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.
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