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The Stock Market Is a Debt-Fueled Bubble: Steve Keen

Stocks fell into the red ahead of the closing bell Tuesday and while the S&P 500 (^GSPC) went on to end its seven-day streak of gains, the Dow Jones Industrial Average (DJI) still managed to eke out its sixth straight day of posting an all-time record high.

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To point out the very obvious, it’s not likely to continue forever. But according to economist and author of the book Debunking Economics, Steve Keen, it stands to get much, much worse in the next one to two years.

Keen tells The Daily Ticker the U.S. stock market is a giant bubble. But the key factor inflating it may not be what you think, according to the economist (i.e. he’s not pointing fingers at the Fed…at least not directly).

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Keen has his eye on margin debt. This is the money people borrow from their stockbrokers to expand their holdings of shares. Keen says the ratio is now 70%, meaning with $300,000 you can borrow $1 million worth of shares.

Here’s where it gets interesting. Steve has found a relationship between the change in margin debt and the level of asset prices. Even more importantly, he points to a correlation between the acceleration in margin debt and the rise in asset prices.

If his theory holds true, this means we’re relying on the acceleration of margin debt to drive rising share prices. And when that acceleration slows down, equity prices will fall.

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“Nothing can accelerate forever,” Keen tells The Daily Ticker. “At some point the acceleration stops, and when it does the market breaks.”

Keen says margin debt levels in the U.S. now are similar to where they were in 2000 and 2007.

“So I think you haven’t got a lot of head room there,” he notes.

As far as the breaking point, Keen, who is credited with predicting the global financial crisis, says, “given such a high level of margin debt-to-GDP, I think that comes in the next one or two years.”

He sees what he believes is a stock market bubble bursting in the U.S. the way Japan’s did in the 1990s. The bubble popped in late 1989, and the Nikkei (^N225) fell 63% in less than three years, but didn’t hit bottom until 2003.

“I think we’re in a long slow bleed, much longer and slower than the Japanese stock market crash, but there’s similar dynamics,” he predicts.

“In 500 years time people will look back and see this as the biggest debt-financed bubble in human history and ask, ‘why didn’t we realize it,’” Keen says. “But we think it’s normal.”

Keen is currently working on a new program for modeling the economy to include private debt, often overlooked by economists, called Minsky.

Lauren Lyster is the host of The Daily Ticker and Hot Stock Minute. You can follow her on Twitter at @LaurenLyster.

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