How wonderful would it be if capital markets were absolutely perfect? Imagine a world where risk assets like stocks only rose and never fell regardless of valuations (OK, you don’t really need to imagine it, because that’s what’s been happening since late last year). Envision if bond yields and borrowing costs remained perpetually low at the same time that inflationary pressures were benign (OK, once again, sounds like today). And imagine having all of this in an environment where the daily uncertainty associated with the prices of these assets was minimal (OK, we’ve got that today too). What a world it would be? And maybe, just maybe this is the world that we have officially entered into during the post crisis period. Perhaps policy makers through their actions have finally discovered the master theory that fully explains and links together all fundamental aspects of capital markets. But in case they have not, it is worthwhile to consider what might take place when capital markets move on to something other than the seemingly perfect conditions that we are experiencing today.
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