The Great Depression Online

Great Depression Online Archive Issue:

What Were They Thinking?

Great Depression Online
Long Beach, CA
March 19, 2010

Inside This Issue You Will Discover…

*** One Was Against It
*** Encouraging People to Do Really Stupid Things
*** What Were They Thinking?
*** And More

One Was Against It

The Federal Reserve met earlier this week.  No surprises.  Just another vote allowing banks to continue lending money to each other for practically free.

“The Fed held its target range for its bank lending rate at zero to 0.25 percent,” reported AP, “where it’s been since December 2008.”

Though one Federal Reserve Bank President was against it…

“The Fed’s decision to keep record-low rates for an ‘extended period’ -- thought to mean six more months -- again drew one dissent.  Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, for a second straight meeting opposed keeping the pledge.

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“This time, he expressed concern that low rates could cause a buildup of ‘financial imbalances’ and put the economy’s stability at risk.”

Low rates, it is thought, provide a boost to the economy by encouraging debt based spending.  Maybe so, but they discourage savings and sacrifices long term capital formation.  Moreover, those who disparage debt, and save their money, get tiddlywinks in return. 

Then there are the speculators, who borrow money on the cheap and buy anything and everything that’s going up.  For a time everyone thinks they’re geniuses.  But before long a new asset bubble’s formed.  The speculation game works great, of course, until just the moment it doesn’t.  Then there’s a crisis.

According to Lakshman Achuthan, managing director of Economic Cycle Research Institute, Hoenig’s right…

“Easy money is a key ingredient of crazy bubbles,” said Achuthan in a recent CNNMoney article.

Encouraging People to Do Really Stupid Things

Booms and busts are part of the business cycle.  Like night and day, one follows the other.  Yet when the money supply’s stable the boom can’t run up as much and the bust can’t wreak as much collateral damage.

But when the Federal Reserve spikes the punch bowl with cheap money, there’s no telling what’ll happen next.  One thousand square foot California bungalow houses built in the 1920’s sell for a million bucks.  What’s more, tech stocks with no earnings go for $100 per share.

Who would buy at such absurd prices?

Only someone who’s brain has been soften and heart has been warmed by the allure of cheap endless credit…and prices that always go up.  To put it another way…

“We know from history,” says Barry Ritholz, CEO of Fusion IQ, “that really cheap money encourages people to do really stupid things.”

What Were They Thinking?

The federal funds rate has been at practically zero for 15-months, so where are the bubbles?

At first glance, they’re nowhere to be seen.  The stock market’s still well below its October 2007 highs…not that we think it’s a buy at the moment.  Housing’s going nowhere.  And while gold and oil are up, they don’t seem to be melting up at a breakneck pace.

Quite frankly, even with the low rates, credit’s still tight, consumer spending’s still hesitant, and employers aren’t hiring.  So, again, where are the bubbles?

Yet when we broaden our horizon to beyond just asset prices, our eye’s pop out and our chin drops in shock.  For there is one very big elephant in the living room…it’s grotesque…and absurb…and it’s puffing up and expanding ever larger by the second.

The bubble we’re talking about is public debt.  Here’s what we mean…

In 1980, the public debt hit $1 trillion dollars.  Ten years later it was at $3.2 trillion dollars.  By 2000, it topped $5.6 trillion.  And from there it has gone practically vertical.  In fact, this year it should reach $14.4 trillion and by 2014 it’s estimated to top $18.3 trillion.

We wish we were making this up; but we’re not.

No bubble expands for ever…eventually they always pop.  Only then will the ultimate consequences be realized. 

Alas, one day historians will look back in awe and wonderment, and they will ask – What were they thinking?


M.N. Gordon
Great Depression Online

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