Have Zero Interest Rates Created Another Wall Street Bubble? Stock market valuation inflated by artificially low interest rates. Investors have no other place to go

WASHINGTON – The real threat against America may not be terror attacks against the homeland engineered by ISIL, after all. Most probably, the real threat is home-made, in the form of foolish monetary policies that have created yet another, gigantic Wall Street speculative bubble.

All looks fine 

This is the ultra-contrarian view forcefully articulated by David Stockman, a Reagan era Budget Director who later on worked on Wall Street.

These days, most analysts look at the American economy and confidently say that all is well. Things are not great, they would agree, but they are mostly OK. The economy grows, albeit at a slower pace than the post-war historic norm. (2% instead of 3%). Unemployment is way down, even though still high by historic norms. (6% as opposed to 4.5%). And corporate America is chugging along at a nice pace, as the buoyant stock market indicates.

Abnormally low interest rates created the bubble

Yes, this is true, argues Stockman. But this rosy picture conveniently hides that we live in the false paradise of zero interest rates resulting from an unprecedented easy monetary policy engineered and kept for years by the Federal Reserve. With interest rates at zero, investors are almost forced to buy stocks. There is no other way to make any money.

Therefore Wall Street’s impressive growth is not the result of a healthy US economy. It is instead the outcome of the massive amount of steroids introduced by the Fed.

Too much debt

On top of that, there are other dark clouds. Enormous budget deficits accumulated in the past few years, (in part this is the result of extraordinary new public spending aimed at countering the horrible impact of the 2008 mega-recession), have caused a major increase of an already large national debt, now beyond $ 17 trillion.

$ 17 trillion is a truly staggering figure.

Add to that trillions of dollars of unfunded liabilities in the form of pensions and other obligations that it will be next to impossible to meet, and the rosy picture suddenly turns very, very dark.

How long can this go on for?

Common sense would dictate that the gravity-defying Fed measures cannot go on forever. You cannot have zero interest rates for generations. By the same token, you cannot keep accumulating large, (even though now relatively smaller), federal budget deficits in perpetuity. As the national debt keeps getting bigger, (even assuming abnormally low-interest rates), there will be a point in which debt service alone will eat up all federal revenues.

Sooner or later, there will have to be a moment of truth. The only question is how soon.

No signs of an imminent crisis

For the moment all is well. The US economy, especially if compared with Europe and Japan, is doing quite well. Likewise, our 6% unemployment rate is much better than the 10% of the Eurozone.

And the optimistic analysts argue that compared with historic averages US stocks do not appear overvalued.

Yes, except that for many years we have been living in an unprecedented environment of forced zero interest rates. At some point this will have to end. At that point stocks will lose much of their current appeal. What will happen then? A slow, orderly transition away from Wall Street? Or a sudden panic, starting with the immediate collapse of the most speculative sectors?

Who knows really. Is Stockman just an inveterate pessimist? Is he just determined to see the glass of the US economy half empty? I do not know.

Artificial environment distorted our perceptions

However, I do know that the Fed has created an artificial environment that has enhanced the appeal of stocks as a preferred form of investment. Therefore stocks must be overvalued. I just do not know how overvalued.

I also know that the US economy is not doing that great. Sure enough, we are doing much better than Europe or Japan.

But this is no great achievement. Europe is a Continent in slow but steady historic decline, with no sign whatsoever of any new trend working towards revival.

Under Prime Minister Shinzo Abe Japan tried to engineer a reversal of the same negative trends. But Japan is unlikely to succeed. Whatever else can be said about “Abenomics”, Japan is headed towards rapid demographic decline. A country of old people does not hold much promise of exuberant growth.

Too many anomalies

So, is America really headed towards disaster? We do not know. But we do know that are just too many anomalies in our economy and in our perennially out of balance public spending, starting with artificially low-interest rates.

Of course, it is possible to rationalize everything. Prior to the 2008 disaster triggered by the US housing bubble, most experts were confident that there was no bubble. Starting with then Fed Chairman Alan Greenspan, everybody agreed that Wall Street had correctly priced any risks involved in the securitization of sub-prime mortgages. Well, now we know that it was not so, not by a long shot. In short, everybody was wrong.

Bad public policies are the root of our problems

Right now we face a different type of danger. After the 2008 collapse, policy makers have done their very best to breath new life into a semi-comatose economy. But all these emergency measures are not free. Hence our stupendous, and growing, national debt. Likewise, lacking any serious attempt at reforming public spending with the goal of recreating some fiscal balance, while incentivizing economic activities via a pro-growth tax reform, the US Fed stepped in. It injected oxygen into the economy in the form of zero interest rates.

Not normal

So there you have it. Low growth, high unemployment, chronic deficits, enormous national debt, zero interest rates and a long bull market. Sorry, but none of this is “normal”.

Given all this, the almost universal belief that current stock market prices reflect real value may be the latest delusion. I am sure that there is a bubble. I just do not know how big, and how soon it will burst.


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