We ‘fixed’ the dot com bubble by dropping rates to 1%. That created the real estate bubble. We ‘fixed’ the real estate bubble by dropping rates to 0%. Now what? If there is a move down in stocks from here…how does the government reflate it all again? Can we go lower than 0%? I caught this exchange on CNN over the weekend:
FAREED ZAKARIA: Christine, when you look at this crisis and step back, a lot of people would argue one fundamental driver here was the very low interest rates that fueled a lot of bubbles. The cost of capital really collapsed between 2004 and 2007 and made people do stupid things in all kinds of areas. So the cost of capital is now very low. I mean, interest rates are at the lowest rates in I don’t know two generations. Isn’t it possible that we are fueling new bubbles and if so, shouldn’t that worry us all?
CHRISTINE LAGARDE, FINANCE MINISTER, FRANCE: We had to refuel. That’s really what happened about a year ago and if you look at what we did, we managed to kick start the economy. We managed to avoid protectionism, which could have taken place and we started regulating the financial system in a better way, which was an absolute must. To do all that, we had to collectively, us, member states from all around the world, we had to refuel because there was nobody else and nothing else available.
Refuel? Here is one way to look at that explanation: Assume there is a hypothetical population problem. Some government type says, “That was fixed. All is fine now.” We find out later that the government mowed people down with machine guns to ‘fix’ the problem. That’s how the so-called refueling with interest rate manipulation feels.