The economics profession has long had a vigorous academic argument over “natural” interest rates. What would rates be if we could somehow remove all the

Do low interest rates create bubbles?

subjective actors—central banks, commercial lenders, government agencies—that conspire to set them? What would nature do if we left it alone?

It is an academic argument because, in the real world, we cannot do the kind of experiments that would produce a definitive answer. Guesses are all over the board. History, however, suggests that rates below 2% are neither natural nor sustainable. Worse, bad things happen when they get that low.

This isn’t a new revelation. Whenever money becomes very cheap, experience teaches us to expect that it will be misspent. People noticed centuries ago how low interest rates led pushing investors to take excessive risk in search of more and higher returns and created speculative bubbles that always end badly. We are at the end stage of one such bubble right now

If taking more risk is the only way to make a real return on your money, then most investors will take more risk. We see it today in stocks, junk bonds, real estate, private equity, venture capital, and commodities. We have invented entire new asset classes like crypto for the sole purpose of helping people take more risks in search of higher returns.

We will see in future letters how Greenspan, Bernanke, Yellen, and now Powell all distorted the markets and created bubbles, as did the ECB and other major central banks. Zero-interest-rate policies inspired wild speculative bubbles as investors “reached for yield.”

None of this is new. It has happened many times before, going back centuries, and never ended well. This time is unlikely to be different. Some expect a soft landing. I hope they are right, but it would be the first time.

Source: John Mauldin | MBSHighway.com