Steadily declining interest rates

An overlooked feature of monetary policy over the last four decades is that, while it involved very low interest rates towards the end of the period, it is characterized by consistently falling interest rates over 40 years (Figure 5.1).

As we will discuss in this chapter, this means that capital gains on all assets were virtually assured. Even if you (or your pension fund) had been fully invested in government treasuries at a low interest rate, the fact that the rate was falling meant that you would get capital gains to add onto your total return. Stocks and housing did even better, in part because of the perceived ‘Greenspan put’ – there was no risk, because Chairman (of the Fed) Alan Greenspan – called ‘the maestro’ – was believed to ensure that any falls in the stock market or slowdown in the economy would be countered by monetary expansion. Even the housing crisis of 2007/ 08, during ‘helicopter’ Ben Bernanke's period in charge, only temporarily dented house and stock prices.

A thesis of this book is that the policy makers know what they are doing in the sense that they are deliberately choosing their policies, wise or unwise. It is unlikely that the policy makers of the early 1980s sat down and drew up explicit plans to consistently lower interest rates over time. Instead, this pattern might be a natural development of their initial policy choices as reinforced by the policy makers’ subsequent decisions. But, at the very least, the policy makers have had numerous opportunities to take a different path, and have chosen not to do so.

But, if declining interest rates – and the associated ‘guaranteed’ capital gains – must stop when they hit a zero interest floor, then the 40-year boom in asset values had to come to an end. It did not have to end in inflation, but could have ended with an implosion in asset values. When the post-war boom came to an end in the US, the Dow Jones Industrial Average peaked at 9,400 in 1966 and slowly but inexorably fell to 2,500 in 1982. The Japanese Nikkei average approached 40,000 in 1989 and fell to about 8,000 in 2003.