This Boom is a Problem

220px-Dangclass1.svgWriting for the Globe and Mail, Tom Bradley is worried about the markets:

It feels like investors have become complacent about – well – everything.

The strongest consensus I’ve seen in recent years relates to low interest rates. The rationale is, rates won’t go up because we can’t afford it. A question from a client last week embodies this view. He asked, “Can interest rates actually increase?”

Related to rates is an increasing comfort with debt. Carrying costs are low and families are okay with heavily leveraged balance sheets. Instead of, “How fast can I get my house paid off?,” the question is, “Should I get an investment loan to go with my mortgage, home equity loan, credit line, car lease and credit cards?”

One of the striking features of Austrian business cycles is the emphasis on the things one doesn’t see that are going wrong during the boom. In other words, while by all appearances the boom seems like a great time, in reality it is quietly sowing the seeds of its own demise.

It is exactly this feature – the emphasis on the unsustainability of the boom – that gives Austrian economists an advantage over other economists when assessing business cycles. No other look at the business cycle has any broad measures against which it can judge whether the boom “should” be happening in the first place. Instead the bust always gets the blame as the problem, which is only really true if it wasn’t caused by the boom that precedes it.

Bradley is correct about three facets of today’s markets. First, interest rates are at all time lows. While in the past this used to mean in real (inflation-adjusted terms), with central banks pegging their main financing rates at or close to zero, this is true in nominal terms as well. Second, not only are debt levels high but borrowers don’t have much incentive to pay them off any time soon. Finally, and most importantly, no one expects this situation to reverse any time soon. Why would it: don’t you know we’d all be doomed if interest rates rose?

The longer these imbalances continue, the more difficult the problem will be to unwind. There’s no such thing as a free lunch, and when interest rates rise again (probably in a response to rising risk due to bad investments made in the past) we’ll see whether this boom was sustainable or not. Of course, Austrian economists are able to answer that question already.

(Originally posted at Mises Canada.)

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