What happens next?

This graph has many people concerned. Most of us have only a slight understanding of the Fed Funds rate. We know that the Fed likes to lower the (target) rate to help the economy, but eventually must raise the rate to prevent overheating. It’s one of the most powerful tools the Fed has at their disposal for influencing the economy. Indeed, that’s pretty much all anyone needs to know.

What is troubling is that since the 80s, the trend has been to cut to lower lows and raise to lower highs. The rate went high in the 80s to repair the reckless monetary expansion of the 70s. This was a prudent move by Volcker, but it created significant pain for many. Our economy is dependent upon the expansion of credit. In turn, we’ve become dependent upon lower borrowing rates to encourage the expansion of credit. Without credit expansion, our debt-laden economy implodes.

We are now at a limit for the effectiveness of this tool. Hitting this limit is not without consequence. Savings accounts do not provide any meaningful returns right now. More important, however, is the fact that unless the trend of lower highs is broken, this tool will not be available for the next economic crisis (the jury is still out on whether it was available enough for this crisis). While it makes sense to worry about the problems we have now, it is important to recognize that we may be sewing the seeds for a larger crisis down the line.

(source: St. Louis Fed: FRED Graph)