Bad Medicine

Washington Post ^ | October 5, 2008 | James Grant

[reaganaut1]

Low interest rates, easy money and malleable accounting rules are what plunged Wall Street into crisis. Yet it is low interest rates, easy money and malleable accounting rules that top the list of federal fixes. The unifying theme of the new bailout bill, all 451 pages of it, is the hair of the dog that bit you.

The unblinkable fact is that Americans own too much house. We overpaid and overborrowed, and many of us are "upside down," as the car dealers say. What to do? Recognize the losses and write them off. What not to do? Inflate the currency and debase accounting standards.

But inflation and debasement are the very policies being put in place. The Federal Reserve, not waiting for Congress, embarked last month on a radical program of money-printing. Reserve Bank credit -- the raw material of bank lending -- is growing at the year-over-year rate of 61 percent.

Credit creation is the Fed's signature crisis-management policy: Let a bubble inflate, then watch it burst; clean up with lots of dollar bills. After the stock market broke in 2000, then-Fed Chairman Alan Greenspan set about easing policy. In company with Fed Governor Ben S. Bernanke, the man who wound up succeeding him, Greenspan warned against "deflation." He vowed that this country would not sleepwalk through a decade of falling prices, as Japan had done. Rather, the Fed would push interest rates low enough to jolt the U.S. economy back into prosperity.

So it pushed the "federal funds rate" -- the interest rate that the Fed directly controls -- to 1 percent in mid-2003 and kept it there for a full 12 months. Here was a curious chapter in modern monetary history: Too little inflation was the problem, not too much, Greenspan and Bernanke insisted.

[reaganaut1]

I agree with Grant that the Federal Reserve's keeping rates too low for too long was a major cause of the housing bubble.

Goldman Sachs is predicting the Fed Funds rate will be cut to 1% in 2009 http://www.freerepublic.com/focus/f-news/2097002/posts , and the market is already pricing in a 0.5% cut to 1.5% at the October 29 meeting http://www.bloomberg.com/apps/news?pid=20601103&sid=av6n4Ox5e9XA&refer=news . I fear that we will soon be inflating another bubble. Maybe the Fed does need to cut rates, but it will need to be more aggressive in taking rates back up than in the last cycle.

Congressman Paul Ryan (R.,Wis.) has proposed repealing the Humphrey-Hawkins Full Employment Act of 1978 and restoring the Fed mandate to a single goal of low inflation http://www.house.gov/ryan/speeches_and_editorials/2008speechesandeditorials/5108WSJ.htm .

Ron Paul wants to reinstate the gold standard . I don't think it has a chance of happening, but it seems less absurd than it did ten years ago.

I don't know how the monetary system should be changed, but it clearly has not been working well.

[HarleyD]

The Federal Reserve, not waiting for Congress,

I smell a RAT. The Federal Reserve might not have waited to start printing up the money, but there can be NO DOUBT that this was contrived by this Democratic Congress and a lack luster Presidency. They're just trying to make excuses for when this thing fails to blame it on Bush and McCain.

[LiberConservative]

All “credit” is evil. Credit assumes that the borrower and lender both can predict the future.

[supercat]

All “credit” is evil. Credit assumes that the borrower and lender both can predict the future.

So should people not put money in banks? The only way banks can function is by using deposits to make loans. Without borrowers, banks would have to charge holding fees for money rather than paying interest.