Bubblenomics

The Bubble is back. In a world of paper money, then Chairman of the Federal Reserve Alan Greenspan commented that part of his job was to make sure that paper money retained value as if it were gold. At that time, I took his comment to apply strictly to the framework of inflation. Yet since then, I have seen that his comments also referenced asset inflation or "bubbles." 

Although Chairman Greenspan claimed that he did not have the ability to spot bubbles, he did take action against the Tech Bubble of 1999. He consistently tightened money supply until short-term and long-term rates reached high levels despite a notable absence of inflation. What was he acting against if not the perception of a bubble?

Those actions contrast sharply with the current market. Despite similar bubbly valuations in a wide range of noticeably unprofitable companies such as Snowflake or Tesla, the Federal Reserve is forced to support liquidity and market euphoria. With political tension in rapid decline, people are able to turn their attention to the dramatic rise of the stock market and ask themselves, "does this make sense?"

I finally understand why the Fed always takes away the punch bowl when the party gets fun. It is not simply so that inflationary structures get built in. It is also to discourage speculation and gambling as activities that denigrate the fundamental concept of hard work as the way to build wealth. There is a moral structure built into the Fed's design. Further, the Fed has to be careful about how many "white elephants" get built with cheap capital combined with rosy projections. Those structures are sunk costs.

But as long as the Fed is required to support a Covid-impaired economy, it appears to me that the punch bowl is here to stay.  It will be taken away at the first opportunity. When that punch bowl removal happens or is perceived to be likely, the notion of a punch hangover will wreak havoc on valuations in these bubbly areas. Caveat investor.