This Is How Long the Bubble Will Last
THE underlying economy (U.S. and global) has a strong deflationary bias. Central banks can’t tolerate deflation, so they respond with inflationary measures such as money printing, zero rates and guarantees of all major securities markets.
Those policies won’t actually cause inflation, for reasons explained below. But, they will cause bubbles in certain asset classes, especially stocks.
There’s a serious question as to whether the central bank “inflationary measures” will actually work. They won’t.
Powell can talk all he wants about asymmetric inflation targeting and letting the economy run a little “hot” for longer than expected, as he did in his Jackson Hole speech on August 27, but he doesn’t actually know how to make inflation happen.
As I’ve stated repeatedly, money printing alone doesn’t cause inflation without velocity. And right now velocity is dropping sharply, as it has since 1998.
Nobody Understands Inflation!
Libertarians, Austrian School economists, Monetarists and Neo-Keynesians all got it wrong. They yelled that Fed “money printing” would lead straight to inflation. What they missed is that money printing does not cause inflation. It’s velocity (the turnover of money) that causes inflation.
Velocity is a psychological phenomenon outside the Fed’s control (unless the Fed wants to bid up the price of gold, which is not even remotely being considered at the moment). Not only is inflation not a danger; deflation is much more likely and is a much greater danger to the financial system.
Deficit spending also does not cause inflation when government debt levels are over 90%; right now they’re 135% and climbing. Inflation also does not happen when there’s slack in the economy, such as 30 million unemployed.
So, there’s no real inflation threat on the horizon.
There’s no doubt that inflation will emerge in the end. But, the timing is tricky; it could take several years of monetary ease and dollar debasement (mostly relative to gold) before inflation finally takes off.
It took a long time to switch the consumer mentality from inflation to deflation and it will take a long time to switch it back again.
This does not mean that money printing has no impact. It does. Money printing may not cause price inflation, but it does create asset bubbles in stocks, bonds, real estate, commodities and other asset classes.
The most likely impact of Powell’s new Fed policies is therefore not consumer inflation, but asset bubbles. These have already emerged.
Of the various assets, real estate is a mixed-bag now because low interest rates, which help values, are being offset by mass migration from the cities, which hurts commercial real estate values.
There’s a lot of skepticism in the bond markets because interest rates are already so low. Rates will go lower, even negative, but skepticism puts a break on the bond bubble.
The one clear winner is the stock market.
How Long Can the Bubble Last?
With a fundamentally weak economy and a continuing pandemic, how much longer can the stock market melt-up continue?
Right now, my models are telling me that the stock market rally will continue as long as the Fed monetary ease continues or gets even easier.
There’s no end in sight for Fed ease, so there’s also no end in sight for the stock market rally. That doesn’t mean there won’t be bumps along the way. There will be, and stocks have pulled back since September 2.
But the trend is up.
Chart 1 below reveals this stock melt-up dynamic with great precision. The chart shows the three major U.S. stock market indices on a year-to-date basis.
The S&P 500 (SPX) is shown in orange. The NASDAQ 100 (NDX) is shown in purple and the Dow Jones Industrial Average (DJI) is shown in green.
All three major indices traced a similar pattern over the course of 2020, albeit with less volatility in the NASDAQ 100. All three achieved new all-time highs between February 12 and February 19 before the full-impact of the COVID-19 pandemic had been internalized by market participants.
All three also crashed sharply from February 21 (when the Italian data began to reveal that the disease was not contained in China) until March 23.
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