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How the Federal Reserve Created the Recession and How International Central Bankers are Making the Same Mistake

By: Steve Johnson

6/8/2009 - 33 Comments

The goal of the Federal Reserve is to stabilize the economy, yet it has become apparent that their actions have only distorted the markets, creating booms and busts.

The primary tool by the Federal Reserve is its control over the Federal interest rates, which are used my all banks to borrow money.  Control over bank interest rates makes the Federal Reserve a Central Bank.  Central Banks are found in many counties although it has been a long standing debate as to whether a central bank is necessary.
If a government is willing to trust the interest rates that are set by the market, then a nation has no need for a central bank.

How The Federal Reserve Manipulates the Economy

The problem is when Central Banks act to manipulate their economies for short-term reasons like to pay for a war or for political gain.  These short-term decisions to lower the interest rates to juice the economy have tremendous power in boosting the economy. 

The side effect is that businesses are misguided into bad investments.  Many businesses are created out of the boom that are not sustainable, yet that appear like good investments at the time. This is how nations over build houses and automobiles - we just did in the last decade.

The longer that interest rates are held lower than market rates, the more bad investments are made.  The bust comes when the people begin to run out of credit to purchase the products that were over produced.  This tipping point is the beginning of a recession and the beginning of the realization that many of the businesses during the boom yaers have been over invested in and are unsustainable (like GM).  

The recession that we face today is a direct result of the artificially low interest rates of the last decade that the US Central Bank used to juice the economy. 

Global Central Banks are Making the Same Mistake

The only way to fix the problem is to allow the bad investments to clear the market (let businesses fail) and then set the interest rates back to rates that are supported by the market – driven by profit and loss risk dynamics.  But, instead of letting that take place, the US Central Bank has lowered the interest rates once again to near zero – and global Central Banks have followed. 

It’s like when your car starts to slip on a patch of ice and you over correct the problem by turning the wheel too hard in the opposite direction only to realize that your car is now slipping even more in the other direction, at which time to turn the wheel even harder in the other direction and end up rolling over in the ditch.  The second correction only made the problem worse than your first correction, just as the Central Banks are doing. 

It’s time to abandon political party politics and find someone that can steer the economy back onto the road by letting go of the wheel before we end up in the ditch with the nation in total collapse.

Senator Ron Paul is the only politician who seems to understand the damage that the Federal Reserve has caused and that should be enough to listen to what he is saying.

Obama needs to abandon his political agenda and focus on long-term solutions to the economy.  We needs record spending cuts rather than record spending increases.   If he does not change direction soon, Obama is going to lead the nation into a Depression.

If the Fed continues to ignore the warning signs and carry on inflating the money supply, the risk of hyperinflation becomes severe.  A deep recession is the only solution to the problem created by the Federal Reserve, to flush the bad businesses down the drain and allow new businesses to be built on predictable consumer demand. 

This unnational disaster that is desperately needed is not politically popular to say the least, but is essential to rebuild the economy.   But instead of facing a very bad recession caused by failed monetary policy, we have spread the fiscal madness around the world like a plague - leading the entire world into a sea of inflation.

Great Danger Is Just Ahead

Great danger is just around the corner for America and the rest of the world who have followed us into the snake pit of hyperinflation.  Inflation is not like other economic problems that can be rationally dealt with.  Inflation is not controllable and is very difficult to face. 

Inflation is like trying to stay standing during an earth quake, when the ground under your feet is shaking.  Inflation removes the most fundamental constants of an economy in stable prices.  Unstable prices leads to unmanageable accounting, by governments, businesses and individuals.  No one can calculate the cost of goods or services in an inflationary economy – because they are constantly changing.


This week I participated in several blog carnivals

They did an excellent job and as usual, there are tons of great articles. If you have the time, I highly suggest you skim through this week’s carnivals.

Carnival of Personal Finance: Vacation-time edition

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The Case Against the Fed

This book, written by Murray Rothbard, an economist and historian of fairly well known repute, is a scathing attack on not only the Federal Reserve, but the interests that created this institution. Rothbard explains how the Federal Reserve is the true source in the destruction of wealth, which has led to the destruction of the middle class and continues to sift money into the hands of the wealthiest.

What Has Government Done to Our Money?

Rothbard gives us an exceptionally clear, detailed description of what money is and how it has come to be manipulated by governments and central bankers into almost worthless inflationary fiat paper currency. He then explains how gold became the most respected and trustworthy currency of choice and the prospect of either hyperinflation or the greatest depression the world has ever seen may be arriving in the very near future.

The Revolution: A Manifesto

Dr. Ron Paul's THE REVOLUTION: A MANIFESTO is a concise and convincing argument for a return to America's libertarian principles. But the best and most important chapter, without a doubt, is Chapter 6, "Money: The Forbidden Issue in American Politics." Here Dr. Paul details the operations of the Federal Reserve System in stunning clarity. You see, the effects of inflation are not uniform -- the Fed System works as a wealth redistribution system from poor and middle-class to the rich and politically connected. This is the true cause of the increase in inequality and the diminishing middle class.

Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse

In discussions of today's economic meltdown and what to do about it, the Federal Reserve is a stealth helicopter: it never shows up on the radar. With the exception of a few esoteric specialists and those Ron Paul Revolutionaries who burst into chants of "Abolish the Fed!" Historian Thomas Woods notes in this important book, the Federal Reserve bears a large part of the blame for the mess we're in. In the first part of "Meltdown," Woods shows how both in theory and in practice, Fed policy fueled an artificial boom and is now leading us to a much larger meltdown.