The Federal Reserve has abandoned monetary policy normalization. Instead of guarding against the risks of fueling asset price bubbles, the central bank has chosen to resort to initiatives that were adopted in the aftermath of the global financial crisis. While the End the Fed crowd had warned about the Eccles Building swaying markets into bubble territory, the central bankers, pundits, and prominent investors dismissed this as conspiratorial talk that only those crazy folks from the Mises Institute dabbled in and obsessed over. Today, however, both the Fed and the pillars of Wall Street are conceding that easing is indeed affecting asset prices. It is incredible because the go-to talking point for years had been that printing money and cutting interest rates do not blow market-wide bubbles.
What happened? Did the Swamp suddenly pass legislation that bans lying in the U.S. or something?
QE or Not to QE
Dallas Fed Bank President Robert Kaplan sat down for an interview with Bloomberg News, and it was a compelling interview because it was a rare moment of candidness by a member of a clandestine organization. Essentially, Kaplan conceded that low interest rates and the expansion of its balance sheets are contributing to the dramatic surge in asset prices.
“My own view is it’s having some effect on risk assets,” Kaplan said. “It’s a derivative of QE when we buy bills and we inject more liquidity; it affects risk assets. This is why I say growth in the balance sheet is not free. There is a cost to it.”
Kaplan, who participates in the Federal Open Market Committee (FOMC), is urging the central bank to be cautious about expanding the $4.05 trillion balance sheet even further. Despite the Eccles Building only recently tapering the taper and triggering a massive increase in the balance sheet, Kaplan believes it is “very important that we come up with a plan and communicate a plan for winding this down and tempering balance sheet growth.”
Although the country is facing a huge election in less than ten months, Kaplan does not think there will be any adjustment to policy, and his general support for current actions will not waver. In the end, according to Kaplan, the Fed will “do what’s right for the U.S. economy.”
For those unfamiliar with Fed policy, Kaplan’s remarks are about as significant as Representative Al Green (D-MI) admitting that the impeachment process is only about ousting President Donald Trump from the White House and not about principles nor the constitution. And, like the impeachment sham unfolding in Washington, it has been clear to anyone who has paid attention to monetary policy and the stock market that the Fed, at the very least, is facilitating the seemingly overvalued record highs we are witnessing every day.
Most Awesome Force
Data from Bloomberg and Morgan Stanley point to the S&P 500 generating higher returns when the Fed balance sheet is expanding. It makes sense because if the Fed is cutting rates and growing the money supply, the central bank is constructing a pipeline from the printing press to Wall Street. The easy money flows into the stock market, feeding the acceleration and appreciation of a whole host of asset prices. And this is what everybody is suddenly realizing.
Critics of the Federal Reserve System typically say that it is the most powerful institution in the world. Reading about the daily intricacies of the organization shows that it possesses omnipotent power that allows it to influence markets, drive investor behavior, make or break presidencies, and fuel the booms and busts of the business cycle. To paraphrase Howard Beale from Network, the Fed is the most awesome force in the whole godless world, and woe is us if it ever falls into the hands of the supposed smartest men and women in the room.
The Fed wields so much power that investors hang onto every word emanating from any central banking official. Its supremacy over the planet was evident in the months leading up to the Fed cutting interest rates for the first time in several years. U.S. financial markets ebbed and flowed based on what Chair Jerome Powell or Federal Reserve Bank of New York President John Williams had to say, prompting analysts and investors to comb through prepared speeches or offhanded remarks. The Street searched through any statement, no matter how innocuous or irrelevant.
The history of the Fed’s impact on markets has been well documented over the years. Students of the Austrian School of Economics have produced volumes of works that assess its participation in the 1929 stock market crash, the 1980s savings and loan scandal, and the 2007-2009 financial crisis.
Investors have now seen a connection between the Fed’s fourth round of quantitative easing (don’t call it QE!) and the steady increase in asset prices. Every day, it appears the stock market is recording new highs. Since rate cuts take four to six months to get priced into the market, it makes sense why we are witnessing these daily records. Is it any wonder President Trump keeps pushing the Fed to slash rates? The lower they go, the more they benefit Trump’s re-election chances ahead of November because it is all about the economy, stupid.
Tired of Winning?
If the day ends in “y,” the stock market is posting another record high. When this used to happen, champagne flowed from the heavens and former Fed Chairs – Alan Greenspan, Ben Bernanke, and Janet Yellen – would do the shimmy shake to celebrate. Now that it is happening all the time, we are indifferent to all this winning. This common occurrence has triggered apathy among millions of Americans who look to their 401(k) accounts and shrug or sigh as they see more dollars added to their net worth every month.
Wait a minute. Isn’t this precisely what President Trump promised during the 2016 election?
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