Question

Why low IR creates bubbles?

Answer 1

An economic bubble is trade in an asset at a price or prive range that stringly exceeds the assets's intrinsic value.

All the roads lead to Rome and low interest rates always leads to bubbles.

When central bank crunches interest rates to a record low , it always and wothout question leads to bubbles and muddle headed investments in the economy.

Interset rates are the price of money. Based on basic demand and supply , low interest rates means either a lack of demand for money or an excessive supply of money.

Lack of demand is not the issue here ; government continoues to borrow and run deficits: siotheproblem must be an excess supply. Clearly, there is lots of money chasing too few investment oppurtunities. Investors are bidding prices up, and interest rates down , in a quest to actually buy assets.

With interest rates as low asthey are negative around the world and at unprecedented lows here the queastion is why?

There are really only two explations;

1) they are willing to take loss for non financial reasons

2) they believe that other investors will pay even higher prices and accept even lower or more negative , interest rates later on.. buyers are either forced to buy policy reasons or some other non market factor or they believe the trend will continue.

Bubbles includes prices going up because of non fundamental reasons and that is exactly what is happening with interest rates. Forced buyers in this case includes central banks, pension funds and insurance companies which are driven by , not fundamentals. Traders are riding the trend and will be there untill it changes regardless of the fundamentals. This is a momentum market that can could change quite quickly like a bubble.

Interest rates matter because they underline the value of every other financial asset. Stock prices, for example are at historical high levels and big part of justification for that is current low interest rates.