Will the Bubble Pop Even if the Fed Never Raises Rates?

There is no ready-made answer in Austrian business cycle theory (ABCT) to the multi-trillion dollar question now looming over the global economy and markets. Is the present virulent asset price inflation disease likely to enter any time soon its final phase of bust and recession? Will this happen even though the Federal Reserve has flip-flopped on even token steps toward policy normalization and leading foreign central banks (i.e., the Bank of Japan, ECB, and Bank of England) to pursue experiments with negative interest rates and novel forms of mega-balance sheet expansion?
Rate Hikes Usually Come Before Crises
In the small sample size of modern business cycles and especially those featuring severe asset price inflation, there is no unambiguous example of transition into the crash and recession phase without a prior significant tightening of monetary conditions. The closest is the 1937 crash and subsequent Roosevelt recession. But the Fed’s attempt to normalize monetary conditions via three hikes in reserve requirements through late 1936 and early 1937 – barely three years on from when the monetary base started to explode under the influence of huge gold inflows from Europe – blurs any lessons which might be drawn.
By contrast, the Fed is now past its sixth anniversary of launching massive monetary base expansion and even wilder monetary experimentation has been occurring abroad. The Yellen Fed has flip-flopped in its program of ‘rate lift off’ on any sign that the S&P 500 might be seriously retreating from present highs. Implicitly, today’s monetary experimenters appear to assume that they can at will exercise a series of ‘Greenspan (or Yellen) puts’ to prevent any serious pull back in market prices until an economic miracle emerges which will justify in fundamental terms presently inflated asset prices.
Many investors around the globe – suffering from interest income famine – are inclined to give the Federal Reserve the benefit of the doubt. Asset price inflation is characterized by the transitory flourishing of speculative stories unchecked by normal rational scepticism which has been numbed by yield desperation. The ‘success’ of The Grand Monetary Experiment has become the biggest speculative story of all.

This post was published at Ludwig von Mises Institute on Aug. 8, 2016.