Bernanke, our beloved drug dealer

“We had two bags of grass, seventy-five pellets of mescaline, five sheets of high powered blotter acid, a salt shaker half full of cocaine, and a whole galaxy of multi-colored uppers, downers, screamers, laughers.” is a quote from Thompson’s book Fear and Loathing in Las Vegas. However if you thought it was a banker talking about QE, you were not too far off.

The analogy with Quantitative Easing is that since first announced by the fed at the end of 2008, QE became a source of comfort for investors. Unlimited amounts of dollars would be printed and used to purchase all kinds of assets. Eventually, investors with their new drug became more and more confident and risky assets like junk bonds saw their prices soar.

Many argue that the stock market is in a bubble. To me, it doesn’t look like one. Albeit, what is sure is that QE has a strong influence on stock and bond prices. So when our beloved drug dealer sends the customer into rehab, a period of adjustment will surely occur.

QE CHART

The fed thesis for using QE is a Keynesian one. The idea was to provide liquidity to the market at a time when the largest banks were insolvent. The decrease in rates would then revive consumption and confidence in the markets would follow.

However, I am convinced that no Fed official anticipated the formation of new bubbles so quickly. At the time in 2008, all they could focus on was a bursting housing bubble and a global financial crisis. None of them took into consideration that markets are forward looking so that by the time confidence and consumption are restored, a new bubble would have formed and they would be back at case 0.

In fact, it is only in June 2013 that Bill Dudley (FRB-NY) who is a voting member of the FOMC: added a third mandate to its dual one, namely financial stability: “Financial stability is a necessary prerequisite for an effective monetary policy.

Furthermore, Richard Fisher (FRB-Dallas), who is a non-voting member of the FOMC this year: acknowledged that the Fed is monitoring market movements. However, he suggested that the Fed has become concerned about bubbles that have developed in a number of financial markets, mentioning EMs, REITs, and junk bonds specifically.

If new bubbles emerge from QE, Bernanke will surely not be the only one to take the blame. Market participants will be blamed too and the whole cycle will start once again.

“A drug is not bad. A drug is a chemical compound. The problem comes in when people who take drugs treat them like a license to behave like an asshole.”
― Frank Zappa, The Real Frank Zappa Book

Georges Boustany

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3 responses to “Bernanke, our beloved drug dealer”

  1. Marc Semaan says :

    Hi Georges, congratulation for your first blog.
    I just want to comment on your statement concerning the stock market bubble. The Fed intervention is manipulating bond yields which is affecting the equity risk premium which means that securities are not correctly priced. If you go back to fundamentals you can see the decoupling between the asset pricing and the real value of these assets.. i don’t believe that the market today, where the world growth is so weak, deserves a record high prices.

    • Buzzonomics says :

      Hey Marc, Thanks for the comment!

      I absolutely agree that the fed is manipulating markets and that prices do not reflect reality. But, I do not think that the stock market is in a bubble yet. Forward S&P P/E is around 14, that’s not cheap but not bubbly 🙂 I think at 16x you could start talking about a bubble.
      Prices by themselves don’t mean much, the market is forward looking and for this reason its hard to tell if current valuation is warranted or not. Right now, S&P forward earnings are at a record high and profit margins are very high too. That’s what’s driving high valuation. But for it to continue, there must be growth and revenue increases.
      I actually think, it’s a good thing for the fed to taper a bit at year-end. This way, the recovery will last longer and the chance of a bubble is lower.

  2. 1258 says :

    what might trigger the popping of this bubble? In 2000, it was interest rises plus a few high profile bankruptcies of dot.com businesses that had run out of cash, and Nasdaq crashed. The good news was that it wasn’t a debt-fueled bubble (unlike the US housing market) and the losses incurred weren’t systemic.

    History repeats itself in broad terms, but each cycle is different. It does seem there are more companies with real cash flow underpinning the mania this time around, and – partly as a result of the infrastructure built in the last investment boom leading up to the crash of 2000/2001 – there are real productivity gains and service innovation for consumers and businesses which are impacting every day life.

    No denial that we’re in bubble territory, and its timely to issue health warnings to retail investors spending cash on equity at these prices (as opposed to companies issuing over-rated paper as an acquisition currency), but I believe history will judge this period as one of ‘creative mania’. As long as we keep debt out of the picture….

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