U.S. financial asset markets recovered from the Armageddon of 2008 more rapidly than other financial markets around the world. As can be seen in Charts 9.1, 9.2, and 9.3, since the beginning of 2013 financial assets have traded in the United States at spreads that are near (or even below) the complete market bands near the bottom of each graph.
Trading in this range represents attainment of the financial market equilibrium Adam Smith envisioned in 1776. As a consequence, the response of U.S. capital markets has been in line with the projections shown in the complete market row (top row) in Table 9.1. Complete market conditions mean that the cost of operating Smith’s great wheel of circulation is sustained at the minimum price necessary to keep it functioning—ideal conditions for growth of productive sector capital and wealth generally.
It is in these conditions that bubbles are most likely to develop and spawn the fear that creates new crises. Bubbles pose, therefore, a long-term challenge to the theory of financial stability. As credit spreads rise above equilibrium, it is clear that the ability of an economy to grow is impaired. As that rise becomes more rapid and significant, moreover, a financial crisis occurs. By observations made between 2005 and 2014, the United States now has sufficient experience with policies that benefit and harm markets to handle future crises of fear caused by high and rising risk spreads.
A final question we should ...