Will a 50-Year-Old Economist's Warning Be Repeated in Today's Market?

In the 1920s, during the proliferation of automobiles and electricity, there was a widespread perception that 'this time is different,' yet the market ultimately faced a major crisis due to excessive credit expansion.

During the dot-com bubble of 2000, the argument justifying market overheating based on technological innovation was dominant. While technology is a core economic factor, the fundamental cause of crises was always issues of money and credit.

John Kenneth Galbraith is regarded as an economist with exceptional ability to apply economic theory to reality, having served as a policy advisor in the Kennedy administration and as an ambassador.

Rather than just creating theories, he authored books that combine theory and reality, weaving together difficult economic histories and the private lives of famous economists, making them accessible to readers.

During periods of credit expansion, human 'greed' strongly influenced the market, while during periods of credit contraction, 'fear' was the driving force.

Compared to 50 years ago when this book was published, the form of money has transformed significantly from cash-centric to credit cards, cryptocurrencies, and stablecoins.

However, regardless of financial form, human greed and fear towards money remain the same as in the past, and the cycle of credit expansion and contraction is expected to repeat in the modern economy.

Productivity significantly improved in the 1920s with the proliferation of automobiles and electricity, but a bubble formed due to excessive leveraged investment, such as buying $100 worth of stock with $10.

When the Dow Jones Industrial Average plummeted by 90% due to the bubble's collapse in the 1930s, authorities focused on "purification policies" like restructuring failing companies, missing the timing for an effective response. This led to reduced bank lending and weakened consumption and investment, exacerbating the Great Depression.

Government debt is surging, mainly in developed countries like the US, and the Federal Reserve's excessive liquidity injections during the 2008 and 2020 recessions led to a decline in currency value and trustworthiness.

The recent surge in the US 10-year Treasury yield to 5.2%, its highest level since March 2002, is closely related to this decline in confidence. Furthermore, concerns about an AI stock bubble and over-investment are growing.

As interest rates rise, households inevitably reduce consumption over time, which can lead to funding difficulties for AI companies.

In the stock market, rising interest rates increase the discount rate, putting downward pressure on growth stocks. Consequently, there is a possibility that the stock market could see an adjustment starting in the fourth quarter of this year, followed by an economic recession in the US next year.

The current situation is unlikely to lead to a severe recession on the scale of a 90% market drop like the Great Depression, and the Fed is expected to eventually respond with an accommodative monetary policy.

However, with US government debt exceeding 120% of GDP, there are limits to expanding government fiscal spending. Additionally, with PC inflation rates surpassing 3%, maintaining a tightening stance for price stability is also necessary, making bold policy responses from the Fed challenging.

The success or failure of economists' theories depends on their application to real economic problems, and a single person's theory has limitations in explaining the entire economy.

Recalling that economists' theories were applied differently to the 1977 oil shock and stagflation, it emphasizes the importance of a flexible approach based on economic conditions.

Inflationary pressures persist due to geopolitical risks between the United States and Iran, and the US-China rivalry is escalating as China's GDP share relative to the US has risen to 18%. While AI has positive aspects in increasing productivity, there are also concerns about a bubble and over-investment in related stocks.

The essence of money is credit, but when too much money is released, problems arise, and combined with investor greed, it triggers bubbles.

Historically, cycles of greed and fear have repeatedly led to asset price bubble collapses, and just as Goethe's "Faust Part Two" hinted at the dangers of issuing currency without a credit basis, excessive money supply ultimately leads to problems.

During the COVID-19 pandemic in 2020, the US Federal Reserve's quantitative easing supplied massive liquidity, leading to a temporary boom of surging asset prices, but ultimately resulted in inflation.

This led to the US Federal Reserve's inflation target of 2% being consistently exceeded, demonstrating that issuing money depreciates its value and causes inflation.

In the long term, the average US money growth rate has closely matched the sum of real GDP growth and consumer price inflation, but the 2020 money growth rate was a staggering 27 percentage points higher than the optimal level, serving as a major cause of current inflation.

Milton Friedman compared monetary policy to turning a shower faucet, warning of the dangers of abrupt policy changes. Just as turning the faucet rapidly towards cold water when hot water is flowing causes a sudden gush of cold water, the Fed's monetary policy exhibits a similar pattern.

The over-supplied money in 2020 is now contributing to the current high-interest rate environment and delayed resolution of inflation. Historically, the credit expansion and contraction cycle has repeated, regardless of the market's belief that 'this time is different.'

The recent debate over a bubble in the AI industry shows similarities to the automotive and electricity boom of the 1920s and the IT bubble of the 2000s.

While technology continues to influence the economy, the expansion and collapse of asset prices have been a historical process driven by human greed. The US 10-year Treasury yield surpassing 5% is interpreted as a strong signal indicating a contraction in consumption and investment.

Amidst ongoing debate about an AI-related stock bubble and over-investment, many experts claim that 'this time is different.'

However, the same argument was made in the late 1920s during the proliferation of automobiles and electricity, and just before the IT bubble collapse in 2000, but in hindsight, it wasn't different. Ultimately, while technology significantly impacts the economy and society, the creation and collapse of asset bubbles have been repeatedly driven by greed.

The recent surpassing of 5% by the US 10-year Treasury yield is a powerful negative signal for the market and should not be underestimated.

High interest rates inevitably lead to a contraction in consumption and investment after a time lag, and the stock market can also be negatively affected. Even if AI technology makes a significant mark on human history and profoundly impacts the economy, the fact that the cycle of money expansion and contraction repeats must not be forgotten.

Stock investors should learn from past history that, though forms have differed, history repeats itself. This is because the process of bubble formation and collapse, accompanied by human greed and fear, has recurred in the stock market.

This book is recommended to students studying economic history and policymakers, emphasizing the need to develop insights for judging grand economic trends and applying them to policy. Galbraith's insight that economic theories can vary depending on the situation remains valid.