Monday, August 27, 2007

James Grant on the the Fed's Past Monetary Profligacy

Barry Ritholtz at the Big Picture directs us to an article in the NY Times by James Grant of Grant's Interest Rate Observer. Many excellent points are made in this piece, but I would like to call special attention to the following paragraph that highlights how the Fed's misguided fear of deflation in 2003 contributed to the mess we are in today:


... Under Mr. Greenspan, the Fed set its face against falling prices everywhere. As it intervened to save the financial markets in 1998, so it printed money in 2002 and 2003 to rescue the economy. From what? From the peril of everyday lower prices — “deflation,” the economists styled it. In this mission, at least, the Fed succeeded. Prices, especially housing prices, soared. Knowing that the Fed would do its best to engineer rising prices, people responded rationally. They borrowed lots of money at the Fed’s ultralow interest rates.

Now comes the bill for that binge and, with it, cries for even greater federal oversight and protection. Ben S. Bernanke, Mr. Greenspan’s successor at the Fed (and his loyal supporter during the antideflation hysteria), is said to be resisting the demand for broadly lower interest rates. Maybe he is seeing the light that capitalism without financial failure is not capitalism at all, but a kind of socialism for the rich... Jiggling its interest rate, the Fed can impose the appearance of stability today, but only at the cost of instability tomorrow. By the looks of things, tomorrow is upon us already.

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