Is Another Financial Crisis Coming to the United States?"In general, we find that monetary policy should react to asset prices and should try to “prick” or “burst” asset bubbles." (Roubini 2005) Though it is clear they have not done so, anyone can see that there is an asset bubble in the stock, bond, and housing markets yet the FED continues their Zero Interest Rate Policy, and continues to print money at unprecedented rates while increasing debt and the deficit. The government's refusal to curb asset prices many years ago has led to a massive asset bubble that is waiting to collapse as soon as they raise interest rates, but now because commodity prices are very depressed as compared to 2007 "then the level of corporate debt remains beyond that which can be financed out of the depressed cash flows of a recession, and debt continues to accumulate, setting off a chain reaction of bankruptcies." (Barnett 2000) This asset bubble has been exasperated by "investment managers are willing to bear the low probability “tail” risk that asset prices will revert to fundamentals abruptly, and the knowledge that many of their peers are herding on this risk" which is particularly problematic in "an environment of low interest rates following a period of high interest rates" and can lead to "sharp and messy realignments" (Rajan 2005)
A "sharp and messy realignment" will lead to massive deflation in asset prices and force the government to increase their deficit spending to maintain their 2% inflation target, and because the primary way to finance a larger deficit in a depressed economy will be to print more money, and because "large budget deficits financed by money creation are widely believed to be the primary force sustaining prolonged high inflation processes." (Kiguel 1989) then this could lead to hyperinflation as deficit spending reaches unsustainable levels and the only way to conceivably pay it back is through hyperinflation or default.
If the FED would have raised interest rates many years ago when an asset bubble was becoming apparent then we could have possibly avoided such a big mess, but since they let this bubble extend out as far as possible without any attempt at curbing it when it does correct the FED is now left with very few tools to stimulate the economy. Interest rates are out. This leaves them primarily with printing money and deficit spending to raise inflation rates. They also have a few other tools, like raising the price of commodities artificially (see Gold Reserve Act). All of these methods will lead to the eventual destruction of the dollar and of any debts that are denominated in dollars, if and when another recession comes the government is left with the only option of destroying the dollar to save the economy. Now a destruction of the dollar is obviously a far off tale right now, but if this next recession comes then it is very likely to be the government's last resort to stimulate the economy and prevent a total financial collapse. Chances are it won't work to prevent a total collapse and the US will lose its position as the reserve currency of the world and we will fall into an extended period of economic turmoil. This will continue until there are "Substantial reductions in the budge deficit, monetary reform, and a fixed exchange rate." (Kiguel 1989) with outright elimination of the deficit being the most important factor.
