higher
the rates went, I don't think the markets were saying
``wonderful, wonderful.''
But today, even with this most recent announcement of the
accelerated quantitative easing, there is almost an immediate
response--as a matter of fact, instantaneous response. We are
going to print a lot more money and those individuals who are
holding stocks seem to be delighted with that and bonds rally.
My question is: Under today's circumstances, with this
constant effort to keep lowering interest rates, now that they
are down to essentially zero, below zero when you talk about
real interest rates, who benefits from this? Who is really
benefiting? And who are the people who are suffering? Can you
divide it up and find out if there are some groups who have no
benefit whatsoever and some people actually get punished? And
other people are rewarded, whether it is temporary or not, at
least they think they are being rewarded.
And if there is a case where somebody benefits, and
somebody else is hurt, is this done on purpose? Or would you
want to make a stab at it to say is this sort of a consequence
of just bad policy? Or what might be the motivation here if
there are winners and losers?
Mr. Grant?
Mr. Grant. Mr. Chairman, the great French economist
Frederic Bastiat talked about that which is seen and that which
is not seen. There are many obvious beneficiaries. There are
many obvious victims. Let me suggest a subtler distortion that
these policies are responsible for, and then I will touch on
some of the ones that are perhaps as important or more so.
Capitalism is a little like the forest floor. There is
life. There is death. There is regeneration. There is movement.
The famous phrase ``creative destruction'' defines the
inevitable ebbing of economic power that was once constructive
and now has passed its prime.
One of the consequences of these subsidized interest rates
is that organizations that perhaps ought not to be around are
given new life. The financial markets on Wall Street are
increasingly welcoming to the most marginal credits because
there is a stampede for interest income. People are starving
for it and Wall Street is providing for it.
When nearly anyone can get a new loan--when nearly anyone
can get a pass in the public market that means there are not
enough bankruptcies. It is a problem, albeit a paradoxical one.
We need new enterprise and we need the exit of unprofitable or
over-the-sell-by date enterprise; so ultra-low interest rates
perpetuate the status quo.
Interest rates, as someone mentioned, are among other
things, great sources of information. When interest rates are
pressed to the floor, the credit markets provide less and less
information. The information is there, but it is not to be
intuited by prices.
So, as to the other beneficiaries and losers, some of them
are painfully obvious. The Fed talks more or less nonstop about
inflation, but then I think is troubled by the lack of it. It
wants to see more of it. Well, one department of American
finance in which there is rampant inflation is the cost of
obtaining a dollar of income. One might say the cost of
retirement is in a terrific inflationary crisis.
A friend of mine and of Lew's, a Wall Street figure of
wonderful renown and of some mordant future, said a while ago,
before he passed away, ``You know,'' he said, in all
seriousness, ``you really can't get by today without $100
million.''
The point survives the exaggeration. You need more and more
capital to maintain a decent income as a saver. That, to me, is
not the least of the cost of these policies.
Chairman Bernanke, in Jackson Hole, spoke to try to put our
collective minds at ease about the unintended consequences of
quantitative easing. And he said, ``I can enumerate four
possible pitfalls''--four. There are 400,000 possible pitfalls.
The Chairman, I think, is in error when he implicitly tells
us that for every monetary cause A, there is a predictable
monetary effect B. There are effect B, C, D, N, Z, and myriad
effects that are so weird that no proper letter in the English
language can describe them.
What we are now embarked on is one of the great monetary
experiments of all times and, Mr. Chairman, we are the lab
rats.
Chairman Paul. Mr. Lehrman?
Mr. Lehrman. Mr. Chairman, you mentioned the period of
1979, 1980--that period of high interest rates over which Mr.
Volcker presided. I was there and I remember it, just as you
do. One of the remarkable things about a review of the history
of the Federal Reserve System from 1914 until the present is
that the techniques that have been used either to suppress
interest rates or the use of vaulting interest rates to bring
about changes in economic activity has seen no reform.
That is to say, Paul Volcker, you will remember in 1979,
said his goal was to target the bank reserves; that is to say,
to control the stock of money in circulation. This was another
new experiment on interest rate manipulation, of course, with a
noble intent.
But this was just another form of interest rate
manipulation which ultimately wound up putting the prime rate
at 21 percent and market rates for a long-term Treasury at the
highest level that they would been in American history,
approximately 15 percent.
It is forgotten in the dreamlike remembrance of that period
that from 1979 to 1982 the American economy was in recession,
the unemployment rate in New York State in 1982 in November--I
remember that date very well for personal reason--was 11.2
percent, higher even than the unemployment rate at the peak of
the ``Great Recession,'' which we have undergone since 2008.
It was not a halcyon period. President Reagan's first years
of the Administration were almost impeached economically
because of that.
So as the French say, the more it changes, the more it is
the same way; that is to say, Federal Reserve interest rate
manipulation and management for one purpose or another.
Who benefits and who suffers? In each period, under each of
the Federal Reserve Chairmen who exercised this extraordinary
power, it was different.
Today, I want to point out only in response to the question
the technique and its effect by which the Federal Reserve
actually does operate in open market operations at the New York
Federal Reserve System and has done so since the First World
War.
The Federal Reserve enters the market and purchases
outright or on a match sale or on a repurchase agreement
Treasury securities from the market against which they issue
new money.
That new money is made available only to the banks
because--or the today 16 authorized dealers. So their
portfolios are reduced and substituted with new money, which
they then are in a position either to lend out to dealers and
brokers or speculators or Wall Street investors who can post
collateral, liquid collateral, by which they then can satisfy
the lend that they can repay the loan.
So the very first effect and the dominant effect, the
generalized effect is commodity dealers and equity dealers who
have first access to the money which is created anew by the
purchase of Treasuries, which themselves cannot be repaid as
they are refinanced with renewal bills.
This is a prescription and has been in effect for a very
long time, but especially since the end of the Second World War
and even more dynamically since the end of Bretton Woods in
1971, to enrich the investor class.
I cannot incriminate them because to a certain extent I am
a member of that class, but one does not have to be a rocket
scientist to see that the Federal Reserve's process of
monetizing the U.S. Treasury debt, providing new credit to the
banking system to lend to their preferred clients divorces
supply from demand, creating a monetary demand unassociated
with the production of new goods and services.
When total monetary demand exceeds supply, which is the
prescription and the technique of the Federal Reserve,
inflation must get under way.
Now, that inflationary process today is hidden by the vast
unemployed resources which we now have. And as a result, the
new credit money immediately goes into the commodity and equity
markets as well as into speculative vehicles like farmland, for
example, which is the most exotic investment today of a sort of
inside Wall Street investors.
No change can occur in such a process without a full reform
of the Federal Reserve System and a reform of the monetary
system.
Chairman Paul. Thank you very much.
I now recognize Mr. Luetkemeyer for 5 minutes.
Mr. Luetkemeyer. Thank you, Mr. Chairman.
I appreciate your comments, Mr. Lehrman. They are
interesting. You called farmland an ``exotic'' investment.
I am looking to try and buy the farm next to mine, and I
wouldn't think it would be an exotic investment. But I
understand where you are coming from.
I am just kind of curious, if the Fed would not purchase
all of the government's debt, would there actually be a market
out there, in your judgment, for our debt because of the size
of the debt that we have, the amount of money that it would
take to service that debt? Is there enough capital out there to
service that debt? Is there enough capital out there to
purchase that if we don't run the printing presses here at the
debt and pick it up, in your judgment?
Mr. Lehrman. May I first say, Congressman, that I am the
owner of a 1,600-acre farm--corn, soybeans. And it is exotic
from the standpoint of speculators who have never set foot in a
cornfield, but certainly not from those--
Mr. Luetkemeyer. That is who I am bidding against on the
farm right now, are those guys.
Mr. Lehrman. So then you understand what--
Mr. Luetkemeyer. Yes, I do.
Mr. Lehrman. --I was getting at.
Mr. Luetkemeyer. But to me, it is not exotic. I would like
to buy my neighboring farm, but to those folks, it brings the
price up. I understand, but go ahead.
Mr. Lehrman. So the question is: What would happen if, as
the founders of the Federal Reserve System intended, the
Congress of the United States and the budget of the Treasury
were not able to finance its deficit by selling securities
ultimately to the Federal Reserve System? Is the open market
substantial enough to accommodate the vast sums presently
required by the Treasury in order to finance its current
spending?
The answer to that is we would find that out, and it would
be the ultimate discipline, which would require Congress on
notice to the public that the financing of the Treasury was
forcing interest rates higher and higher and excluding
businesses and commercial firms from access to the credit
markets because at the present level of deficits--let us call
it all in about $1.5 trillion, including the credit financing
bank--it would absorb almost all the net national savings
available in the market, which gets right to the point of this
hearing. What is the effect of the suppression of interest
rates and their manipulation and the financing of 77 percent of
the Federal Reserve's budget deficit in Fiscal Year 2011; what
is the effect of that?
It disguises from the public, the sovereign people, the
effects of the fact that only 60 percent of the revenues which
Congress decides to spend are financed through taxes, and 40
percent of them through printed money either through the banks,
the commercial banks, for foreign central banks.
Mr. Luetkemeyer. I think there is another point to be made
here too, which is the fact that because they are driving rates
so low they are also disguising or hiding the fact--the
exposure that we have when you go to $16 trillion worth of debt
in just--an additional $4 trillion, $5 trillion, $6 trillion in
the last 3 or 4 years--the amount of exposure we have to
interest rate fluctuation. Right now, the cost of interest to
our government is rather low compared to what it has been in
the past because of driving interest rates down.
If that would not happen the rates would go back--it would
be very easy to double or triple the rates, because they are so
low right now. Imagine what it would do to our budget if you
doubled or tripled our cost of funds.
Mr. Lehrman. We dealt with that issue at the last hearing,
Congressman. We dealt with that issue. And were you to
normalize the long-term interest rates--let us say for 30-year
Treasury bonds--were you to normalize them consistent with the
past history of the generation and given the scale of the
direct debt of Treasury right now at $16 trillion, the total
amount of the Federal budget devoted to interest payments could
rise to as high as $800 billion, even towards a $1 trillion if
the deficit were to continue.
That puts, I think, a number on the effect.
Mr. Luetkemeyer. Very good.
Very quickly, how do we unwind this? What happens when we
unwind this thing?
Mr. Grant?
Mr. Grant. We don't know. The Fed is--
Mr. Luetkemeyer. We are still going to be a laboratory even
for that.
Mr. Grant. Yes. That, too, will be a learning-by-doing
experience.
Mr. Luetkemeyer. How painful will it be, do you think?
Mr. Grant. Sorry?
Mr. Luetkemeyer. How painful do you think it will be?
Because--until interest rates rise, will inflation take place
or will we go into a depression? Will it be runaway glory,
everything going to be hunky-dory here? Or where are we going?
If the Fed has to unwind this thing and get rid of the 2-point
whatever--$8 trillion now--
Mr. Grant. Congressman, we can rule out hunky-dory.
As for the rest, we will see.
Imagine a day in which the Treasury, to finance another
$1.5 trillion deficit is raising, say, $15 billion in 2-year
notes in the morning; and in the afternoon the Fed is holding a
special auction to liquidate the remaining excess portion of
those balance sheets. So they will be one auction on top of
another.
We simply don't know the outcome, but we do know, I think,
that the Fed's assurances must be discounted. The Fed is
remarkably complacent with regard to its capacity to form
financial judgments. This is the outfit that panicked in front
of the prices of computer clocks in 1999--neglected to see or
to take due measure of the speculative mania in technology
stocks that ended in the early aughts. And that positively saw
not one aspect of the greatest credit crisis in three
generations looming before it in the mid-2000s.
And we are meant to believe that the perspicacity of the
judgment of the Fed will now help them anticipate the end of
the necessity for this Q.E. and to unburden themselves of the
excess security.
So I don't doubt that they mean to have the techniques to
affect the exit. What I do doubt--and I think there is evidence
in support of doubt--is that they have the judgment to mark the
time and the need.
Mr. Lehrman. May I say a word on that question, Mr.
Chairman?
Every Thursday, at about 4 p.m., the Federal Reserve System
publishes its balance sheet. That balance sheet as of Thursday
night, last night--I looked at it--shows that to do it in round
numbers, the Fed owns approximately $3 trillion of securities,
primarily Treasury securities and mortgage securities,
mortgage-backed securities and agency bonds.
If you look further into the detail and the footnotes you
will observe that the largest fraction of the balance sheet of
the Federal Reserve System is in long-term securities.
The historic practices of central banks during long periods
of stable prices was only to own short-term securities so that
were inflation to arise, they could, to use your phrase, unwind
their portfolios selling securities, or letting them run off
into the market in order to reduce the quantity of money and
credit in circulation and stabilize the price level.
The Federal Reserve is now faced not only with the daunting
task of unwinding the enormous monetization of Treasury and
mortgage-backed securities, but they have encumbered the
balance sheet with long-term securities which will not run off
on a regular basis the way short-term commercial bills do with
90-day maturities.
They have the largest fraction of--far and away the
dominant fraction in 10-to-30-year securities. So the only way
they can get rid of them is to sell them into the open market.
If the economy is running full-tilt at full employment, and
let us say the employment rate might be at 5 percent, it could
have nothing less than, as you implied, a very dynamic effect
on interest rates in general, not just in the United States,
but worldwide in as much as the United States dollar is the
world reserve currency.
Mr. Luetkemeyer. Thank you.
I yield back. Thank you, Mr. Chairman.
Chairman Paul. Thank you.
We are going to a second round now of questioning.
The first question I have I would like to get sort of a
short answer for, because I have another question that follows
and we will be voting on the Floor pretty soon. But what is
your concept of the current situation now and whether or not we
have a bubble? Most of us recognize a NASDAQ bubble. Others
recognize the housing bubble. Do you see a bubble right now
that could suddenly change and change the markets and all
perceptions?
Mr. Grant?
Mr. Grant. Yes, Mr. Chairman, I do. I see a bubble in
Treasury securities. I see a bubble in sovereign debts
worldwide. The world has come to believe that the promises to
pay of sovereign governments are intrinsically safe--not
everyone--but Northern European governments are meant to be
intrinsically safe. Australia, I think there are seven or eight
AAA-rated governments left on the face of the Earth. People are
crowding into the claims of these governments, not least into
our own.
These are interest rates that have not been seen in modern
times in Northern Europe. There are plenty of governments
borrowing at negative interest rates. And as was the case in
every single market bubble in history, there are wonderfully
persuasive stories circulated to rationalize what on the face
of it is an abuse of common sense.
So I nominate bonds themselves as our looming bubble.
Chairman Paul. Mr. Lehrman, any additional comments?
Mr. Lehrman. The number of bubbles--even with vast
unemployed resources in nations around the world, not just in
the United States--is legion. And Jim has just mentioned some,
but the Congressman and I were talking about farmland.
The value of farmland, as one vehicle for speculation, not
only among well-positioned farmers, but I mean to say the
investor class, the price of farmland, high-quality, let us say
160-bushel-per-acre, non-irrigated farmland from Central
Pennsylvania all the way to the foothills of the Rockies, that
is to say the great corn belt, has doubled just in the past 4
years.
This has never been experienced at quite this rate of
change; or I should say this bubble has never occurred on this
scale in the past. It is one more example.
Chairman Paul. My follow-up question is to you, Mr.
Lehrman. I would like Mr. Grant to comment as well. You talked
about a long-term solution, more about the monetary reform and
the use of gold. I want to concentrate more on that shorter-
range solution or something you suggest that could help. And
that is to look to the original Federal Reserve Act and not to
allow the Fed to buy Treasury bills, but to allow the Fed to be
the lender of last resort to sound commercial loans.
Did I state that correctly?
Mr. Lehrman. Exactly.
Chairman Paul. Okay. If the Fed buys a commercial loan,
they could buy this with money creation. Would this be
expanding the money supply? Would this be monetizing a debt?
And could it lead to a problem as well? Or would you argue that
this is not monetary inflation?
Mr. Lehrman. I would argue it would not be monetary
inflation. The difference is profound. The purchase of
commercial bills for the purpose of production by the Federal
Reserve or by commercial banks against the issue of new money
goes to solvent firms who, in the process of production, then
sell their output and they repay the loans.
And as a result, the new credit which has been advanced
against the commercial bill or against the productive loan
expands the money supply during that particular market
interval. But 90 days later or 120 days later, the goods that
were produced as a result of that financing realize their value
and then those loans are liquidated, restoring equilibrium to
the money market.
Chairman Paul. So do you separate this from being the
lender of last resort? Or would you put it in that category?
Mr. Lehrman. I use the phrase ``lender of last resort''
because that is, of course, the rationalization that everybody
uses to give the Fed the privileges to create money without
limit. As the lender of last resort, the Fed would have the
possibilities of buying solvent commercial loans in the open
market, which themselves would be liquidated in a windup
naturally in the course of economic activity.
Whereas, in the case of the Treasury, the Treasury is never
able, under present circumstances, and has not been since
pretty much the end of the Second World War, to liquidate the
bills or the bonds which they are selling. And it leads to a
permanent expansion of the money supply never to be unwound by
the natural course of production.
Chairman Paul. Would doing this interfere with interest
rates?
Mr. Lehrman. In the case of commercial bills or productive
loans, which the Fed would then discount when they were offered
by the commercial banks against the desire for new credit, this
would, in the same sense, lead to a rise in interest rates when
credit demands were higher, and a fall in interest rates when
the commercial loans were being repaid to the commercial banks,
and the commercial banks repaying the central bank for the
loans that they obtained against commercial lending collateral.
Chairman Paul. Okay. And our voting has started, but I
would like to get Mr. Grant to make a comment on that, if he
could.
Mr. Grant. I would vote. I am with Lew.
Chairman Paul. Pardon me?
Mr. Grant. I said I would go vote; I am with Lew on this. I
can't add to this or shouldn't take your time in adding to it.
Chairman Paul. Okay. Mr. Huizenga from Michigan, would you
like to ask some questions?
Mr. Huizenga. I would. Also, Mr. Chairman, I want to say
thank you for your service to our country and your time here in
Congress, as well as your service to the philosophy, the battle
that we have going on.
And the question I have is, I am curious if we can touch on
the dual mandate of the Fed and what you believe that may have
done to get us in the current situation. And would you suggest
us changing that dual mandate of having them pursue low
inflation and high employment? And any time I have, I would
like to give back to the Chair if he so desires to do a follow
up.
Mr. Grant. Congressman, I think that one might, again, go
back to the founding precepts of the Fed. The Fed got into
business, if you read the opening paragraphs of the Federal
Reserve Act, the Fed was to create a market in commercial bills
and to exchange paper for gold in such a way as to support the
working of the gold standard.
And the phrase added was, ``and for other purposes''--
pregnantly, it was added. But I would keep the mandate even
simpler than one. I would say that the Fed ought to be in
business to support an objective definition of the value of the
dollar.
In this day and age, we could not have anything resembling
industrial commerce as we know it without the most precise
specifications of material weights and measures. And somehow,
we have neglected this in money.
Money is what someone thinks it should be in some
particular public institution like a central bank or a Treasury
Department. The lead article of the Financial Times this
morning was a plaint by the finance minister of Brazil against
quantitative easing on the grounds that the willful
depreciation of the dollar--or I might say the willful
redefinition of the dollar--would certainly lead to the
interruption of trade and to frictions that did not exist
previously.
The gentleman to my left has written a fabulous book on
this, and I think it is his view as well that what is wanted is
the restoration of objective value in the dollar. And if the
Fed could do that and maintain it, it seems to me that good
things would follow.
As it is, we have arrived at the most peculiar point in
which people have come to think that if the Fed can raise up
the value of stocks, bonds, farmland and commodities, somehow
prosperity will follow. It seems to me that is a very peculiar
horse in front of a very odd cart.
Mr. Huizenga. I appreciate that.
And Mr. Chairman, I am happy to yield my time to you.
Chairman Paul. I thank you.
I will recognize Mr. Luetkemeyer.
Mr. Luetkemeyer. Thank you, Mr. Chairman.
Just very quickly, I only have a couple of questions.
Mr. Grant, what do you believe would be the ideal interest
rate or the ideal range that the Fed should shoot for, that our
rates should be for, say, our T-bills or Fed funds rates or
home loans or somewhere in there? Use some of those figures.
Mr. Grant. Sir, I think the Fed should not be shooting at
those rates. I think that they should be determined in the
marketplace. If you look back on history, kind of a normal
mortgage rate was 4.5 to 5 percent; T-bill rate, maybe 3 to 4
percent; long-dated securities, yielding perhaps 6, 7 percent
depending on the credit; and higher with regard to junk or
speculative grade credits.
But I would let the wonderfully invisible forces of the
marketplace into this line of work and let them do their
thing--
Mr. Luetkemeyer. Okay, if that is the case then, do you get
rid of the Fed, or do you think there is a place for it?
Mr. Grant. Sir?
Mr. Luetkemeyer. Would you get rid of the Fed then or do
you believe there is a place for it?
Mr. Grant. I believe that the Fed ought to be doing much
less than what it is doing, and it could do with many fewer
economists. They could be doing with a much narrower mission
statement and as long as we are talking about reforming this
outfit, we should not fail to institute the Fed's first office
of unintended consequences.
Mr. Luetkemeyer. Mr. Lehrman, would you like to comment on
that?
Do you believe we need to have a Fed or do you believe--
Mr. Lehrman. I have made the case in my book and in
previous books that if we are going to have a Federal Reserve
system--for it should be said it is not an indispensable
necessity--but if we are going to have a mere agency of the
Congress maybe with the stature, so to speak, of the Interstate
Commerce Commission or the Federal Communication Commission,
then it must be circumscribed by very careful rules, whereby it
conducts its policy such that it is consistent with the
activities of a free market and a free people.
So, that yes, I can embrace the Federal Reserve Act of
1913, and the very few moments in which it conducted itself
according to Article I of the Constitution, Sections 8 and 10,
namely, to define the value of the dollar, regulate the--
Mr. Luetkemeyer. So you could live with it as long as it
went back to its original intentions and functions?
Mr. Lehrman. I think we can go forward. We can't go
backward, but I think we can go forward to a restoration of a
Federal Reserve System which operates with some restraints
imposed by Congress, the definition of the collateral, which is
eligible at the Federal Reserve for discount against new money
to encourage economic growth as opposed to encourage Treasury
budget deficit.
Mr. Luetkemeyer. Thank you.
Mr. Chairman, I yield back.
Chairman Paul. Thank you.
I wanted to thank our Members who are here today, and our
witnesses. And I appreciate very much you being here.
The Chair notes that some Members may have additional
questions for this panel, 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 these
witnesses and to place their responses in the record.
This hearing is now adjourned.
[Whereupon, at 10:36 a.m., the hearing was adjourned.]

A P P E N D I X

September 21, 2012

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