What's Causing the Turmoil in the Markets?

In a nutshull the Federal Reserve has short term interest rates pegged too high. With the Fed Funds rate at 5.25% and low inflation the financial system is stressed and getting more stressed every day. A 5.25% Fed Funds rate in a low inflation environment is simply too high for the economy.

Currently I am earning just about 5% in a money market fund with no restrictions. That's just too high a rate of interest in an economy with low inflation.

While I'm being paid 5% for the use of money, whoever the financial company that is paying me that interest is loaning my money back out to in order to earn a profit has to pay a much higher rate of interest. The financial company must charge enough extra interest to not only pay me the 5% but also to cover their expenses and to make an acceptable rate of return for bothering to do the business.

So whoever is borrowing the money from the financial company has to pay well above 5% interest short term for doing so. In a low inflation environment it's just too hard for the borrower to pay back such a high rate of interest. Only the most profitable businesses and most capitilazed individuals can afford to pay such high rates of interest.

As the higher rates have made their way through the system an increasing number of businesses and individuals are defaulting because they cannot pay back such high rates in a low inflation environment. The Federal Reserve simply has interest rates too high given the inflationary environment of our economy.

Back in 2003 the Federal Reserve had the Fed Funds rate at 1.00% and that was too low a rate for the economy. Today they have the rate too high at 5.25%. So where should the rate be? Obviously somewhere between 1.00% and 5.25%. If we split the difference we end up with 3.125%, which is certainly in the ballpark for a low inflation environment. At that rate businesses and individuals would have a far easier time paying back their loans plus interest and the default levels would be much lower and likely not rising at a rapid pace.

If the Federal Reserve injects massive amounts of liquidity into the system, inflating the money supply, they will cause inflation. With higher levels of inflation it would be easier for businesses and individuals to pay the higher interest rates. But inflation causes all kinds of other problems and that is not the right solution. The problem is the high level of interest rates given the inflationary picture in the economy today.

The Federal Reserve should cut the Fed Funds rate and do it sooner rather than later. But the problem is that for the most part the same people who lowered the Fed Funds rate to the too low 1.00% level and then massively increased the rate by 5.25 times over a short time frame are the ones trying to figure out what to do.

The solution for the market turmoil and economy is relatively simple and easy to see but having to rely on such people to suddenly start shooting straight after having missed the target so many times is problematic for the economy and the markets going forward.