In 2018 Fed chief Powell promised to raise rates and make progress using the Quantitative Tightening (QT) program to reverse out the asset purchases of the QE program. But by December 24, 2018 stocks had dropped about 20% since the previous high point of stocks that was reached in September, 2018. Powell decided to end the QT program and start cutting rates instead of continuing to raise them.
When politicians get elected after promising to cut government spending they often catch an illness called Potomac Fever when they start working in Washington. This illness results in them suddenly empathizing with various special interest groups that want handouts at taxpayers’ expense; thus they break the pledge to cut and instead raise spending. With Fed chiefs, they end up breaking a pledge to cut the opportunity cost of artificially low yields incurred by savers and instead reverse course because they feel sorry for stock market participants hurt by a crash. They somehow “forgot” to help retirees on fixed income who seek a yield from bonds.
I think the reason for Fed chiefs catching this disease is because no one wants to the “man with the pin” who popped the giant financial bubble. This reminds me of when investing great Stanley Druckenmiller couldn’t resist buying bubbly tech stocks at the top in 2000, lost a little and was able to get out and later commented that he “simply couldn’t help myself” from buying tech stocks at the top because he was frustrated at other investors making money. Prominent investors and Fed chiefs do succumb to emotional impulses despite high intelligence and good experience.
What it means to be the man with pin who pops the bubble is that most people will hate you for causing a crash, a stock market meltdown, a recession, etc. Yet few recognize that in making stocks too high this hurts young people starting out in their 20’s trying to buy a house and stocks, since they will be forced to pay ruinously high prices resulting in a high likelihood of them experiencing a Japan-style deep crash where huge unrecovered losses occurred. The Nikkei crash started on 1-2-1990 and is still 38% below the top after 30 years, with some real estate down 90%, and some mortgages were sold at a 95% discount. The people who were young in Japan in 1990 have spent their entire working life being exploited by this problem, resulting in ongoing underconsumption that has resulted in low economic growth. The Nikkei crash was caused by Japan’s central bank chief who realized the 1980’s bubble was too big, with stocks trading at 4 or 6 times fair value. Perhaps the Confucian tradition of East Asia, that requires orderly behavior, inspired the central bank chief to crackdown because of being offended by the disorderly aspects of an ever-accelerating bubble. What worries me is the more democratic non-Confucian countries like the U.S. and Australia may lack the willpower to pop their bubble and thus we could have a “melt-up” where stocks go uncontrollably and insanely higher; then eventually the inevitable drop from a very high place down to fair value would be quite deep. Assuming PE10 theory is correct then fair value is roughly 1,500 for the SP, a drop of 55%. Jeremy Grantham said sometimes bubbles go to four times fair value (true for Japan in 1990, US Nasdaq in 2001, US NiftyFifty in 1974); if so, that implies, in my opinion, the SP would spike up to 4x 1,500 = 6,000, then drop 75%. Nasdaq crashed in 2001, where it took over 12 years to breakeven before counting Present Value and tax anomalies; those items would require a wait of 15 years to breakeven.
When Fed bubble making results in artificially low rates then savers are forced into a deflationary lifestyle of cutting consumption and increasing savings, the opposite of the policy intentions; also this triggers a climate of lower consumer confidence sending economic ripples that create more problems. Some savers react by switching to aggressive placing of high risk bets on flaky pseudo-investments, instead of cautious fundamental investing. Ultimately most people won’t be happy with a rollercoaster ride of high risk betting outcomes; thus their eventual unhappiness would result in more deflationary economic results.
Investors need independent financial advice about the risk of melt-ups and giant crashes.