With his latest interest rate cut Alan Greenspan adds additional fuel to the
fire burning away the foundation of a U.S. economy that has already been weakened
by too much debt and too little savings and production.

During the Fed-created boom of the 1990’s, many investments were made based
on false signals which the Fed’s easy money policy sent to the markets. By
lowering interest rates and expanding money supply, the markets responded as
if true savings had been increased, and time preferences for money had been
extended. In addition, as foreigners temporarily diverted their savings into
U.S. assets, additional false signals were sent to the markets, enabling further
malinvestments.

When the equity bubble burst in 2000, the market began cleansing itself of
the excesses of the boom. However, Greenspan’s irresponsible rate cuts interfered
with the market’s natural corrective process by postponing liquidations and
creating additional misallocations of capital. The recession, in actuality
the cure for the illness that infected the economy in the 1990’s, was cut short
by the Fed, allowing the disease to spread throughout more sectors of the economy,
particularly housing. In its efforts to mask the symptoms, Greenspan has done
irreparable harm, as the disease is now so advanced that it may be terminal.

Cutting rates is part of the problem, not the cure. In order for the economy
to truly recover interest rates need to rise, more businesses need to fail,
individual balance sheets need to be repaired, capital needs to be re-allocated,
bad debts need to be written off, investors need to lose even more money, real
estate prices must be allowed to fall, and workers need to be laid off (human
capital needs to be re-allocated to more productive uses as well.) All of the
preceding may sound harsh, but that is what needs to happen and that is what
will happen. The Fed cannot stop, but merely postpone, this process, and in
so doing make the ultimate correction that much more severe. The same holds
true for the Federal government, as more deficit spending will only delay and
exacerbate the problems. Moreover, if the Fed persists on this course to its
ultimate conclusion, hyperinflation will destroy the dollar, leading to problems
of far greater magnitude than those listed above. And based on the bond market’s
reaction to last week’s quarter point rate cut, the Fed might be forced to
get “unconventional” sooner than it thinks.