The second reason for our financial and economic problems: aggressive Fed tightening

The evidence suggests that we are going through this incredible crisis because of two main reasons: social engineering and Fed tightening. Yes, since 2004 the Fed has tightened aggressively to bring down inflation and harness the housing bubble. They made a huge tactical mistake and we are paying for it.

Greenspan encouraged the housing bubble by bringing interest rates down to 1% and discouraging Congress to regulate derivative products. The Fed then increased interest rates to levels high enough to cause a recession and precipitate a credit crisis.

Beginning in 2004 the Fed started tightening (click on graph to enlarge). Two things happened: interest rates went up from 1% to about 5% and the monetary base (the money banks can lend) started slowing down. Let me focus on the monetary base.

The long-term growth of the monetary base is close to 6%. This is the growth rate of stocks, GDP, profits, income, and all the major economic variables. By forcing the growth of the monetary base well below 6% from 2004 to 2007, the Fed purposely starved the economy (click on graph to enlarge). They tightened because of the fear of inflation. They forgot about a derivative bubble exacerbated by rising housing prices due to the social engineering policy of Congress. In other words, they tightened too much and for too long and at the wrong time. As they did in 1929!

So, what are they doing now? They are panicking! They are flooding the banking system with money, with the monetary base soaring at the incredible pace of close to 40%! Again, you should remember that the monetary base has grown at an average pace of about 6%. Now they are making it grow at a 40% pace, covering up a gross miscalculation. They should have stopped raising interest rates when they were 3%.

In other words, they acted as true bureaucrats. In spite of their PhDs, Nobel prizes, and academic achievements, they are reacting to the problems they created rather than attempting to anticipate them. This is the predicament of the bureaucrat. Why stick the neck out and be bold?

It is the curse of a country allowing bureaucracy to grow. The issue is not what should the ideal political system and political belief be. The issue for any country is the size and power of the bureaucrats on the payroll of the government.

More, much more when you read older posts and subscribe to The Peter Dag Portfolio by going to https://www.peterdag.com/.

George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977