How the Fed creates bull and bear markets (part 2)

There are some economists who overestimate the effect of loose money and credit in creating market crashes.  While they correctly identify loose monetary policy as a prime contributor to a financial market bubble, they ignore the devastating impact of a subsequent tight money policy.  Loose money doesn’t cause a market crash by itself; it’s the combination of loose money followed by tight money and credit conditions which serves as the catalyst for a crash. 

There is an “X-factor” to all of this, however.  While there is no sign of monetary policy tightness on the Fed’s part, there is what might be called “policy tightness” by the world’s leading governments, including the U.S. Congress.  Fiscal austerity current reigns supreme among U.S. and European governments and it could eventually prove detrimental to the Fed’s efforts at continuously flooding the system with liquidity.  As Dr. Scott Brown of Raymond James has said, fiscal tightness amounts to a “self-inflicted restraint on growth” and that amounts to “very bad economic policy.”  It also explains why, despite record levels of liquidity, the economy has been able only to tread water in recent years while financial markets have soared to new heights. 

Could it be that austerity will ultimately prove to be the catalyst that kills the recovery?  The question remains unanswered but with the downward pressure exerted by next year’s 120-year Kress cycle bottom, a failure of Congress and other governments to admit that austerity has been a failure could prove fatal.