George Melloan writes in WSJ:
The nearly 2,000-point rise in the Dow Jones Industrial Average since last June no doubt at least partly reflects asset inflation, since there has been very little in the economic or political outlook to justify it.
Midwest farmland prices were rising at a 13% annual rate last fall even after a summer of crippling drought. How could drought-stricken farms be gaining value so rapidly, other than through inflation generated by cheap credit? House prices also are climbing again in many areas, much as they were during the asset inflation of the 2000s. Those are the same houses that were on the down escalator not long ago. Call it "asset reflation."[...]
We've been down this road before. Mr. Greenspan was cautioning himself as well as Wall Street in his AEI speech when he said, "we should not underestimate, or become complacent about the complexity of interactions of asset markets and the economy." After nearly a decade on the job, he knew the uncertainties of managing a fiat currency. He also knew that tightening the money spigots in boom times required the courage to face the political outrage that invariably results.
Seven years later, Mr. Greenspan would fail to heed his own warning. Urged on by his soon-to-be successor, Ben Bernanke, Mr. Greenspan would hold interest rates down too long, setting off a mid-2000s credit binge that sent assets soaring, home prices in particular. Congress developed a blasé attitude toward huge budget deficits, simply because Fed policy made them easy to finance. State and local governments overleveraged themselves. This was "irrational exuberance" indeed.
When the Fed finally tightened credit, the bubble burst, with a resulting stock-market crash, a vast wave of home foreclosures, public-sector pension funds in distress, and many state and municipal governments technically bankrupt. As Mr. Greenspan had feared, a crash in asset values did profound damage to the real economy. We are still living with it.
At least Chairman Greenspan understood the risks. It is not clear that Chairman Bernanke is aware that he has now set the Fed's asset-inflation machine on automatic pilot by promising near-zero interest rates well out into the future.[...]
The "wealth illusion" of asset inflation is seductive, which is why central banks in charge of a fiat currency and subject to no external disciplines so often drift in that direction. Politicians smile in satisfaction and powerful Washington lobbies cry for more.
But an economy built on an illusion is hardly a sound structure. We may be doomed to learn that lesson once again before long.