Did the Fed Overdo the Rate Hikes?

I still have my concerns about our markets, as inflation continues to grow and the economy has slowed drastically since the last quarter. If we assume a lag of 6 months of 6 hikes the way the fed has been ratcheting up for 17 consecutive brutal sessions since mid 2004, then it it possible that the numbers we got last week are an indication that the Fed did indeed start to overdo it somewhere around the September rate hike and may have overshot the mark by 6/17ths, let's call it 30%.

The Fed dropped rates from Jan '01 through June '03 but took long pauses between moves from 1.75% in Jan '02 to 1.25% in late '02 and then waited and hoped that would do the trick all the way to June '03 when they dropped the final 1/4 point. The economy was already getting in gear around April of '03 where the ridiculously low rates (Fed was too loose) sparked the famous "housing bubble" which drove, for example, TOL up from $10 in April '03 to $58 in July '05.

So the Fed dropped rates from 6% in Jan 2001 all the way down to 1.25% in Nov 2002 and there was no real effect (granted we were still freaked out from 9/11) for 12 more months. If 12 months is the standard lag time, we are screwed but let's assume it's 6 months and that they overshot by about 1.25%.

That means the correct rate should be about 4% and the current rate is 30% too high already. That means consumers are paying 30% too much for credit, for cars, for homes, etc. and, on the other end of the coin, it means banks and corporations (who currently hold almost $1 Trillion in cash) are being overpaid for money in the bank, keeping it from being put to work properly.

The Fed fund rate was 1.75% or less from December 11th 2001 through November 10th 2004 and the markets turned up in Q2 '03, 18 months after a 50% rate cut. The fed has given us 2 50% rate hikes in the past 18 months so if they are as wrong now as they were in 2003, they may have gone way too far already.

While I'm certain we have the ability to adjust to these rates over time (rates were between 5% and 6% from 1995 through 2000 while the markets doubled and were up from 3% in 1992) I think this latest round of hikes was done more out of fear (fear of terrorism, fear of a dollar collapse, fear of consumer debt) than out of good monetary policy.

As I said Friday, inflation is far from dead and there is not much the Fed can do about it as the US is no longer most of the world economy. Cutting back on US consumption of resources only makes them cheaper and more attractive for booming Asian economies and we are more in danger of being outproduced now than we were when we first got paranoid about Japan in the '80s.

I think the general problem is that the guys who are making monetary policy mainly got their degrees during the cold war when half the world was communist and Europe was still rebuilding from a war. The "hipsters" like Bernanke grew up in the 60s when the US was still the world's economic engine and their schools taught them it was all up to us to run the planet.

Although I feel like Galileo trying to explain that we may not be the center of the universe, I think we need to adopt a more realistic world view in setting economic policy, perhaps put the guys who wrote Freakonomics in charge of the Fed, we certainly need some new blood!