Asset Bubbles Will Burst as Interest Rates Return to Normal Levels

The air will run out of the asset bubbles and the interest rates will normalise. Although people have been able to create this illusion for 15 years, extreme policies will no longer work in the future, writes financial expert Charles Hugh Smith on the Daily Reckoning portal.

Here is an abridged version of Charles Hugh Smith’s story:

People have a knack for normalising extremes. We quickly get used to conditions that would not have been tolerable before. We do this because of adaptation and because we tend to transfer recent history into the future (recency bias).

In a short time, we have convinced ourselves that this is not only normal, but also healthy. Extreme policies have driven the economy for the last 15 years in a row and made the rich richer. We’ve now reached the top of the American mountains, so hang on tight, it’s going to be a “fun” ride down.

The normal situation was changed in 2008, when the importance of the financial world grew by leaps and bounds and fraud was essentially dealt with

The rich did not want to accept the losses from the dishonest casino, and since then we have lived in debt and the “wealth effect” created by the Federal Reserve, which dramatically increased the wealth of the richest 10 percent at the expense of the other 90 percent and the long-term stability of the system.

However, if we shed light on all the machinations, propaganda and frauds, a real picture of the economy opens up for us. It doesn’t matter whether we like it or not. It won’t change the future. The result of all the extreme policies and distortions is about to unfold before us.

If the economy is made to live on an ever-increasing debt burden and bad loans are not recommended to be realised as losses, then there will be only two possibilities in the future. Japan took the first path in 1989-90, when the credit bubble burst in the country and the wealthy refused to give up the fake wealth they got from the bubble economy.

Stagnation and Inflation

This has resulted in 35 years of stagnation and the loss of vitality of Japan’s economy and society. Japan survives thanks to exploding debt levels, zombie companies and overseas assets. The younger generation has given up on marriage, family and buying a home because they can no longer afford it.

If this kind of national decline seems like one of the paths, then it is worth removing the blinders and looking around: we are already on this path.

Another option is high inflation, which will eat both wage earners and savers alive. If consumption is financed by debt and rich spending (the “wealth effect” created by the central bank), productivity stagnates. At the same time, fresh debt money injected into the system pushes up inflation, creating instability.

The stock market of the 1970s reveals the magic of inflation: stocks go up and down for years. After new peaks, there is relief – we are back at the same level again! But it wasn’t like that. Adjusted for inflation, “buy and hold” investors lost 2/3 of their capital back then.

Bursting of Asset Bubbles

A third alternative is to burst the debt-based asset bubble, despite everyone’s desire to normalise extremes. The result is an economic crisis, where debts are written down the chimney and stock markets crash. The result of a classic asset bubble burst is a situation where price levels fall to pre-bubble levels.

Extremes begin to move toward normality, whether we want it to or not. Let’s take real estate, which has become affordable only for the wealthy. This is the first massive distortion that begins to normalise.

The U.S. national debt is exploding because we’ve shifted debt growth from the private sector to the public sector, which allows for a slightly nicer portrayal of things.

Unfortunately, for 15 years, the delusion that interest rates will go back to zero and “everything will be fine” has corrupted people’s minds. The reality is that everything has been “fine” for 15 years, and that’s why interest rates are starting to move up. It doesn’t matter what stories we believe.

Interest Rates are Normalising

Historically, it has been normal for interest rates to be between 5-7 percent

If we try to “solve” the problem and bring interest rates back to 1 percent, we get 9-12 percent interest instead.

What happens when interest rates normalize? All our money is spent on interest payments. When the credit card limits are full, we can no longer consume with the help of debt. If debt levels don’t grow, the economy won’t grow either.

Corporate profits begin to fall. Not even artificial intelligence can save them because consumers will run out of credit. In the casino so far, most of the winnings have been taken by the richest, whose assets have grown many times faster.

America’s mountains are about to become “fun”—unpredictable, volatile, and skinny for those who have normalised extremes by “fixing” the system.

Key Takeaways

The bottom line is that the era of artificially low interest rates and inflated asset bubbles is nearing its end. As these extremes are normalised, the consequences of years of unsustainable policies will become increasingly apparent.

Whether through stagnation, inflation, or the bursting of asset bubbles, the future will be shaped by the forces of economic reality. The illusion that we can maintain a debt-driven economy indefinitely is fading, and we must brace for a period of correction.

As interest rates rise and debt-fueled consumption slows, the economic landscape will shift, bringing both challenges and opportunities as the system recalibrates.