As Of: May 15, 2001

Federal Reserve Panics

Interest Rates Lowered Another ½ Percent

      Having now made five cuts in interest rates over a very short period of time, the Federal Reserve is displaying, in an unprecedented manner, its concern for the health of the United States economy. It is difficult to describe the actions of the Federal Reserve as anything other than panic. After being credited with engineering an economic expansion of record duration, Alan Greenspan does not want to go down in history as the man who brought the economy to its knees because of his fear of "exuberance". Thus, the Federal Reserve is trying to undo with rapid fire ½ percent rate cuts what it took years of jawboning and 1/4 point rate increases to bring about -- namely, a slowing economy.

      While the focus has been on the actions of the Federal Reserve, the larger question has been ignored. Can the Fed turn the economy around solely by lowering interest rates? There is an argument to be made that our current predicament has to do with structural problems that transcend interest rates. Household savings have plummeted. Consumer spending has exceeded income. While private debt has been climbing, the government has been unnecessarily confiscating taxpayer's assets to generate a budget surplus which the government feels it can spend. Yet the United States is a debtor nation, dependent on foreign investment, and has a social security system that is in jeopardy. All of the recent spending for goods and services has been tilted toward foreign purchases which has created a huge trade deficit, and this has been supported by an exceptionally strong dollar. AGAINST THIS BACKGROUND, THE SOLUTION PROPOSED BY THE FEDERAL RESERVE IS TO LOWER INTEREST RATES AND ENCOURAGE THE CONSUMER TO KEEP SPENDING AND GO DEEPER IN DEBT???

      The Federal Reserve is lowering interest rates in a panic mode because it doesn't have many other tools at its disposal. To the extent that everyone is counting on the Fed to rescue us from a possible recession, it is making a visible effort to do what it can; but unfortunately this effort is without regard to the long run consequences. What happens if interest rates keep going lower and purchasing demand remains high and consumers go deeper into debt? If consumers and businesses do not constructively repair their balance sheets, there are only two possible outcomes: inflation or debt liquidation through bankruptcies. A short term boost to the economy from lower interest rates will only exacerbate the structural problems that have the potential to wreak havoc with far worse consequences than a mild recession.

      Some of the tipoffs to watch for are: long term interest rates remaining high or going higher, gold prices going up, loss of confidence in the dollar, a stock market that keeps going down in the face of interest rate cuts by the Fed, increasing unemployment, no recovery in corporate earnings, increasing bankruptcies and concern for credit quality. This latest rate cut by the Federal Reserve will encourage misplaced hopes and make people think that the economy's problems are being addressed, but there is no guarantee that this action by the Fed won't do more harm than good. I, for one, would feel much better if Congress and the Treasury would take the lead from the Fed and focus on the structural problems that need fixing.