Ultra low interest rates have inflated financial bubbles and could spark a stock market crash in 2016. At least, that’s the warning from former Fed chairman Alan Greenspan.
“The basic problem is that we are not getting any capital investment that significantly adds to the growth of output per hour,” he stated.
In a healthy economy, capital investment would create economic growth when the interest rate is low. Despite the very low interest rate, capital investment has not contributed to the growth of the U.S. economy.
Greenspan blamed the rising cost of entailments that caused low productivity and lack of capital investment.
“Entitlements have been growing under the administrations of Republicans and Democrats close to 10% a year for a half century,” he noted. “We’re finally at a point where it is, essentially, crowding out.”
The Federal Reserve is expected to hike the interest rate most likely in September. When that happens, Greenspan believes that in this environment, a rising interest rate could have severe implication on both equity and bond markets.
“One is the equity premium which, actually, is a little out of line now, but not been materially so. Plus, the level of riskless interest rates. It’s there that the basic problem arises, because, for whatever reason, whether it’s the Fed moving or the market moving itself, bond prices fall, you begin to get very significant downward pressure on stock prices,” Greenspan explained.
“There’s where the real problem lies as far as equities are concerned, is that it cannot be dissociated from the fact that interest rates are historically too low and will have to move higher eventually.”
“We tend to think of stock market bubbles as very substantial price earnings ratios. Well, if you turn the bond market around and you look at the price of bonds relative to the interest received by those bonds, that looks very much like the usual spread which would concern us if it were equities, and we should be concerned.”