Looking back to just yesterday reveals many outcomes that should have been predictable. Yesterday is always full of events that we should have seen coming.
These predictable outcomes in the past can include a simple expectation of a movie we saw in the theatre. If we are disappointed in the movie we just saw because it missed our expectations that were built up by a trailer, our outcome could have been predicted if we researched who produced or wrote the film. Screenwriters typically have a style as well as directors, if we did not like their work in the past it is likely we will not like it in the future.
On September 11th, 2001 a terrorist group attacked the United States. This event immediately changed our expectations of safety in the United States. Although we knew terrorist existed and they had killed thousands around the world, we failed to recognize the threat because our expectations of safety had risen to their limit. Before this event we did not recognize the risks we were taking. Before this attack we never viewed an airplane as a weapon although it had been used as one before. On December 7th, 1941 an enemy that used airplanes in the same manner attacked the United States. It took about a generation to go from peak to peak of our expectations of safety.
The past is full of outcomes that look quite obvious today. Without the ability to step back from the situation and measure their expectations there will always be missed outcomes.
Future events are the most beneficial to predict and we can use the past to help identify their natural limits. The outcomes to events in the past are what we must research to determine the natural limits of the event.
In the case of the current financial crisis, we understand that in the past an over extension of credit results in the same outcome which is deflation. At the end of credit driven economic growth, credit is easier to obtain than ever before. Creditors take on more risk and investors’ demand more return. These perfect series of events in the past have led to The Great Depression, Tulip Mania, The Mississippi Bubble, The South Sea Bubble, etc… All of the aforementioned events shared the same outcome of deflation. Over extension of credit creates inflation. When we look back to the early 1980’s, rates on mortgages were over 15%, $100,000 financed then is the equivalent of $225,000 today with mortgage rates around 5%. What we pay for credit is directly related to the Fed Funds Rate, the higher the rate the less banks lend, the lower the rate the more they lend. The Fed Funds Rate was over 18% in 1982, today as of this writing; it is 0 to .25% (target rate). Inflation over the past 30 years has been masked by credit. The Federal Reserve has lowered rates to reverse the effects of recessions that occurred during this timeframe. It is fair to say they have lowered rates more than raised them. With the overnight bank rate at 0 to .25% the amount of credit available is at its natural limit. At this point it is not a predictable but logical outcome. The quality of credit will start to deteriorate as it did in the past. As outstanding loans default the money supply shrinks and so does the available credit. These actions directly cause deflation which creates a depression.
History repeats itself and scholars look back to determine what they believe could have prevented the event. Since most scholars do not consider these events are caused by human instincts, their conclusions are subjective and typically cause more harm than good especially if one of these scholars directly influences the actions of the Federal Reserve in the future.