The National Interest: The U.S. Economy Is Now A Giant Bubble. A 'Pop' Could Be a Disaster

Article by Desmond Lachman in The National Interest

It has long been said that when America, still the world’s largest economy, catches a cold, the rest of the world economy catches pneumonia. With America now engaged in a budget and monetary policy stimulus experiment of epic proportions, the rest of the world is soon to find out what happens to the global economy when America succumbs to an inflationary fever.

Unfortunately, there is good reason to fear that the results will not be pretty. This would especially seem to be the case considering the fact that the American economic policy experiment is occurring at a time that we are in the midst of a global “everything” asset price and credit market bubble.

In the wake of the September 2008 Lehman bankruptcy, it was clear that troubles in the U.S. economy had serious ramifications for the rest of the global economy. Indeed, the bursting of a U.S. housing and credit bubble had ripple effects throughout world financial markets, which precipitated what economists now call the Great Economic Recession.

Fast forward to 2021. Now, America’s massive monetary and fiscal policy experiment is being conducted against the backdrop of a so-called everything asset and credit price bubble, which is very much larger and more pervasive than the earlier U.S. housing and credit market bubble. 

It is not simply that U.S. equity valuations are at the lofty levels last experienced on the eve of the 1929 stock market crash. 

Rather it is also that very risky borrowers, especially in the highly leveraged loan market and in the emerging-market economies, can raise money at interest rates not much higher than those at which the U.S. government can borrow.

Today’s everything bubble has been inflated by the extraordinarily low interest rates produced by the massive amount of central bank money printing in response to the coronavirus pandemic. This raises the question as to what happens when the pleasant easy money music stops and interest rates start to rise.

While Federal Reserve Chair Jerome Powell keeps assuring us that the Biden budget stimulus does not risk higher inflation, the bond vigilantes evidently do not share his view. Since the start of the year, they have driven up the key ten-year U.S. Treasury bond rate from below 1 percent to over 1.6 percent. There is the real risk that if the Federal Reserve remains in inflation denial, the bond .....

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