As we journey through the third credit induced bubble in the past decade (dot-com, housing) it is important to remember how quickly the illusion of prosperity can evaporate in the next bust.
The legendary Ludwig von Mises wrote way back in 1931 after a massive bear market rally had corrected the stock market back to near pre-crash levels and shortly before the stock market and the economy resumed their downward trajectory:
“Credit expansion cannot increase the supply of real goods. It merely brings about a rearrangement. It diverts capital investment away from the course prescribed by the state of economic wealth and market conditions. It causes production to pursue paths which it would not follow unless the economy were to acquire an increase in material goods. As a result, the upswing lacks a solid base. It is not a real prosperity. It is illusory prosperity. It did not develop from an increase in economic wealth [i.e. the accumulation of savings made available for productive investment]. Rather, it arose because the credit expansion created the illusion of such an increase. Sooner or later, it must become apparent that this economic situation is built on sand.”
Mises realized that lowering the interest rate below the free market rate causes bad business decisions. Those decisions may look good for a while and the economy as a whole may show apparent growth, but it is all unsustainable. All that is left after the bust are misallocated resources and piles of debt. True prosperity has to be built on savings. Low interest rates that are a result of an abundance of savings give accurate market signals that the resources necessary to carry out projects actually exist.
Ben Bernanke can lower interest rates to zero to encourage borrowing but he can do nothing to actually increase the amount of real resources in the economy. Worse, the low rates cause yet more malinvestment that has to be marked to market and more debt that cannot be paid and will be defaulted on. As long as these policies stay in place the prospect for real prosperity is zero and the best people can hope for is to personally profit from the boom period and get out of the way before the inevitable bust.
We are two years into this relentless move higher in the stock market since the lows from the banking crisis. Nobody knows when the move will end, but one thing is certain for those knowledgeable in Austrian Free Market economics, the next bust will come. It must.