Yesterday, I pointed out the dwindling power of the Fed to stop recessions and deflation. The day before, I pointed out the financial industries inability to capture the upside of the Fed cuts in the short term since they have a severe funding crises. Today we’ll take a closer look at the unintended consequences of the Fed’s rate cuts for the past decade. Disclaimer: This is more of an opinion based on research, that won’t be discussed here, than a true analysis.
Here is the chart of the federal funds rate again:
First, a look at the 1990s. After the S&L Crisis (Savings and Loans Crisis) interest rates went up, but not to previous historical levels. We can thank Greenspan for that. Throughout the 90s we saw sustained low interest rates that failed to curb unproductive economic development. By not doing so he created what is known as an “asset bubble.” This bubble was concentrated around the Technology Industry. Here is what an asset bubble looks like and the subsequent collapse, or “bubble burst:”
I am not claiming that the Dow or S&P 500 will lose that much value. This is just for illustrative purposes.
Instead of letting the financial system weed out inefficient firms afterwards by lifting interest rates after the dot-com bubble burst, the Fed instead chose more inflation. This time it came in the form of Real Estate. During the period of 1.00% interest rates, the Real Estate industry began to push all forms of exotic mortgages to unknowing borrowers that could not pay back their debt. Add the “Income Effect,” where home owners view their income increasing due to rising home prices, and you get a perfect excuse to spend more money than what you are making. In fact, for the past decade real GDP has grown by 2.9% annualized while consumer spending has grown at 3.6%. The extra spending started around a little before 2001 and has since then added an extra $3 trillion to the economy that was never earned. So every time you hear Wall Street mention this being a “consumer led” recession, don’t believe it. In truth, Wall Street has been prospering on the backs of the American consumer. The collapse of the “income effect” is due to Wall Streets massive speculation on Mortgage Backed Securities. The coming crisis is what happens when years, I repeat: years ,of growth in the financial sector are lost.
And now we have the outcome of two massive bubbles, created in part by the Fed, coming down at once with a multitude of other problems. To hear Jim Cramer’s take on this, refer to my previous post and listen to his 45 minute speech, touching partly on the defunct fed, the failures of capitalism, and the two asset bubbles.
The question shouldn’t be whether or not we are going into a recession, but rather: How much of that 3 trillion are we going to lose? For generations, Americans spent more for a couple of years then paid back their debt. In recent history the cycle has broken. I’m betting on the cycle returning in the recent future.
