The Federal Reserve and the Manipulation of Credit
Originally written on March 10. 2009.
What is credit? Webster defines it as the “reliance on the truth or reality of something”. Simple enough. The Federal Reserve controls the supply and creation of money and credit in the United States. Credit creation is defined as the “collective abilities of lenders to make money available to borrowers”. The Federal Reserve, through its monopoly power over interest rates, is able to control the flow of credit. When interest rates are lowered, banks can borrow funds from the Fed at cheaper levels in order to lend it more easily to its customers.
The manipulation of interest rates is an important topic to understand today’s economic climate. For better or worse, the concentrated group of bankers that is the Federal Reserve dictates all monetary and credit policies. Over the past decade the Fed has kept interest rates at particularly artificial low levels in order to boost and stimulate the economy. But, lowering interest rates doesn’t just “stimulate” the economy. It cheapens money for banks to borrow. When the Fed lowers rates to levels that the market wouldn’t normally allow, it builds up a manipulated situation of wealth and credit, which then creates an artificial, short-sighted opportunity for people. While this may create a fantastic situation for the economy in the short-term, the bubble always bursts.
The subprime mortgage escalation that we saw over the past decade would not have been possible were it not for the Fed’s control over interest rates and therefore control of credit. Ordinarily, banks would not have had the capital to continue lending ridiculous loans to people who certainly could not afford them. However, when interest rates are kept low, the artificial creation of credit allowed banks to continue the unsustainable process much longer than the regulatory forces of the market would naturally allow. So, while the printing of money out of thin air is what causes the monetary inflation problems; it is the Fed’s control and manipulation of credit that allows banks to go down the road of unsustainable, irresponsible business decisions without immediately feeling the effects as they would in a free market.
The federal government’s role in this cannot be downsized, either. Primarily through Fannie Mae and Freddie Mac, the government supported the subprime loans and loans in general to people who normally couldn’t afford a loan. While this may be a worthy cause, intervening in the markets will not come without its consequences, usually over the long-term. Whether it comes from the government or a central bank, it is not possible to make the market more “fair” or level out the playing field, so to speak, with interventionist policies. Through cheap credit and government backed loans we have gotten to where we are today.
Just as money can’t be printed out of thin air without having substantial negative effects on the currency, neither can credit be artificially created without it coming back to bite the very hand that fed it. Today, the same path is being followed. The Fed has announced a new program “aimed at boosting the availability of credit to consumers and small businesses.” It seems that the Fed is either unable or unwilling to learn from its past mistakes that brought us here in the first place.
The Fed’s new program will “spur consumer lending” by loaning up to $200 billion, hopefully enough to dupe people into thinking they can once again afford things they thought they couldn’t before. Common sense will tell us that creating more cheap credit will not solve a problem created by cheap credit in the first place.
The problem with the government and Federal Reserve is shortsightedness. The short-term spending and performance of the economy is all they seem to pay any attention to. Therefore, the fed and the Fed (that is my cheap attempt at a pun) do what is in their power to get the economy stimulated for the next quarter, or focus on the next week’s unemployment numbers, rather than stepping back and look at what makes a sustainable economy.
Short-term spending is not what creates a prosperous and sustainable economy. We should be able to know this by now after everything we’ve gone through, but the constant federal and central interventions discourage people from looking at the larger scheme of events. We’re lead to believe that it’s okay for us to go deeply into debt and buy loans that we can’t afford, because the government is “backing” those loans. After the government and Fed’s relentless pursuit to prevent businesses and homeowners from failing, I have a hard time believing that people are going to come away from this crisis understanding the principles and benefits of individual responsibility and hard work.
Saving and investing are what sound economies are based upon, not spending. Rather than constantly spending money in the short-term on items that really are unnecessary and even irrelevant to our personal lives, as the government and Fed encourage, it is through wise saving and investing at one’s own discretion that funds are built up for children to go to school, for houses to be built, and have a sustainable lifestyle that will benefit the economy for years rather than quarters.
While saving and investing may not create an immediately noticeable effect, they will do far more in creating a sustainable, truly prosperous economy over the long run. Focusing on the short-term results and disregarding the long-term aspects of decisions played a major role in the messes that both individuals and governments around the world find themselves in today.
Credit cannot be created nor cheapened by a central bank sustainably over the long-term, as hard as it may try. True and sustainable credit is built from a strong reputation built on the foundations of living within one’s means, saving, investing, and at the heart of it, having a long-term focus. The laws and abilities of the free market are what promote these key qualities for the prosperity of both people, and nations. Federal and central control, manipulation, and intervention promote the opposite: a spending economy, a short-term focus, and living beyond one’s means in order to achieve greater wealth in the short-term, as unsustainable as it may be.
Let us solve our current problems not from more of the same, but a return to the principles of personal savings, hard work, and individual responsibility.