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Minneapolis Fed Pres Says Keep Those Bubbles Inflated

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Minneapolis Fed President Neel Kashkari said the central bank should keep the bubbles inflated.

OK, he didn’t say that exactly. But that was the message reading between the lines of a speech Kaskari delivered this week. Specifically, the Minneapolis Fed president said the Federal Reserve should not raise interest rates in an effort to prevent bubbles.

Given the challenges of identifying bubbles with any confidence and the costs of making a policy mistake, I believe the odds of circumstances ever making sense to use monetary policy to try to slow asset prices down are very low. I won’t say never—but a whole lot of evidence would have to line up just right for it to be the prudent course of action.”

The former Goldman Sachs Group executive was the lone dissenter when the Fed raised interest rates in March.

Artificially low interest rates inflate bubbles. (For an in-depth explanation of bubbles, click HERE.) They incentivize borrowing that wouldn’t otherwise occur. From the central bankers’ perspective, that’s the point. They want to “stimulate” spending and “jump-start” the economy. All of that easy money has to go someplace, so it flows into various assets. Where the bubbles inflate depends on the overall economic and government policy environment at the time. In the 1990s, easy money flowed into the dot-coms. In the years leading up to 2008, it rushed into the housing market.

The Federal Reserve has held rates at historically low levels for nearly nine years now. Of course, we see all kinds of bubbles. The most obvious is the stock market. There is a huge disconnect between stock market prices and economic reality. It’s clear that Fed policy has pumped up a massive stock market bubble. Analysis last year by Yahoo Finance showed 93% of the entire stock market move since 2008 was caused by Federal Reserve policy.

In a recent interview, former Reagan budget director David Stockman warned that the bubbles in both the stock and bond markets are going to pop. He called the stock market “unstable” and “rigged,” warning its ultimate collapse will cause “chaos.”

But the stock market isn’t the only bubble. Easy money has also inflated an auto-loan bubble, complete with subprime loan bundling. Remember when Wall Street got the bright idea of bundling and selling subprime mortgages? Like that.

There is also a retail bubble and a student loan bubble. They’ve even managed to pump up a shoe bubble.

So, what happens when interest rates begin to normalize?

Bubbles pop.

Peter Schiff has compared access to easy money with heroin addiction. The addict needs more and more of the drug to maintain the same effect. When you suddenly take the drug away, the addict gets extremely sick. Raising interest rates is like taking heroin from the addict. The bubbles need a steady flow of easy money to stay inflated.

Kashkari knows it. That’s why he’s urging cation about raising rates. He basically admitted it in his speech, albeit with a bit of spin.

For example, if we see a bubble forming in commercial real estate, raising interest rates won’t affect just the commercial real-estate market, but also housing, automobiles, consumer borrowing and capital-intensive industries, among others. We may want consumers to keep spending, but condo prices to stop rising. Raising interest rates would slow them both down.”

He tries to make us believe the concern is about slowing spending overall in the economy, but I suspect there is more to it than that. I think he knows raising rates will prick the bubbles, and I think he realizes it will be a disaster.

Peter has been making this case for more than a year. As he put it during a CNBC interview last summer, the Fed will ultimately sacrifice the dollar on the altar of the stock market. The central bank’s main goal is to make sure the stock market doesn’t crash again. Peter said they might succeed, but only at the expense of the dollar.

So we’re going into a currency crisis, and this crisis is going to be much bigger than a financial crisis. The impact it’s going to have on the average American, on his standard of living, on his way of life is going to be much more profound. And sure, people won’t lose as much money in their stock portfolio, but if they try to sell their stocks and spend the money, the purchasing power that they lose is going to be much greater then what was lost in ’08.”

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