There is a lot misunderstanding out there related to what conditions lead to bull or bear markets in stocks and other risky assets. One that is particularly misguided is that simply making interest rates lower will lead to higher stock and risky asset prices.

Clearly, this is the view of most people on Wall Street and also of most people in the government and the Federal Reserve such as Tim Geithner and Ben Bernanke. Unfortunately, the evidence from a long historical review of monetary policy does not support this view at all.

It is true that, in the very short run of a few months to a year, something like quantitative easing that floods the system with excess liquidity will lead to higher prices for risky assets. However, over the long run, this temporary increase in asset prices is always reversed.

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Japan specifically has tried this four times during the past 12 years and it has never worked for more than a year or so. You also can look at the U.S. during the 1930s. Interest rates were very low and the government was flooding the system with money, but stocks and other risky assets failed to reach 1929 levels until the 1940s boom created by World War II led to a huge increase in corporate profits and a decline in unemployment.

The opposite case of higher interest rates coinciding with bull markets also is easy to find. Interest rates steadily rose throughout the bull market of the 1950s and 1960s. Even during the 1970s bull markets in commodities continued, though stocks faltered, as interest reached extremely high levels.

It wasn’t until interest rates soared to over 20 percent in 1980 that these bull markets were crushed. Interest rates remained in double digits or the high single digits, very high by today’s standard, for most the 1980s even as stock and real estate markets boomed for most of the decade after 1982.

In the 1990s interest rates, especially real interest rates adjusted for very low inflation, were much higher than today and stock markets had their best decade ever. This was in part because commodities had one of their worst decades ever, but high interest rates didn’t seem to slow down the stock bull market at all in the 1990s.

What all of these academic types and central bankers don’t understand or want to accept is that bull markets are caused by stable money combined with free markets and consistent rules of the game.

Manipulating interest rates to artificially low levels temporarily can increase risky asset prices like we saw from 2003 to 2007 or from 2009 until now, but all this does in the long run is cause massive distortions in the market and allocation of capital away from good investments and into speculation.

The long-term effects of zero or other extremely low interest rates in a deflationary environment like we have are asset bubbles that crash and cause even more economic problems. They say one definition of insanity is repeating the same thing and expecting a different result. Maybe what we need at the Fed and Treasury are some good psychiatrists rather than economists.

Ironically, these misguided monetary and fiscal policies ultimately should lead to higher bond prices and lower bond yields over the long term because economic growth and inflation actually will be lower.

This is because capital is being misspent on unproductive things like speculation and consumption rather than investments that will create growth and jobs. Unemployment will stay high for a long time with these policies.

The implication for investors is that this is actually a good buying opportunity in anti-risk assets such as Treasury Inflation Protected Securities ($TIP) or even long term Treasuries ($TLT) or highly rated municipal bonds ($MUB).

Attempts to create a bull market with zero interest rates ultimately will fail. Only by allowing freer markets, stable money, and consistent rules of capitalist game will we get any long-term growth in our economy and a real bull market in stocks.

Commodities are extremely overheated right now because of combined strong demand in emerging markets and speculation caused by excessive liquidity provided from central banks in the U.S., Japan, and Europe. Although commodities are probably the best way to speculate on continued excessive money printing, this sector will also be the hardest hit on the next correction and is extremely overvalued by historical standards. Emerging market central banks are tightening to deal with inflation.

Ultimately, commodity prices will have to come down or many of these emerging economies will be crushed by inflation and social unrest as is now happening in Egypt. If you’re a sophisticated and nimble trader, you may be able to still make money speculating in commodities before the bubble bursts, but you should not look at commodities as a long-term investment at current prices. They are vulnerable to very significant declines, with metals and agriculture being the most overvalued and energy being the least overvalued. Owning energy stocks such as Energy Select (SPDR ETF $XLE) is probably the safest way to participate in the commodity rally at this point.

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