Trey Lockerbie (00:03:40):
Now it’s hard to say just judging by what you find on the internet, but it’s reported that Charles Koch is estimated to be worth something over $50 billion, he’s in his mid ’80s now. Give us an overview of where Charles started and how he was able to grow his wealth to over 50 billion in that timeframe.

Christopher Leonard (00:04:00):
Yeah, it’s a fascinating story. Charles Koch was born in Wichita, Kansas. He was one of four sons and his dad Fred Koch was an entrepreneur, an engineer and Fred Koch owned this company that was really an agglutination of a lot of different firms. He owned ranches, he owned engineering, manufacturing facilities, he owned oil refineries. And to be honest, it was kind of a hodgepodge of industrial holdings. And I use the year 1967 because that was the year Fred Koch passed away. And Charles Koch was 32 years old at that time and had been made president of the family company and he quickly reshaped it and renamed it as Koch Industries, and that’s really where this modern company that we have today began. And over 50 years Charles Koch was CEO of this company and really did have unadulterated control over it and built a corporate colossus.

Christopher Leonard (00:05:00):
And I think at the heart of what Charles Koch has done, what was most interesting to me is that this guy is a long term strategic thinker. And a lot of what I talk about in the book is how he fought vehemently to keep control of the firm, he’s kept it private all of these decades. He’s plowed 90% or more of the profits into the company to help it grow. And he’s done all of that, so he could always keep an eye on long term strategy, a horizon that’s not measured in quarters or even years, but well over many months, years or even decades.

Trey Lockerbie (00:05:37):
Talk to us about some of the philosophies that went into growing that business. You talk in the book about this thing called this philosophy called Market Based Management, what is that exactly and how did that come about?

Christopher Leonard (00:05:50):
It’s such an interesting thing, so as I said, Charles Koch always maintained tight control over this corporation. I’m just going to call one of his primary obsessions in life is writing a blueprint for how to manage a corporation. But it really does even go deeper than that, he feels like he’s discovered a blueprint for how to run countries, nations and societies, and it’s all oriented around free market beliefs, competitive capitalism beliefs, his big role models would be Friedrich Hayek, Ludwig von Mises or von Mises, I always mispronounce that one. These Austrian economists who said that the best way to organize society is a capitalist market where you don’t hold on to institutions, but there’s this constant wheel of creative destruction that dissolves old institutions and replaces them with new ones.

Christopher Leonard (00:06:48):
And Charles Koch wanted to codify this free market view into a management manual, like the operating manual for Koch industries and that’s this thing he calls Market Based Management. And he’s been refining this philosophy over the years and if you got hired at Koch industries today, you’d spend the first few days of your employment going through days long seminars on how Market Based Management works, and the idea is you’re encoding free market laws into corporate management.

Trey Lockerbie (00:07:21):
What does that look like though exactly? What would be an example of that I guess?

Christopher Leonard (00:07:25):
It begs the question of how effective is it, how real is it? Here’s what it looks like. Let’s say I get hired into Koch Industries as a commodities trader in Houston, Texas, and I’m trading oil futures or oil supplies. Within the Market Based Management system I’m seen as something like a small property owner. And I’m given a certain amount of responsibility, a certain amount of money that I can trade every day, and it’s trying to synthesize a market environment. So if I do well, if I’m making good trades, if I’ve got a good insight into the market, ideally I should be gaining more and more authority, more and more responsibility or within this structure more property. They think of themselves as property owner with a growing role, more money at my disposal to trade. And that’s one example of how this is supposed to work, but it’s got this encoded vocabulary and it’s how these people think.

Christopher Leonard (00:08:26):
Like for example, they talk about mental models, humility and point of view, and these things sound like cliches, but they have strategic and specific meaning inside Koch. Like when I talk about my point of view, I don’t just mean Chris Leonard’s thoughts, feelings and political ideology. I mean this is my sharp analysis of where I think the market is today, that’s my quote point of view. And I’m going to back it up with a lot of research into the fundamental factors driving the market. And I’m going to develop a view of what the world is like with the very concrete goal that I’m going to go out into the markets and trade, on that point of view, which should be superior to that of my competitors. In other words, I should have sharper, clearer understanding of how the world works.

Christopher Leonard (00:09:17):
So you’ve got all these guys walking around, men and women, I’m sorry, all these guys and gals inside Koch Industries walking around using these terms, like point of view and mental model. And to me the biggest effect of this philosophy while it is effective I think on the Xs and Os, on the tactical reality it’s effective. But it’s very powerful, very powerful in creating a common vocabulary and the sense that people inside Koch are rowing the boat in the same direction. And that’s really important with a company like this, which is so diversified. You got to have people in the natural gas unit versus people who make a particle board, versus people who are trading commodities, all feel like they’re part of a unified whole. And it seems again like kind of a cliche, but to have everyone speak in the same language and having the same point of view, really helps unify the team. And I think that that’s one of the powerful things of that whole philosophy.

Trey Lockerbie (00:10:18):
That raises the question around how unique that operating system is to Koch industries. Meaning you would think it’s been very successful for that company, it hasn’t been adopted anywhere else that you’re aware of.

Christopher Leonard (00:10:32):
That’s one of the interesting things, it has not. Zero outside adoption as far as I’ve been able to determine. It’s not like there’s this playbook getting used in different companies. And frankly, I think that’s something that frustrates Charles Koch. As you mentioned, he’s getting into the Twilight of his years. He’s working 20 years past the age when many people retire. And you can see he’s very focused on trying to package and export this philosophy. He’s written at least three books, commercially published books about market-based management. First of all, it’s very difficult to export Koch’s secret sauce. This is a very specific company with very specific capabilities and skills that are difficult to export. Koch is extremely good processing raw material, that’s what’s at the heart of their oil refining, their natural gas production, their nitrogen fertilizer plants, their Georgia Pacific plants.

Christopher Leonard (00:11:35):
A lot of those skills and mindsets don’t export to a newspaper or a clothing retailer. But also it’s fascinating to me, this dilemma that Charles Koch faces when he writes about it because secrecy is key to this corporation. They get a lot of black eyes in the media for being this opaque and secretive organization, frankly, a lot of that’s true. But it’s not just because they’re trying to do something nefarious, it’s because the whole key to this company’s success is knowing more than your competitors know about markets, so you can trade well, so you can buy I and sell other companies well. And when that’s your major strategy, don’t show your cards. Secrecy is strategic. So when Charles Koch tries to write about Market Based Management, I can read it. I’ve read all of his books, frankly, several times and interviewed people in the company. You can see how he’s got to hold back. He can’t really talk about what they’re doing because it would give away too much of their information. And so I think that’s hobbled his books and maybe slowed down their adoption.

Trey Lockerbie (00:12:43):
You have interviewed quite a few people, especially for this book, I think hundreds of employees and people close to Charles. What was your takeaway as far as what were some of the traits you would say created his success over the last 50 years? What are maybe the personality traits or otherwise?

Christopher Leonard (00:12:59):
Relentless and obsessive drive to achieve and that’s one of the biggest mysteries to me of this guy. He was born quite wealthy. He became almost incomprehensibly wealthy, you could never spend all the money he makes, but he still shows up at work before the sun is up many time. And this is a guy who has been just relentlessly focused on pushing and growing this company to make it as large and successful as possible and to be truly unwavering in that mission. I think that that’s the most important thing is the internal motivation direction and obsession on the work, that’s one of the things that hits me most. And then second and this is a little bit more specific to Koch industries and what they do, it’s this thing of having the mind of the engineer, Charles Koch is almost dispassionate.

Christopher Leonard (00:14:03):
He a nice guy, he’s charming, he’s folksy, he makes you feel comfortable in a room, but he’s not Mr. Go-out-and-get-beers-with-the-team-and-slap-you-on-the-back kind of guy. He’s analytical. And again, focused with this strategy that’s long term. And he’s really not battered by the ups and downs of markets, and I think that comes from working in the energy industry for so many decades where the volatility can just be gut wrenching. And so for his management style, he’s always focused on how this is going to benefit the company over a period of one, two, five, 10 years. And if you come into the office and you’ve had an absolutely catastrophic quarter, there’s not going to be yelling, slamming fists on the table, it’s going to be more of, “Okay, is what’s going wrong a symptom of a much deeper problem, or is this a downside in the market? Does this present us an opportunity to buy?” And so I see this real engineering mindset and a long term strategy that’s I think at the core of his success.

Trey Lockerbie (00:15:08):
Given that Charles Koch is now in his mid to late 80’s, what would you say his legacy will be? And what do you think he would want his legacy to be?

Christopher Leonard (00:15:22):
Okay. I feel like I can answer the latter part pretty easily. I think he wants to be seen as one of the great business figures of our era. I think he wants to be seen as one of the most successful business people of our era and not to be cheesy, but a philosopher king. Again, the guy has published three books about his own personal history, his management philosophy, I think he wants to be seen as a deep thinker in terms of corporate affairs. The actual legacy he left behind is going to be complicated by the one topic we’ve not talked about, which is politics. He really does think he understands the blueprint for how society should organize itself, and he hasn’t been shy at all in trying to make that vision a reality, he’s been very politically engaged for decades and that’s going to be a key part of the history that’s written about him.

Christopher Leonard (00:16:24):
And the thing that really rises to the top on that, this isn’t going to surprise any of your guests I think, is his stance around global warming and around the fossil fuels industry, which is just key to Koch Industries’ long term profitability over the decades. He’s fought very, very hard against any kind of government regulation to either hinder fossil fuel emissions or put a price on carbon emissions, when the history is written I think that will be a key part of his legacy. And also I think within the business community his corporation will be a case study in corporate management, that’ll probably be looked back upon for a long time.

Trey Lockerbie (00:17:08):
Now you are an investigative journalist, I’m sure part of the appeal of writing about Charles Koch had to do with some of the political aspects that he’s involved in. Can you just give us an idea of maybe an example of him and his controversial way of potentially working within the shadows, because I think it ties potentially to this next subject we’re to talk about around the Fed.

Christopher Leonard (00:17:34):
Yeah, it’s just fascinating. Charles Koch has this well known saying that the only whale that gets harpooned is the one that comes to the surface. And it’s kind of a joke in the sense that with his political team, I’ve interviewed folks up and down all the levels of his political team, they operate below the surface and this really borrows directly from the corporate playbook I just told about of strategic secrecy. And I think Charles Koch has a very detailed, granular view of the machinery of government in the United States. And he’s very smart about how to approach that, how to hit the pressure points, where there’s good opportunities to buy low, sell high, to gain a foothold, to push your agenda. And by that I mean getting out into the state government level where you can get a state seat, a state house or state Senate for $15,000 of campaign money.

Christopher Leonard (00:18:33):
So they’ve been very smart in taking this 360 degree approach to influencing politics. And you asked about a specific story, they pushed very, very hard against the cap and trade bill to control climate emissions back in 2010, and they’ve got an extraordinarily sophisticated network to do that. I show in the book how they pay someone to do a study without having Koch’s name on it, and then they pay their think tanks to amplify that study and go testify in front of Congress about it. And then they use material from those congressional hearings to make political ads to target vulnerable senators who are in the way of their agenda. It’s a pretty complicated machine that all works together and Koch can keep its fingerprints off of it, and it’s done in my mind a remarkably effective job of pushing their agenda on Capitol Hill.

Trey Lockerbie (00:19:30):
Fascinating stuff. Okay. Let’s talk about this new book that you’ve written, it’s a topic we talk a lot about on the show, which is the Federal Reserve and its influence. I would say going back even five, maybe 10 years ago, hardly anyone was really knowledgeable about the Fed, but I feel like it is entering the mainstream now. I think a lot of folks are starting to become aware of their power and influence and how much markets really depend on their every move even on Main Street. So I’m kind of curious if you had a personal experience with that or what led you to investigate this aspect of the economy?

Christopher Leonard (00:20:11):
This is how these two things bleed together. One of the things I love about being a reporter is you get to meet all kinds of people. I just love it. I have talked to folks totally across the political spectrum in all walks of life. And reporting Kochland put me into contact with some extremely interesting people. And there’s this one guy I talk to, who talked to me on background so I can’t say his name, I’m not trying to be coy or anything. Super brilliant guy. And we talked for 11 hours during our first interview to talk about asset markets and this was back in the year 2016. And I think that this guy didn’t have people to talk to about this and was just happy to have an open ear. And he laid out for me what he was seeing in markets and it blew my mind.

Christopher Leonard (00:21:03):
And one headline I’ll take from what he told me is that in the first century of its existence, the Federal Reserve printed about a trillion dollars. And specifically what we’re talking about is it increased the monetary base to about $900 billion. The Fed as an institution has one superpower, it can create new dollars out of thin air and no one else can do that and that’s why the Fed is one of the most powerful institutions in the world. And these dollars it creates are the new money, high powered money, foundational money that we call the monetary base. So over a century, the Fed boosts the monetary base slowly and incrementally to $900 billion. And then in about three and a half years after the crash of ’09, the Fed prints $3.5 trillion. In other words, it does three and a half centuries worth of money creation in about three years.

Christopher Leonard (00:22:00):
So, wow, what we’re talking about now is a step change, a breaking of the graph, a new era in history. And this has had really dramatic side effects in our economy, in our financial system, in our banking system. I mean this money wasn’t a neutral force, it really did change the shape of the American economy. And that’s what got me obsessed with the Fed in 2016. I had read a lot about the Fed and its emergency rescue efforts during the crash of ’08. But it’s what came next, it’s what came during the decade of the 2010s that I felt was not written deeply enough about, there wasn’t a book about quantitative easing or seven years of 0% interest rates. And that’s the era that really fascinated me and so that’s what this book is about. It starts when this era in my estimation really started, which was November 3rd, 2010. And then it takes us up through the present day after the COVID crash, and what you see is a system totally re-engineered by the Federal Reserve.

Trey Lockerbie (00:23:14):
Let’s talk about some of the fundamentals around the Federal Reserve, especially for those who haven’t studied it. If you go on the Federal Reserve website, it says it’s not quote unquote owned by anyone. And it’s a decentralized board of governors essentially from both public and private characteristics is what it says. Talk to us about the makeup of the Fed and how its governance actually works.

Christopher Leonard (00:23:39):
The Fed is the result of a bizarre experiment of genetic engineering in government, it’s part private enterprise, it’s part bank, it’s part government agency. And I actually I try to walk through this history really briefly in the book, but up until 1913, we really experimented a lot with money. The United States was very resistant to creating a central bank. If you could have a modern industrial capitalist society without a central bank, we would’ve done it. There’s always been this reticence in the US to create something that could be so powerful as a government run central bank, the worry was that it would displace the private market. The problem is we had this wild west of currencies. Literally in the late 1800s, there were hundreds of currencies in the United States. So if I went to Oregon and stayed in a hotel, I would present a bank note from Ohio and we would have to argue about the soundness of that currency.

Christopher Leonard (00:24:40):
This led to an era of financial instability. We had long periods of deflation. We had regular bank panics. And finally in 1913, we established a central bank with two key jobs. One was to create a national currency called the Federal Reserve note, otherwise known as the dollar. The second thing the Fed did was it took the role of being lender of last resort. So if there was a bank panic, the Fed could create new money, lend it to banks that were otherwise sound, that would’ve been hurt by the panic and stop the panic. So that’s what the Fed was created to do and it actually did a pretty exceptional job along those lines over the next century, which we can talk about. But to your point of who owns it, who runs it, the tensions around the central bank are built into the Fed.

Christopher Leonard (00:25:33):
It’s really a network of 12 regional banks, there’s no one Federal Reserve bank. There are these 12 banks around the country clustered in a map that really reflects what the world looked like in 1913. There are two banks in Missouri, for example, and only one really out on the west coast in San Francisco. And the governing structure was supposed to be decentralized, to reflect the Federalist model of the United States, the regional bank presidents had authority. But then the Fed created this governing body in DC, this is the key headquarters of the Fed it’s in a building on the National Mall called the Eccles building. The Eccles Building’s not a bank, it’s this home of a board of governors. And what we’ve seen over the decades is that power has really consolidated away from regional banks and into the Eccels Building, where you’ve got seven governors who are selected by the president and approved by Congress, who really make these key decisions about how our currency is managed and now way more than that.

Christopher Leonard (00:26:42):
What the book is talking about is how the Fed has become incalculably more interventionist than it ever has been in its history, and is now doing way more than just setting interest rates. But anyway, those decisions are confined now to the board of governors largely in DC. And the last thing I’ll say is that these governors sit on a very important committee called the Federal Open Market Committee. The FOMC is probably the most powerful body on economic affairs in the United States.

Trey Lockerbie (00:27:11):
Well, the book is called The Lords of Easy Money: How the Federal Reserve Broke the American Economy, that’s a very strong claim.

Christopher Leonard (00:27:21):
Yes sir.

Trey Lockerbie (00:27:21):
And so I want to talk a lot about that and the roadmap to get there. Tell us the story of Thomas Hoenig and let’s start there because he had this example he was trying to… I would say an example of rebellion he was trying to display post the GFC and how feudal was that or how prosperous was that? And how much of an impact did was Thomas able to make?

Christopher Leonard (00:27:46):
Let me please hasten to say lest your listeners think I’m a bomb thrower, when I say broke the American economy I believe the evidence is overwhelming. The Fed has dramatically widened the gap between the very richest of the rich and everybody else, which destabilizes society. The Feds actions over the last decade have created a lot of fragility and instability in our financial system by stoking asset bubbles and corporate debt, commercial real estate bonds, stock market, you name it, we’re in a real predicament because of that today. And then finally it has simply encouraged immense amount of indebtedness in households, corporations, and governments, so we have a lot of bills that have yet to be paid because of what’s happened over the last decade. So I think a great place to start and talk about this is with this guy named Thomas Hoenig who was president of the Kansas City Federal Reserve bank.

Christopher Leonard (00:28:42):
And when I got obsessed with quantitative easing, I started researching it and saw that the really pivotal vote that started all of this on November 3rd, 2010, was the vote to unleash a new and unprecedented round of money printing or quantitative easing and the vote was 11 to one. And so as a reporter you’re just sort of like, “Well, that’s an interesting number.” It’s not six to five or three to eight, it’s 11 to one, who was the one? Why would someone be the sole person who voted against it? And that’s what led me to Thomas Hoenig, who was the one no vote. And that’s really what began the core of this book, because Thomas Hoenig has been misremembered by history. He’s seen as this cranky dissenter, this Old Testament monetary policy guy, who’s a “ultra hawk” who is against government intervention and who voted no for the sake of voting no.

Christopher Leonard (00:29:41):
And who critically was most worried about inflation and hyperinflation and he was proven wrong because we never had price inflation until the year 2021. All of that is wrong, that’s what shocked me. When you go back and read the actual historical record, it tells a very different story. And luckily we have access to the internal debates. Transcripts of the internal Fed debates released after a five year delay. So we can go back and see what people said at the time, both inside and outside the Fed and Tom Hoenig was making a very specific argument that takes some time to unpack. But what he was saying in 2010 was, “If we go down this path, if we decide to become the central force driving economic growth in America and we decide to do it by keeping interest rates pegged at zero, while pumping 3.5 trillion into the Wall Street system, we’re going to create a lot of bad side effects.

Christopher Leonard (00:30:41):
We’re going to create asset bubbles, just like the .com or housing bubble, that’ll make wall street very vulnerable to shocks and crashes. We’re going to find it impossible to stop printing the money. Once we start, we’re not going to be able to get back out of this plan. And we’re going to essentially enrich the very richest of Americans.” Because the primary way these policies work is by stoking asset prices and the top 1% of Americans own 30% of the assets. He called it an allocative effect, “We’re going to allocate money in America toward the biggest of the big banks and the richest of the rich Americans while creating a lot of instability.” And this is an argument he made again and again, and again. And you can see in terms of his dissent, he’d been at the Fed longer than anybody else during this critical period of 2010, he’d been there for 32 years, was never a dissenter.

Christopher Leonard (00:31:35):
He’d cast two no votes in his entire career. And then in 2010, he casts an unbroken string of eight no votes. Well, that tells you something, he threw his entire career on the line to try to stop this policy and he failed entirely. But he knew he was going to fail, I think, toward the end, but he wanted to send a message to the American public, to at least let them know that there had been a debate about this and some people had tried to say no.

Trey Lockerbie (00:32:02):
Well, that debate is especially interesting because you touch on this in the book how cultish it sounds at the Fed, if I can say that, meaning that they do not want debate, it’s very controversial to have a no vote. They want to be seen as this unanimous power that is doing the right things for society and shouldn’t be questioned so to speak, at least that’s how I read it in the book. Talk about the debates that actually occurred behind doors.

Christopher Leonard (00:32:32):
You got it exactly right. You could say cult, you could say extreme group think. This really does tell a much bigger story. That period I talked about in the 1800s, early 1900s, the politics of money and how to manage our currency it was a retail political issue, it’s stuff that people cared about. When Williams Jennings Brian ran for president, he had this famous quote up on the campaign stump where he talked about, “You shall not crucify mankind on a cross of gold.” It was this line that just drew the huge applause, that was a line about money policy. He was talking about monetary policy. That all changed to be honest when the Fed was created, this started this slow evolution of taking the politics of currency away from the public, and putting it into the hands of a very small group of technocrats inside the Fed.

Christopher Leonard (00:33:36):
And the thinking behind that wasn’t entirely crazy. The thought was the power of managing currency is so important, we can’t leave it in the hands of grubby corrupt politicians. It must be left in the hands of an institution that is insulated from the passions of politics, so that was the idea. But what we’ve really seen definitely accelerated since the Greenspan era began in 1986, was that the Fed started to present itself as this Olympian group, this Olympian committee of brilliant PhD economists who are not really even making policy decisions, but who are just solving math equations, that’s the sort of the Greenspan mystique that I talk about in the book or the Fedspeak phenomenon as they call it. And Fedspeak is just to make everything sound so impossibly complicated that anybody hearing it must instantly assume, “I could never understand monetary policy. Thank God we’ve got someone like Greenspan, Bernanke, Yellen or J. Powell in charge who can understand this.”

Christopher Leonard (00:34:48):
A key part of enforcing this view that the Fed is an Olympian group of brilliant technocrats is to have consensus and unanimity. It’s very important that the votes on that committee I mentioned the FOMC, the votes are almost always unanimous, it’s a big deal when one or two people vote no on the FOMC committee. We see Supreme Court decisions all the time that are five to four, six to three, you name it. At the Fed it’s almost always 12:0, 11:1, 11:1, 10:2 in a wild outlier, this is very much done on purpose. One of the most interesting interviews I did for the book was with a former Fed governor named Betsy Duke, who’s a former Wells Fargo banker, who’s a Fed governor for many years. And she just talked very candidly about how those board of governors would meet before the meeting and decide what the vote was going to be, all orchestrated by the chairman at the time Ben Bernanke.

Christopher Leonard (00:35:55):
And this is key because the governors always hold seven seats on the voting committee of the FOMC, they always have a majority. You can’t vote… you can’t beat the governors, it’s well known. And so the governors would come into the meeting knowing how they were going to vote. And so at most you might have one cantankerous regional bank president vote no, but they’re always isolated, they’re always marginalized and that’s how consensus gets built at the Fed. And frankly that’s why the consequences were so significant for Tom Hoenig to vote no so many times. I think it’s safe to say I have come to the conclusion that Tom Haig was right and that he made principled informed argument in his dissents, but it’s also fair to say he largely threw away his reputation through this string of no vote. He certainly could kiss any job consulting for Citadel or Blackstone goodbye. He trashed his reputation in certain circles on Wall Street, but he felt it was really important to vote no on this and to break the consensus.

Trey Lockerbie (00:37:02):
Well, going back to breaking the American economy, I’d like to understand where you think it started to bend and break, for example. My impression is that if we go back to the Greenspan era, there was an opportunity there to raise rates that was avoided or at least ignored for too long, mainly I think because of this pressure on Greenspan either to be a likable guy, or to just be amenable to Wall Street. But there seems to have been this missed opportunity and that’s when the bubble started to escalate up the food chain so to speak. But is that correct in your opinion, does it go back farther than that? Where do things really start to get squirrelly?

Christopher Leonard (00:37:46):
No, I think you’ve really put your finger on a very important historical moment with the Greenspan era. I do want to point out that in the book I talk about the great inflation of the 1970s and the lots of lessons we can draw from that. There’s this fantastic history, it’s three volume, 2000 page history behind me by Allan Meltzer about the Fed. And he just walks through in granular detail how during the 1960s the Fed knew it was keeping rates to low, and it would try to raise rates a little bit to slow down inflation, but then it would face political pressure because the economy was hitting a Rocky road. So it would lower interest rates again and put more money into the system and that’s what led to the great inflation in the 1970s. The Greenspan era is critical, it is the foundation of where we are today.

Christopher Leonard (00:38:40):
And in my mind one of the most important policy frameworks that happened during the Greenspan era, this decision to focus only on price inflation. What I’m saying here is the Fed felt that it could keep rates low, as long as it desired to stoke more lending and hopefully more growth, as long as it never saw consumer prices rise too fast or too hard, and consumer prices that’s everything bread, gasoline, television sets. At the same time, the Fed and the leadership made a very concerted decision that they would not worry about asset price inflation or asset bubbles. And if assets were roiling and frothing, and there was this irrational exuberance we’ve heard about. The Fed was not going to step in and try to stop that, this was a really important policy decision.

Christopher Leonard (00:39:36):
And it coincided with a very interesting period in history when we really didn’t see price inflation during the 90s, during the 2000s. If we’re being honest the Fed has no clue why we haven’t seen a strong price inflation, everybody’s got their good guess as to why it never happened, but the key is the price inflation is the one thing that could have put the brakes on the Fed’s easy money policies. And so you saw Greenspan keep rates too low for too long, it led to the stock market asset bubble which crashed, the Fed responded with more low rates in the 2000s. It kept rates too low, too long in the 2000s, which created the housing asset bubble, which crashed. And that brings us to ’09 in the shadow of that massive financial crisis, huge, huge global crisis. And the Fed did a great job of stepping in to stop the bleeding during the finance crisis, which everyone would want it to do. It’s what came next, it’s what the Fed did during the recovery, during the decade of the 2010s that I argue broke the US economy.

Trey Lockerbie (00:40:49):
So that raises this question around the governance of the Fed and how important the actual players are. We could blame Greenspan, we could blame Bernanke, Yellen, now Powell, but are these people like how powerful are they truly? Meaning there seems to be this agenda coming from a higher power of some kind whether it’s the president or otherwise. And if it wasn’t Bernake doing X, Y, and Z they would’ve voted him out and put someone else in, there’s an opinion about this. So is this an era of human judgment or is this an era of higher power policy at play?

Christopher Leonard (00:41:31):
Okay. I think there are a couple things going on. Let’s look back again to that instructive example of the 1960s. When you go back and look at why the Fed kept money too easy for too long in the 60s, it was because the leaders at the Federal Reserve are humans just like the rest of us, they’re reading the newspapers. And when unemployment is low, citizens look to their government to do something. And we’ve got two engines of action on economic affairs, we’ve got our fiscal authorities, which would be Congress, the White House, the Department of Treasury, fiscal authorities and then you got your monetary authorities at the Fed. This is a big story to unpack, but definitely since 2009 our fiscal authorities have been on the sidelines, more or less paralyzed by dysfunction, not able to take huge action to stimulate economic growth from either a conservative angle of slashing government, slashing entitlement, slashing regulations, or from a liberal perspective of a new deal where you’re directly hiring workers, you’re breaking up the big banks.

Christopher Leonard (00:42:45):
Fiscal authorities have not been able to do anything big on either front and that leaves the monetary authorities to step in and act. So yes, this institution is driven by humans and I think they… well I know they acutely feel the pressure to do something because they’re human beings too. So you’ve got a political bias I’d say toward intervention or toward exerting pressure. But then you talk about the higher power, it’s very interesting that you’ve got Bernanke, Yellen and Powell, I think essentially all pursuing the same philosophy of monetary policy. And when we saw this supposed debate recently about whom Joe Biden ought to appoint to be chairman of the Fed, Lael Brainard a Fed governor or J. Powell. These two people had zero daylight between them on core monetary policy issues, so what’s going on?

Christopher Leonard (00:43:46):
I think the best assessment is that easy money policies do not antagonize the most powerful institutions in the United States. And that would be the very, very large hedge funds, the very, very large private equity firms, the biggest of the big banks. If you’re keeping rates low and you’re stimulating financial speculation and debt accrual and the sale of debt, the people who you are not going to make mad are Jamie Dimon, the head of Carlyle Group, Larry Fink. People like this are not going to take to the airwaves at CNBC and criticize you. So there’s this movement in that direction I think, it makes it a lot easier to slash interest rates, to peg interest rates at zero. The problem is when the asset bubbles you’ve created inevitably crash, that’s where things get heated and hectic and there’s a lot of criticism.

Christopher Leonard (00:44:59):
But amazingly during crash moments like that, everybody turns to the Fed for yet more easy money policies to help bail everybody out, the Fed is seen as a hero and the situation repeats again. So I actually think that there are systemic pressures that push the Fed toward easy money policies. The one time you saw somebody break from this was in the early 1980s when Paul Volcker who was a Wall Street guy came in and was chairman of the Fed, hiked interest rates from about percent to 19% and killed inflation, destroyed an asset bubble and re-rationalized the monetary system, no one has done that since.

Trey Lockerbie (00:45:40):
I guess my question around the higher power also ties to this example of going back to I think 2015, where Jerome Powell started to take action to raise interest rates, they called it, the result a taper tantrum because the markets crashed 20, 25% just from these microscopic interest rate increases. But you had Trump at the time on every news site available to him, screaming at Jerome Powell publicly saying, “Our rates should be negative. Our rates should be lower. Jerome Powell should lowering rates.” And having the president on all the airwaves demanding lower interest rates and actually seeing Powell than lower rate. It was just interesting to see was this a reaction from Jerome Powell of political pressure, or was this something that was just made sense economically, mathematically?

Christopher Leonard (00:46:34):
Well, in my view having reported this Donald Trump is uncouth, rude, doesn’t play by the rules, says whatever he wants, tweets like crazy goes on TV and says all kinds of crazy things. And people talk about how he bullies officials like poor Jeff Sessions, the former attorney general was just bullied out of a job. J. Powell wasn’t being bullied by Donald Trump, J. Powell was being bullied by asset prices. That’s what mattered to J Powell, that’s what got his attention and that’s what ultimately caused him to do exactly what Trump wanted, which was to pivot on time tightening, to stop trying to normalize the financial markets, to stop pulling back the Fed’s extraordinary stimulus and to simply cut rates and resume the printing of money through quantitative easing. If you really walk through what happened it’s such a fascinating history of the Fed trying and failing to normalize between 2015 and 2019 and then leading into the COVID crash.

Christopher Leonard (00:47:44):
I think it’s a myth that J. Powell stood up to Donald Trump or in any way defended the… that was just political theater, the whole thing was political theater. In fact, the Fed had been trying to “normalize.” And what that means is they wanted to raise interest rates back up to a historically normal level of let’s say 3%. When you look back over the last 60 years, three to 4% was seen a normal interest rate. And at the same time the Fed was trying to draw down the trillions of dollars in cash, in excess cash that it had injected into the financial system, there was a lot of pressure on the Fed to do this. Incidentally, not coincidentally, a lot of this pressure came from J. Powell who argued vehemently when he became a governor in 2012 that the Fed needed to pull back.

Christopher Leonard (00:48:37):
And the reasons are clear, again, when you push this much money into the banking system, you are stoking asset prices, you are creating asset bubbles. And that would be absolutely fine if you could live in that condition forever, but unfortunately, asset prices almost always converge again with the value of the asset, these bubbles crash. And J. Powell when he got to the Fed in 2012 was saying, “We’ve got to draw down these excess cash levels. We’ve got to raise interest rates, or we are going to see a ‘large and dynamic event,'” economist talk for a major crash, “that we’re not going to be able to control.” The Fed had been trying to do this, they’d been trying to normalize honestly since about 2010 when you look at the transcripts, but in a very public way since 2014 and they were not able to do it. The Fed said that during 2016, it was going to raise rates from zero to 1.375%, they couldn’t raise any higher than 0.5%. They were never able to truly withdraw the excess cash from the financial system through so-called quantitative tightening.

Christopher Leonard (00:49:45):
All of this came to a head in late 2018, I don’t know if you remember Christmas Eve 2018 there a stock market crash that was very bizarre because Christmas Eve is usually a pretty light trading day, but the S&P was down 3% that day. And Powell pivots, Powell pivots in January, 2019 and says, “We are not going to normalize. We are going to stop raising interest rates. We’re going to stop drawing this excess cash out of the banking system.” And then by July of 2019, J. Powell is cutting interest rates in the face of economic growth. The Washington Post reported on this really well, Heather Long great reporter on the Fed at the time was pointing out how bizarre it was for the Fed to cut rates as the economy was growing. And what it shows was the Fed was trapped just as Thomas Hoenig warned they would be, the Fed was trapped and had to keep pumping money into the system or else the system would short circuit.

Trey Lockerbie (00:50:46):
Let’s talk about one other short circuit you described in the book which is in this chapter called the invisible bailout. And it talks about the yield curve inverting, the repo market seizing up, walk us through that scenario. What drove us to that that eventually that sparked the big crash we started to see around the COVID impact in March.

Christopher Leonard (00:51:06):
That’s right it’s such a fascinating story, this happened in September of 2019, which in retrospect was as good as things were going to get for a long time. This was a few months before the first COVID case shows up in the United States and the Fed at this time in late 2019 was involved in the struggle I just described. They knew they needed to withdraw the excess cash from Wall Street that they had pumped in through quantitative easing. They knew they needed to raise interest rates slowly but surely up to a level of maybe three to 4%. They never got higher than two and a half percent, by the way, which is historically a very low interest rate. So the Fed was struggling to quote normalize when in September we saw a banking panic. It’s very interesting. I’m sure your listeners there are enough in financial markets, they know what the repo market is.

Christopher Leonard (00:52:02):
But it’s a short term loan market that’s really the lifeblood of Wall Street, it’s an ultras safe, overnight loan market, whereby I as a big bank, “loan somebody some treasury bills.” They give me the corresponding same amount of cash and then we flip back really quickly the next day. And I pay a minuscule interest rate for the privilege of that loan. The interest rates are so low because a repo trade is supposed to be riskless, the person loaning the money has hold of these treasury bonds that are the collateral. In early September, 2019, the repo market seized up, it was shocking. I interviewed the top officials at the New York Federal Reserve bank whose job it was to see the repo market. And Lorie Logan, who was over the trading desk and John Williams who’s president of the New York Fed and the traders who worked for them.

Christopher Leonard (00:52:59):
Talk about being shocked in early September when repo rates start to spike, they knew there might be a little bit of increase at this time for various reasons, the short term market rate jumps from about 2% to 10%. It can’t be overstated that these are bank panic numbers when a repo loan costs 10%, it’s a bank panic. What was so strange about this was there was no reason for a bank panic. I liken it to that thing we see now in the era of global warming, the so-called sunny day flooding when a town will flood when there’s no storm. It was like why would we be seeing the repo market seize up when there’s no big news on the horizon? Because back in ’08 the repo markets had spiked, but Bear Stearns had collapsed it made sense.

Christopher Leonard (00:53:46):
What was going on and what the Fed understood is that they had taken too much excess cash out of the banking system. They had quantitatively tightened just a little bit too much and just that little bit too much caused the markets to seize up. And we got to remember there was still tremendous amounts of excess cash at this time, but it was too little to keep the system operating and the Fed had to rush in with a bailout. First they did hundreds of billions of dollars in repo loans, but then they unleashed quantitative easing again, which had once been an emergency program, but is now necessary for daily maintenance of the financial system. The Fed printed 400 billion in a few months to pump cash back into Wall Street and that brought those repo prices down again. And to me what’s so telling about this story is it shows the Fed was trapped in this money printing cycle just to keep the basic bread and butter, nuts and bolts of Wall Street working, just to keep the repo market settled.

Christopher Leonard (00:54:54):
And the reason I call it an invisible bailout is because the Fed presented this as a plumbing maneuver, this is what we had to do to keep the system flowing. But really what they were doing and the book lays out how this works is they were bailing out hedge funds who had taken on enormous, risky, highly leveraged bets called basis risk trades and they got caught short by the repo price increase and they got bailed out by the quantitative easing, and this was standard operating procedure in late 2019 and that’s before the first COVID case.

Trey Lockerbie (00:55:27):
Now my understanding is it also opened up swap lines between countries for possibly, I don’t know if it’s the first time, but that seems to be a normal thing nowadays as well, where you have these countries that are dollar dependent and they’re short on actual dollars and needed the dollars which keeps… Because this is a global effort now, we’re talking a lot of about the US, but the US impacts the entire world. So when the US repo market seizes up, it has implications across the world and you had entire countries needing dollars all of a sudden overnight. And so what are the implications of that or is that actually a new found release valve, that’s actually a benefit of some kind.

Christopher Leonard (00:56:07):
Well, it’s fascinating. So the swap lines really open up in March, 2020 when COVID hits. I want to point out there’s a great book about COVID called Shutdown by Adam Tooze, and it really brings to light this was a historic generational economic catastrophe, there’s no getting around that. But we’ve also got to recognize this was a wave that hit financial markets that were tremendously fragile, priced to perfection and vulnerable to a shock, as we just talked about. The Fed couldn’t even raise interest rates and that’s why COVID hitting that market created a financial crisis that was worse than 2008. And it’s amazing what happened in the market for US treasuries in March of 2020. Financial Times put it well when they said, this analyst said that this wasn’t supposed to be possible, the treasury markets literally seized up. The Fed responded by executing the entire emergency playbook of 2008, 2009, basically over one weekend.

Christopher Leonard (00:57:14):
And what I’m saying is all the stuff Ben Bernake did over about eight months, the Fed did in a weekend, and a huge part of that was the swap lines you just talked about. And that’s such an interesting part of this whole thing, because the swap lines were barely discussed publicly when they first were initiated in 2008. And like you said there, basically a subsidizer guaranteed loan in dollars to foreign central banks that are dollar dependent. So it means that the Fed is expending it’s dollar creation power to help central banks in Europe. And it was employed to a huge level in ’08 and then it quietly died down. And then it was deployed once again, very, very quickly in 2020, but even the swap lines were just the beginning of what happened in 2020.

Christopher Leonard (00:58:09):
I talked about earlier how the Fed printed 300 years worth of money in a few years. In 2020, the Federal Reserve printed 300 years worth of money in about two months. And they did massive rounds of quantitative easing, which continued to this day, it has become normal operating policy. And the Fed expanded its remit dramatically, it started directly buying corporate junk debt, for example, it was one of the massive asset bubbles that the Fed had been stoking over the last decade was in corporate debt. The Fed said it was going to directly buy those kinds of loans. And when the price came due for the easy money policies of the 2010s, the Fed responded literally by quadrupling down on the easy money policies.

Christopher Leonard (00:58:59):
And so there was a lot of debate, a lot of controversy over the Fed’s balance sheet, which is a reflection of its intervention, how big it is. The Fed’s balance sheet hit 4.5 trillion in 2014, that was a big deal, it had never been that big. Now it’s hovering near 9 trillion and a lot of this has been added since March of 2020, so that’s where we are today as it’s sort of quadrupling down on the program.

Trey Lockerbie (00:59:29):
So our co-host Preston just put out a tweet thread that we’ll link to in the show notes, but it’s a fairly masterful thread that outlines I think this sentiment that everyone seems to feel, but not truly understand. And what he did is he basically outlined the top 80% of indices and market weighted them to show that since 2009, the markets were up about 171%. But if you adjust that for the M2 money supply creation or at least increase, it’s only up 6.9, since 2009, 12 years ago. Meaning that everyone is hearing that the economy is strong and that real estate is up and jobs are low or at least they were, but the middle class is struggling to keep up.

Trey Lockerbie (01:00:16):
THe best analogy I’ve come up with is it seems like we are a human body surviving solely on caffeine. At a certain point it breaks down without nutrition. So in your book you call out this long crash at the end and that’s what it feels like. If you’re crashing from this caffeine, but it’s taking a very long time, you’re trying to drink little bits more here and there. What do you see coming next I guess as far as the long on crash and does it accelerate?

Christopher Leonard (01:00:45):
Yeah. Now, first of all, I really have to push back at that negative characterization of caffeine. You can survive off of caffeine for a long time, I’m kidding.

Trey Lockerbie (01:00:54):
12 years apparently.

Christopher Leonard (01:00:57):
Exactly. All right. I fully validate by the way the point of view reflected in that tweet thread and exactly what you just said. This is why I wrote the book is I feel like what the Fed has done is critical to understanding this very bizarre economy we live in. It is like a funhouse mirror in the sense that asset prices like houses are a rising double digit levels and asset prices in the stock market are rising. Corporate debt markets are breaking records right now after they almost collapsed catastrophically in 2020. So you see this froth and ferment and at the same time a real economy can only ascribed as limping sideways. Wages have been flat for decades. Thank goodness, they’re rising a little bit now, but not fast enough to keep up with the price inflation that we’re seeing.

Christopher Leonard (01:01:56):
You can go on and on about the fragility of our supply chain, which has come into direct view and just the falling behind of the middle class. So the Feds policies help describe the mechanics behind this strange environment in which we find ourselves. And so what happens next? The long crash I’m talking about, refers to the idea that after a financial crash, you have very weak growth and that is exactly what we were seeing in 2010, when quantitative easing really began. And rather than grow our way out of it, the Fed tried to flood the system with money to stimulate our way out of it. Ultimately, that program only encouraged stock buybacks, mergers and acquisitions, a run in these debt markets, didn’t do much for the working class. We have now doubled down on that again to avoid the catastrophe of these lower asset prices after March of 2020.

Christopher Leonard (01:03:01):
So now the Fed is in a real bind. It’s like getting squeezed in a vice in the sense that it keeps upping the money supply to calm down asset markets, and keep asset prices high, and make it look like everything’s normal, and that works fine as long as you never have to pay the bill. One of the big problems with price inflation is that it can be very destabilizing economically, it’s really hard on working class people if wages don’t keep up, which they’re not doing today. But maybe even more worrisome is the triggering effect that price inflation could have on the Fed. In other words price inflation is right now forcing the Fed’s hand, they are going to have to tighten much more quickly than they would otherwise want to. This balance sheet of 9 trillion I just talked about, or I think it’s 8.8 trillion right now.

Christopher Leonard (01:04:02):
If you had the job of winding that down, you would want about five to 10 years to do it. You could kind of normalize over five, 10 years, the Fed’s not going to have five or 10 years. So what that means is as they raise rates, as they withdraw the excess cash from quantitative easing, we’re going to have to face the reality that markets will rationally readjust themselves to a new reality of higher rates and less excess cash on Wall Street. And time and again we’ve seen that that reality looks like a retreat from risk assets, a drop in the value of com collateralized loan obligations, which are built on leverage loans and vehicles like that. Another way of putting that is a wrenching downward adjustment in asset markets. So that’s the pressure where the Fed is today is how do you navigate these waters where you’re forced to raise rates, but you can’t do it without crashing the economy.

Trey Lockerbie (01:04:58):
Now you end the book by stating that there are a lot of bills yet to be due, we’re talking about trillions now. Is a crash the worst thing in your opinion and do you think there’s any change in the Fed’s policy, once they fully lose control of the narrative especially around inflation?

Christopher Leonard (01:05:19):
A crash is terrible and terrifying and awful. I’m 46, I’ve lived through two of these so far, two century floods financially, one in ’08, one in 2020, it’s absolutely brutal. High unemployment is absolutely brutal. And so there’s nothing to be celebrated at all about the dilemma that we’re in, and there’s nothing easy about trying to get out of the position we’re in right now. So I do think that this hindsight is 2020, but the Fed should have restrained itself and shown more wisdom starting in 2010. The situation wouldn’t be as bad as it is today. But that being said there’s no easy way out of this position. And to me as a reporter key thing is just that people can understand how we got here, at the very least try to work from a common set of facts to understand how we got into this position, as opposed to this idea that Donald Trump bullied the Fed into doing something or now Joe Biden has ruined the economy. This is a systemic issue that’s been building for a decade, and I at least want to understand how we got here.

Trey Lockerbie (01:06:44):
I think it’s a great point about it seems to be no longer… people shouldn’t conflate it with a political issue. It doesn’t seem to matter who’s in power, like you said, it’s a systemic issue.

Christopher Leonard (01:06:55):
Yes.

Trey Lockerbie (01:06:55):
And my biggest takeaway from this book is what incredible foresight by Tom Hoenig, 10 years ago, my goodness. And what a righteous profile you display in the book to give him, I guess, more credibility than… or some credibility that he seems to be due. So fantastic book, I really enjoyed it. Christopher, where can people learn more you? Where can they find the book? And any other resources you want to share before we let you go?

Christopher Leonard (01:07:25):
Well, folks who are interested I’m Googleable or christopherleonard.biz, my site, and the book will be available in January from all your wonderful book sellers.

Trey Lockerbie (01:07:36):
Thank you so much again for coming on the show. I really enjoyed it.

Christopher Leonard (01:07:39):
Okay. Thank you so much.

Trey Lockerbie (01:07:41):
All right everyone, that’s all we had for you this time. If you’re loving the show make sure to follow us and reach out to us on Twitter. You can find me personally @TreyLockerbie. And if you didn’t know we’re also on YouTube, you can see a lot of these interviews with the video component there. And we are constantly innovating on the investorspodcast.com, where we have tools like TIP Finance and many others. Check it out and we’ll see you again next time.

Outro (01:08:06):
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