Too many dollars were churned out, year after year, for the economy to absorb; more credit was created than could be fruitfully utilized. Some of it went into subprime mortgages, yes, but the monetary excess that fueled the most threatening "systemic risk" bubble went into highly speculative financial derivatives that rode atop packaged, mortgage-backed securities until they dropped from exhaustion.
The whole point of having a central bank is to calibrate the money supply to the genuine needs of an economy -- to purchase goods and services, to fund productive investment -- with the aim of achieving maximum sustainable long-term growth. Since price stability is a key factor toward that end, central bankers attempt to finesse the amount of money and credit in the system; if interest rates are kept too low too long, it causes an unwarranted expansion of credit. As the money supply increases relative to real economic production, the spillage of excess purchasing power results in higher prices for goods and services.
But not always. Sometimes the monetary excess finds its way into a narrow sector of the economy -- such as real estate, or equities, or rare art. This time it was the financial derivatives market.
In the last six years, according to the Bank for International Settlements, the derivatives market exploded as a global haven for speculative investment, its aggregate notional value rising more than fivefold to $684 trillion in 2008 from $127 trillion in 2002. Financial obligations amounting to 12 times the value of the entire world's gross domestic product were written and traded and retraded among financial institutions -- playing off every instance of market turbulence, every gyration in exchange rates, every nuanced statement uttered by a central banker in Washington or Frankfurt -- like so many tulip contracts.
The sheer enormity of this speculative bubble, let alone the speed at which it inflated, testifies to inordinately loose monetary policy from the Fed, keeper of the world's predominant currency. The fact that Fannie Mae and Freddie Mac provided the "underlying security" for many of the derivative contracts merely compounds the error of government intervention in the private sector. Politicians altered normal credit risk parameters, while the Fed distorted housing prices through perpetual inflation.
At this point, dickering over whether Alan Greenspan should have formulated monetary policy in strict accordance with an econometrically determined "rule," or whether the Fed even has the power to influence long-term rates, raises a more fundamental question: Why do we need a central bank?
"There are numbers of us, myself included, who strongly believe that we did very well in the 1870 to 1914 period with an international gold standard." That was Mr. Greenspan, speaking 17 months ago on the Fox Business Network.
In the rules-versus-discretion debate over how best to achieve sound money, that is the ultimate answer.
Ms. Shelton, an economist, is author of "Money Meltdown" (Free Press, 1994).