"The Federal Reserve announced a half-percent cut in the targeted fed funds rate — not unexpected given the Fed's need to support the banking system, currently under stress from the collapse of the real estate bubble. Step back for a minute, however, and consider the bigger picture.
The current crisis is a result of the Fed allowing money supply to grow, post 2001, at a faster rate than the increase in national income (output). This has a fourfold effect:
Inflation. Prices rise as more money chases the same quantity of goods. Savings decline. Investors receive less interest and their capital is eroded by inflation. Asset prices rise. Investors buy real assets as a hedge against inflation — and in anticipation of price increases due to inflation. Debt rises. Cheap money attracts new borrowers who compete to buy the now scarce real assets, further forcing up prices (as in the current real estate bubble). Unfortunately expectations of further price increases soon become entrenched. There is no self-moderating mechanism in the market to bring rates and assets back to a happy equilibrium. In fact, the opposite is true. Expectations of price increases become self-reinforcing, attracting further speculators to the market and driving up prices faster and faster. As any stock market chartist, economist or biologist will tell you: no self-reinforcing cycle can last. The market has to collapse when it runs out of new speculators to attract or when existing speculators attempt to cash in their paper profits. Like a giant Ponzi scheme, it can only end in tears.
The danger is that the further the Fed allows rates and prices to stray from their true equilibrium, the greater the hardship required to bring them back. Like a bushfire, the conflagration can easily get out of hand, taking on a life of its own. Yet we are assured not to feel concerned. We are in safe hands. The problem is under control. And the experts have come up with a simple (and painless) solution: just increase the money supply and the problem will go away.
The problem is not a failure of the market. The problem is the absence of a free market. Rates have been distorted by the Fed (and other central banks) for so long that the free market cannot function to establish an equilibrium interest rate that matches supply and demand. So the economy is condemned to perpetual boom and bust cycles, with all the hardship that that entails."
