The Fed lowered interest rates last week.

This was a mistake. They should have raised rates. They've been too low for too long as it is. Today, the Fed rate should be between 4 and 5%. Bumping it up to 1.5% would have been a decent move last week and it would have signaled that the Federal Reserve, and Ben Bernanke, finally get it.
There's a fundamental misapprehension of what the problem in our economy (heck the global economy) is. Hourly on the cable news networks we are reminded that the problem is a credit crunch, a lack of liquidity, a credit supply problem.

A credit supply problem? No. That's the misunderstanding. The supply of credit has correctly adjusted itself to the market as it exists today. The problem is one of credit demand. We want too much and the market has finally clamped down.

And the Fed and the governments of the world, with the US leading the charge, are intent on ripping the supply and demand balance open. We want what we want, and the market wants what it wants. The question that remains is who will win?

When business run their inventories in a Just In Time fashion, they become very efficient. When they try to apply that to their revenue, and, for example, take out loans in order to make payroll, it's a recipe for trouble.

What's going to kill us in this mess, isn't' the lack of credit. Once we re-establish some kind of financial discipline and live per our means, that will correct itself. We have to give up insisting on satisfying our credit addiction first--we'll see how long that takes. In the meantime, the steps we are taking to get a fix, are going to exacerbate other problems in the market. Inflation is the first among them.

Inflation is generally understood to be an increase in prices. This is not the case. High inflation can, in fact, be accompanied by lower consumer prices. Inflation is an increase in the money supply. When that increase, decreases the value of the money, then prices may rise--it take more, less valuable money, to pay for a commodity who's value has not changed. But all of this relative and commodity prices do change--so the two things, inflation and prices, are not tied together.

When Ben Bernanke made the statement that we "have the keys to the printing presses and we aren't afraid to use them" and did so in a public place in front of reporters, he announced that we were not concerned with controlling inflation. In fact, he seems to think we can inflate our way out of our economic problems.

Printing more money is the classic way to cause inflation. Another,easier and less controllable way, however, is to engage in credit.

When a bank extends a line of credit, they do not have a reserve on hand to account for every dollar in the credit line--the theory that pertains that no one needs all of their money at once--or more precisely, not everyone needs all of their money at once. So if $100,000 is extended in credit, the bank only has a fraction of that on hand under the assumption that not all of it will be used, or if it is, not al of it will be used by all such credit holders, or if it is, that all of them will make enough finance payments, at interest, that the bank can meet it's obligations to pay also. It's a big balancing act.

And for every dollar leant that is not backed by a real dollar, the economy has been inflated. A "bubble" has been created. Bubbles burst when the loan is either paid back or defaulted. Add up enough small bubbles and then collapse them in a hard landing by defaulting, and we get big problems--have enough of that kind of thing go on at once, or in a domino effect with one market collapsing another, and that kind of deflation causes recessions and depressions--contractions in the money supply. More balancing act.

Cutting the interest rate has already had an effect on the markets--the Dollar, which has been increasing in strength against foreign currencies, dropped again--higher interest rates make investing in dollars more attractive and vice versa. and that's an important thing, but more importantly, the Fed rate controls most other interest rates in the country, say on interest bearing bank accounts--like savings. Lowering the rate discourages saving. It also encourages demand for credit. And credit demand is already too high.

So say the Fed pry bar succeeds in forcing the credit market open. The high, and now higher, credit demand gets satisfied. And still the capacity to pay the loans back isn't necessarily there, and the amount the banks have in reserve still isn't high enough to cover and still no discipline in the market.

The bubble gets bigger.

And we wait for it to pop.