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Irrational Exuberance Replay: Former Fed Chair Warns Bond Bubble About to Burst

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Last week, former Federal Reserve chairman Alan Greenspan issued an emphatic warning during an interview on CNBC’s Squawk  Box: Beware, the bond bubble is about to burst. And when it does, it will take stock prices down with it.

The current level of interest rates is abnormally low, and there is only one direction in which they can go, and when they start, it will be rather rapid.”

Greenspan headed the Fed from 1987-2006, so he has some experience in blowing up asset bubbles. His tenure at the central bank featured an extended period of low rates, but nothing compared to what we have today. In fact, Greenspan pointed out that going back to the time of Alexander Hamilton, long-term interest rates have never been as low as they are today.

The former Fed chair stopped short of predicting when the crash will happen, but he emphasized the prolonged period of low interest rates will come to an end, and the bull market in fixed income that has lasted more than three decades will end along with it.

I have no time frame on the forecast. I have a chart which goes back to 1800, 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.”

He emphasized it will take most people by surprise, noting that “it looks stronger just before it isn’t stronger.”

Greenspan is probably best known for his “irrational exuberance” speech in 1996. At that time, he warned about asset prices, foreshadowing the popping of the dot-com bubble.

Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?”

During the recent CNBC interview, Greenspan said it was “perfectly fair” to characterize his latest remarks about the bond market as an “irrational exuberance” type of statement.

You can never be quite sure when irrational exuberance arises. I was doing it as part of a much broader speech and talking about the analysis of the markets and the like, and I wasn’t trying to focus short term. But the press loved that term.”

Greenspan swerved into the ultimate problem with central planning. For all of their “data dependence” and scientific methods, the central bankers really have no way of comprehending and accounting for all of the long-term impacts of their policies. The Fed has held rates at abnormally low levels for more than 8 years in an effort to stimulate the economy. They are doing it to “help.” But as Greenspan said, they have no clue when the infusion of easy money will trigger “irrational exuberance.” Regardless, when it does, the results are disastrous. We saw it with the dot-com crash. We saw it with the housing bubble collapse. And we will experience it yet again when the next bubble pops.

Greenspan isn’t the only one worried about an upcoming crisis.  Over recent weeks, officials from a number of the world’s major banks have expressed worry about the current economic and financial trajectory, and fear that a crash may loom on the horizon.  And as Peter Schiff pointed out, despite record highs, everything is not right on Wall Street.

Nevertheless, a lot of Americans continue hold on to their optimism and pile into the stock market. Peter warned this is a mistake, saying we are in the eye of an economic hurricane, and now is the time to buy gold.

Americans are not buying gold, even though gold prices year-to-date are up more than the S&P 500. But the people who typically buy gold in America voted for Trump, and they’re no longer worried about the economy. So they’re not buying gold. They’re buying stocks instead, and I think they’re making a big mistake. They should be selling their stocks and buying even more gold.”

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