In spite of a bit of recent weakness in the stock market, it is hovering in the area of all-time highs. Just a week ago, the Dow Jones Industrial Average stood at $26,616, up thirty five percent in just the last year. That is a lot of increase, considering that gross domestic product increased just over two percent over the same time period. Advisors and analysts make all sorts of excuses for why these levels are reasonable, pointing to corporate profits that are at an all-time high for the year, the recently-passed tax cut, the “Trump Bump,” and a host of other justifications. The value of an investment, however, is based on how much it will earn, now and in future years. The record profits of 2017 are only about one and a half percentage points higher than they were in 2015, yet the index rose forty nine percent over the same period of time.
In spite of all of the justifications, the continued rapid rise of financial markets puts them in bubble territory. How long it will last is anybody’s guess, but, as happened in every bubble market before, it will eventually burst. At that point, various actors and events will be proposed as the cause of the debacle. It will be Trump’s fault or maybe a natural disaster will get the blame. Former Fed chairman Alan Greenspan famously blamed a prior bubble on “irrational exuberance.” However right he might have been about such exuberance, exuberance had a cause that neither he nor most other commentators care to talk about or even recognize.
A bubble market cannot occur without an increase in the supply of money. Without such an increase, a rapid rise in prices in one sector of the economy, such as stocks and other capital investments, would cause a decrease in prices in other sectors, such as food or other necessities. The Fed, however, has pledged to never let consumer prices decline, under the entirely false notion that declining prices led the downward spiral to the great depression. As dollars are siphoned out of consumer markets into financial markets, the necessary price decline in consumer sector is more than offset by increasing the supply of money to prevent decline and ensure mild inflation. That extra push, however, means that even more money is siphoned off to capital markets.
By preventing consumer prices from falling to adjust for unnatural price increases in financial assets, the fed not only hurts consumers directly, the low interest rates and expansionary credit policies it promotes penalize savers and incentivize speculators. This distortion leads businesses and individuals to make investments where they wouldn’t under normal circumstances. It is only after the bubble bursts and economic reality hits home that people realize the mistakes they made. The crash is when the damage, distortion, and waste of resources caused by the irrational, irresponsible central bank policies gets cleaned up. Until then, everyone enjoys the party.
The reason that we, as a country, or any other country with similar central bank policies, never learn from our monetary mistakes is that the real underlying cause is never identified. Instead, scapegoats are targeted. Though some people do deserve blame for nefarious acts, they invariably are bit players and not the kingpins.
When the inevitable meltdown does come, there will again be scapegoats. It would be better for President Trump it it happens sooner rather than later in the first term. The closer to the election that it occurs, the more likely he will lose , because he will be the obvious chump. The Fed will again be let off the hook, as though it was an innocent bystander, though innocent they are not.