Alan Greenspan warns that the current policy of abnormally low interest rates is coming to an end. Greenspan issued the stern warning about the bleak economic outlook in an interview with Bloomberg News. Greenspan predicts the return of interest rates to normal levels will be the precursor to the collapse of the bond market. Ben Bernanke and Janet Yellen both maintained interest rates near zero percent in the years following the global financial crisis until now. Greenspan forecasts severe economic consequences at the end of the unnatural extended period of low interest rates.
Greenspan stated, “We are moving into a different phase of the economy — to a stagflation not seen since the 1970s. That is not good for asset prices.”
U.S. President, Richard Nixon, removed the U.S. dollar off the gold standard in 1971. This time period also gave rise to the petrodollar system. Nixon resigned from the U.S. presidency in 1974, just as a period of stagflation overwhelmed the U.S. economy.
Former Federal Reserve Chair, Greenspan, used the Fed Model to explain his position on the state of the economy in relation to abnormally low interest rates. The Fed Model uses the prices of stocks in comparison to bonds as a rubric to which asset to hold. The undervalued asset being the preferred one to hold using the Fed Model. In the current economic climate that would be stocks. The Dow Jones roared to a record 22,000 points the first week of August 2017.
Financial analyst and experts agree price-earnings ratio (P/E ratio) being near the highest levels since the global financial crisis is an indicator of troubles ahead.
Paul Myners, a concerned former hedge fund manager, told The Guardian the following.
“Even a return to normal interest rates of inflation plus one or two per cent would have quite substantial impacts on a lot of borrowers… You start to run scenarios in which interest rates are higher and the economy is not going so well and the default risk in property, consumer credit and car loans will increase dramatically.”
Of the current state of the economy, Greenspan says, “I have a chart which goes back to the 1800s and I can tell you that this particular period sticks out. But you have no way of knowing in advance when it will actually trigger.”
Greenspan believes that investors should abandon stocks quickly once the interest rates start to rise.
Greenspan further warns that when the interest rates rise, they will do so without warning. Greenspan stated the following.
“When they move higher they are likely to move reasonably fast. We are experiencing a bubble, not in stock prices but in bond prices. This is not discounted in the marketplace.”
It is within this context that Greenspan declined to give a time frame for this bond market collapse. He added, “anyone who thinks they can forecast when the bubble will break is in for a disastrous experience.”
The Federal Reserve Bank has increased interest rates two times in 2017 and plans to reduce its $4.5 trillion balance sheet.
[Featured Image by J. Scott Applewhite/AP Images]