The Mess that Greenspan, Bernanke, Yellen and Powell Made

The Federal Reserve did one thing with quantitative easing: it blew a giant stock market bubble. After 2020, it ignited a speculative fever that is still burning. Meme stocks exploded higher in August. Bitcoin ripped 10 percent yesterday. We are already nine months into a bear market, and 20 months in if you go by the meme stocks, and the speculators are behaving as if none of it happened.

I made this chart of Federal Reserve credibility. It is the inverse value of a bunch of meme stocks.

There are two ways to take inflation out of the system. One is a long period of higher interest rates and slow growth that chokes debt growth. The other is to nuke speculators such that rate cuts would cause only a ripple in the financial markets. How will speculators be wiped out? It will require normalizing monetary policy. Let a major bear market in stocks and commodities happen. And do nothing. Announce the Fed funds rate is at 4 percent and staying there. The Fed could provide some emergency liquidity if that's needed, but charge even higher interest rates on it. Force the market to bail itself out. 

Far from being an extreme policy, that is normal. Before Greenspan, the Federal Reserve didn't care that much about the stock market. If inflation is 2 percent, then a 4 percent yield delivers a 2 percent real return on bank savings. Think it should only be 1 percent? OK, the Fed cuts, but only to 3 percent. That's normalization.

My sense is the Federal Reserve is going there at least briefly. There will come a moment similar to December 2018. Back then, the Federal Reserve hiked rates in the middle of a 20 percent market correction, with bonds two months into a bullish reversal. They went against the market and panicked out within two weeks. A similar moment will come, but it will be far scarier for the financial markets. Then we'll see if the Federal Reserve has the guts to hold the line amid a temporary (yet brutal pricewise) freak-out by the bulls. If yes, they will normalize policy. If not, then we'll do it all over again: QE, runaway inflation, QT, crashing markets.