The cycle of artificial booms and busts described in Part 2 of this series happened under the Clinton and Bush presidencies. In the early 1990s, the Funds rate was 8%. By 1993, the year of Clinton’s infamous tax increase, the Funds rate was in the 3% range and the Funds rate stayed in the 4-5% ballpark for most of the 1990s. The artificially low interest rates were the source of that decade’s economic boom–not Clinton’s tax increase or the GOP’s “Contract with America.” In 1999, the Fed raised the Funds rate into the 6% range in response to the sky rocketing prices and, by March of 2000, the 1990s boom collapsed. The economy went into a recession.
Rather than allowing the market to completely crash in response to the artificial boom of the 1990s, the Fed doubled down on the money creation and lowered the Funds rate to 1%. The low Funds rate led to low mortgage rates. The low mortgage rates and growing money supply created a housing boom (along with government incentives that encouraged home ownership and relaxed lending standards). When the housing prices inevitably skyrocketed, the Fed again increased the Funds rate to 5%, the housing bubble collapsed, and we were left with even bigger debt and less resources.
Below is the Funds rate from 1989 to the present. Notice that the 2000 and 2008 recessions start shortly after the Funds Rate was raised.
Here is the growth in the money supply from 1980 to present. The blue line is the monetary base created by the Fed. The green line is the amount of bank credit created by our fractional reserve system. Notice that the amount of bank credit more than doubled from 1990 to 2008.
Below is the Funds rate in relationship to the 30 year conventional mortgage rate. Notice the nearly identical pattern.
Here is the Funds rate in relationship to the S&P 500 Stock price. Notice again the nearly identical pattern (of course the Funds rate is too small to see the changes).
Here, you can see the Funds rate and the corresponding unemployment rate. Notice that a decrease in the Funds rate results in the subsequent fall in the unemployment rate. Similarly, an increase in the Funds rate results in the subsequent rise in the unemployment rate.
Finally, you can see the impact of the Fed’s manipulation of interest rates on Ohio’s economy.
Notice that Ohio’s GDP was growing in the late 1990s, took a dip between 2000-2001, took off again in the mid-2000s, and took another dip in 2008.
As a result, thanks to the Fed’s manipulation of interest in the 1990s and 2000s, our economy experienced two consecutive boom and bust cycles.
After the market collapsed in 2008, the general consensus is that there was not enough demand in the economy. Suddenly, due to tightening budgets, there was inadequate consumer spending in the marketplace to support businesses. Without consumer spending, businesses are forced to lay off employees. The supposed lack of demand is the reason for the various stimulus efforts by the Fed and Congress. The theory is that the money injected into the economy by the Fed encourages private spending in the market and the increased expenditures by the government substitutes for the diminished demand in the market.
The belief that our economic problems are caused by a diminished demand is completely wrong. When did we stop needing/desiring wealth to satisfy our needs and wants? After all, we need to consume at least food and water or we will die. And does anyone really not wish that they had a better standard of living? When we set aside all the economic jargon and use common sense, the idea that there is not enough demand in the economy is ludicrous. We all need and want more wealth. [Read on OCR: “Our Need for Wealth”]
The fact that there is not a problem of diminished demand is easy to see if you remove money from the economy. Without money, we have nothing to exchange with each other but our own produced goods and services. Thus, our production is our real demand. Money is just a creation of the free market to aid in the completion of business transactions when the two parties don’t want the other party’s produced good. Ultimately, even in an economy with money, it is still our production that pays for our consumption. We cannot consume wealth into creation.
After the 2008 crash, the problem with our economy was the inability to produce wealth. Our tools for creating wealth (savings, capital, and labor) were mal-invested during the artificial boom. What most people don’t realize (especially our politicians) is that those periods of fictional economic growth are the economically destructive periods. The economic boom is a disease. The necessary recession that follows is the cure! [Read on OCR: “The Forgotten First Tool for Creating Wealth”]
Like kids being forced to reduce the size of their castles, the point of the recession is to liquidate all of those bad investments and return savings, capital, and labor to the economy. The businesses that go belly up in the bust phase are simply wasting the economy’s limited resources of savings, capital, and labor in the inefficient production of goods and services. Those businesses need to go bankrupt so the resources can be reallocated to the efficient production of wealth. Moreover, wages and prices must freely adjust to the declining volume of spending for goods and labor as a result of the diminished amount of savings and capital.
Our economy is in such a long period of stagnation because government intervention is preventing the required liquidation. TARP and the various bailouts have simply allowed the inefficient and wasteful use of our limited resources to continue. The government stimulus programs and increased spending have merely seized more savings and capital from a private sector already suffering from a destruction of savings and capital. Unemployment benefits prevent the necessary fall in wages because the benefits create an artificial demand for wages higher than what employers are able or willing to pay due to the diminished amount of savings and capital. The artificially low interest rates maintained by the Fed discourage the needed accumulation of new savings. Finally, all of the Fed’s fresh money creation impedes the fall in prices, which is the cure to the contraction of the money supply circulating in the economy.
In short, the solution to our economic problems is the accumulation of new savings and capital. The quicker the accumulation of savings and capital, the faster the economy can start growing. The liquidation process speedily ends the misuse of savings, capital, and labor and returns the resources to marketplace. Of course, the more the government reduces its own spending, the faster savings also returns to the economy. Consequently, the actions of the government and Fed to prevent the necessary recession are delaying the economic recovery.
John Langenderfer is a practicing attorney with a focus in consumer and commercial law. He can also be reached on his Facebook page.
All opinions expressed belong solely to their authors and may not be construed as the opinions of other writers or of OCR staff.
NEXT IN THIS SERIES: APPLICABLE LESSONS FROM HISTORY. Check OCR tomorrow for the next installment of “Our Coming Economic Collapse.”
RELATED ON OCR: “Our Coming Economic Collapse, Part 1: Introduction”
RELATED ON OCR: “Our Coming Economic Collapse, Part 2: The Boom and the Bust”
READ ALL OCR articles by John Langenderfer here.