I was listening to NPR this morning on my way to work. They had an interesting segment on how to save the financial system (The story can be found in written form here).
The first part of this story is really what we all already know – we are going to pay for being so indebted. Nationalization and socialism is just around the corner. Obama will raise taxes. Our debt burden will slow down the economy and make life quite difficult.
The section called “Twin Peaks” is what really fascinated me . The point is that there are two moments in US history where our debt levels have been equivalent to 100% of the GDP – 1929 and 2007. This is not happy news.
We are in massive debt just like we all were in the 1920s. Who let us get here? To put it simply, the Federal Reserve. We have been operating at record low interest rates since 2001. Now the interest rate is around 0%. That means that credit and lending have been super cheap. Cheap enough to cause market distortions that would encourage us all to borrow more than we could afford.
In the late 1920s the Fed knew the interest rates were too low but did not raise them quickly enough. Credit was too cheap and the country was in too much debt. The following is taken from http://eh.net/encyclopedia/article/Smiley.1920s.final:
By early 1928 the Fed was again becoming worried. Stock market prices were rising even faster and the apparent speculative bubble in the stock market was of some concern to Fed authorities. The Fed was also concerned about the loss of gold and wanted to bring that to an end. To do this they sold securities and, in three steps, raised the discount rate to 5 percent by July 1928. To this point the Federal Reserve Board had largely agreed with district Bank policy changes. However, problems began to develop.
During the stock market boom of the late 1920s the Federal Reserve Board preferred to use “moral suasion” rather than increases in discount rates to lessen member bank borrowing. The New York City bank insisted that moral suasion would not work unless backed up by literal credit rationing on a bank by bank basis which they, and the other district banks, were unwilling to do. They insisted that discount rates had to be increased. The Federal Reserve Board countered that this general policy change would slow down economic activity in general rather than be specifically targeted to stock market speculation. The result was that little was done for a year. Rates were not raised but no open market purchases were undertaken. Rates were finally raised to 6 percent in August of 1929. By that time the contraction had already begun. In late October the stock market crashed, and America slid into the Great Depression.
If you want to blame someone, then blame the Federal Reserve. The Fed has distorted the credit market by keeping interest rates artificially low and the money supply artificially high through a combination printing fiat money (money that is worthless) and fractional reserve banking. This intervention in the free market has caused many speculative bubbles that are now all bursting (dot.com bubble, housing bubble, the list goes on) and crashing our economy. Had the free market been left to work, lending would have slowed long ago under higher interest rates. This would have at least lessened these bubbles if not stopped them altogether.
If you really want to help, then End the Fed so this will hopefully not happen again.
