The last time the Fed raised rates, credit markets collapsed and the economy went into recession

As the entire global economy waits with baited breath for the Federal Reserve’s rate announcement in a few hours, analysts are looking backward to what occurred in 2006 when the central bank last raised rates.  And interesting enough, the results were not good for anyone.

Greenspan used rate hikes between 2004 until June of 2006 to qualify his ‘irrational exuberance’ mantra as the housing bubble would reach its peak just a few months later.  And with this tightening of credit and liquidity, over the next year markets would soar as asset purchases pushed prices to then all-time highs, only to then unveil the fragility of a market that had only succeeded on the back of monetary infusion.

Welcome to 1936-37 and 2007-08.

The first tightening in August 1936 did not hurt stock prices or the economy, as is typical.

The tightening of monetary policy was intensified by currency devaluations by France and Switzerland, which chose not to move in lock-step with the US tightening. The demand for dollars increased. By late 1936, the President and other policy makers became increasingly concerned by gold inflows (which allowed faster money and credit growth).

The economy remained strong going into early 1937. The stock market was still rising, industrial production remained strong, and inflation had ticked up to around 5%. The second tightening came in March of 1937 and the third one came in May. While neither the Fed nor the Treasury anticipated that the increase in required reserves combined with the sterilization program would push rates higher, the tighter money and reduced liquidity led to a sell-off in bonds, a rise in the short rate, and a sell-off in stocks. Following the second increase in reserves in March 1937, both the short-term rate and the bond yield spiked.

Stocks also fell that month nearly 10%. They bottomed a year later, in March of 1938, declining more than 50%! – Zerohedge

If Bernanke were still head of the Federal Reserve, it is probably more likely that the central bank would not be having a conversation about rate hikes, since his so-called expertise was in Great Depression economic analysis.  But since he bailed prior to the Fed having to make decisions on stopping QE and raising rates, there is a very good chance that he will be sitting now in the peanut gallery to crucify his former institution if a rate rise is quickly followed by an economic or financial collapse.


The issue today has never been about interest rates, but about propping up banks and equity markets with too much printed money instead of letting the bad debt dissolve themselves through a cycle of normalization in the economy.  And like 1999, 2007, and now again in 2015, the fruits of policies that were weighted towards monetary stimulus rather than monetary cleansing will repeat itself historically once the Fed begins to move forward with a raising of rates.

Kenneth Schortgen Jr is a writer for,, and To the Death Media, and hosts the popular web blog, The Daily Economist. Ken can also be heard Wednesday afternoons giving an weekly economic report on the Angel Clark radio show.