Fed’s Policies Have Created Stock Market Bubble

The last few weeks have come with increasing turmoil in equities markets.  One day last week the Dow dipped nearly 600 points, only to recover nearly 450 the next.  The market’s gyrations are occurring after their values had been relatively flat for the past year.  This is problematic since prior to the flattening, increasing equities’ valuations masked broader weaknesses in the economy.  For example, increasing equity values offset some losses inflicted on parts of the economy due to the low interest rates that decreased returns on fixed income investments.

The signs are clear; the equity bubble is at risk.  Many blame the volatility on problems with the Chinese economy.  However, as this Blog has proffered previously, Federal Reserve and US governmental policies are the culprits.

The Fed has used artificially low interest rates since the latter part of the 1990s to gin up the economy any time there were signs of strain.  This often repeated blunder created increasing imbalances by disrupting the most basic laws of supply and demand; i.e. this led to economic bubbles.  The US government also ginned up the economy with increased deficit spending, sometimes called “stimulus”.  Now that the economy is cooling, neither the Fed nor the US government has much ammunition left to forestall the next downturn.

Bubbles have been the bane of economies before the Federal Reserve was created.  In fact, one reason the Federal Reserve was created was to smooth out economic bumps through monetary policy.  However, since the 1990s, Fed policy has instead fed bubble creation.  When the dot.com bubble popped, the Fed relaxed monetary standards to bring the stock market back.  It was more aggressive after the 9/11 attacks.  However, the mother of all easing has occurred since the 2008 meltdown with interest rates remaining near zero and with three rounds of Quantitative Easing used.  The weakness of economic growth since shows the fallacy of such interventions.

Supply and demand need to revert to mean in the long term, irrespective of governmental policies.  The adjustment can be delayed, but never eliminated.   When the economy ultimately re-balances, the pain will be more significant than had the interventions not occurred.

The European Central Bank (ECB) has been no better with its macroeconomic policies.  It too has resorted to Quantitative Easing (money printing) in an effort to stop its economy from rebalancing.  This effort has been at best marginally successful.  In fact, today the ECB announced still further easing.  We should expect a similar announcement from the Federal Reserve in an effort to reverse the downward trend in equities markets.  Sooner or later this bit of alchemy will fail and the resulting correction will be ugly.

Tony Sagami of Mauldin Economics posted an article titled “Buy the Dip? Hell No! Sell the Rip Instead” that lays out the economic challenges facing the world’s economies in more detail.  How and when the economic correction will play out cannot be predicted.  However, the reality that the laws of supply and demand will be satisfied is a guarantee.