Why the Treasury bubble must burst.

[boneyard bill]

One wonders if it would have any effect on curbing inflation at all. The Prime was higher than 20% in the late 'seventies, yet thanks to Bretton Woods II we had massive inflation anyway. BWII and oil prices, that is--it would seem that despite all they taught us in school about the Fed's miraculous abilities to control and smooth out the economy, a price rise in one essential commodity can completely overwhelm them.

The Fed forced up interest rates in the late seventies to counter inflation. It did this by clamping down on money creation by selling bonds, thus reducing the bank's reserves. The Fed does not directly control any interest rate except the discount rate which is the rate that it charges for short-term loans.

The big run-up in oil prices had little to do with oil and a whole lot to do with Fed money creation. It was (and still is) a dollar surplus, not an oil shortage.

[boneyard bill]

I think the discussion is getting a little off the point. Interest rates will have to rise. The Fed isn't going to be able to prevent it. It they create more money, interest rates will rise, and if they don't create more money interest rates will rise.

But what is really important is the impact of this on large financial institutions because they hold a lot of T-bonds, and when these go down in value, the financial condition of these institutions will worsen. This is especially true of the big Wall Street banks, and these banks are not in very good shape as it is. So we're probably headed for a crash worse than 2008 and possibly much worse. It could also impact on the value of the dollar in international markets. It could cost the dollar its position as the reserve currency and the would likely lead to a drastic decline the dollar's value relative to other currencies. That would mean a significant decline in our standard of living as the cost of imports would sky-rocket.

We owe it all to the Federal Reserve, but it isn't to the mere existence of the Federal Reserve. While it is questionable that anyone is really competent to set monetary policy better than the market can, it is hard to imagine how anyone could have done a worse job of it than Ben Bernanke. The last thing we needed was another bubble.