All your base are belong to us.
-- Phrase from the intro of video game Zero Wing
Is this what Federal Reserve Chairman Ben Bernanke had in mind when he spoke of the virtuous wealth effect that would develop from quantitative easing (QE)? In yesterday’s trading, Bitcoin, the peer-to-peer digital currency, hit another all-time high against the dollar. Over the past year, it is up over 3,000%, besting any asset class I can think of.
With short-term interest rates being held at an all-time low for almost five years now, the rise in speculative assets such as Bitcoin should come as little surprise. Investors have run out of patience in waiting for the Federal Reserve to end its manipulation of the risk-free rate and are increasingly seeking out riskier assets in an attempt to keep up with inflation and grow their wealth.
As investors love nothing more than a good story, Bitcoin is a natural candidate for their marginal dollar. It is becoming a global means of exchange at a time when central banks throughout the world are attempting to depreciate their currencies. Combine this story with a price chart that is turning vertical and you have makings of a historic bubble.
This could very well be a prelude to what will happen in US equities if the Federal Reserve maintains its current policy of record easing. And perhaps this is what the Fed wants given its stated objective of increasing stock prices. However, at a certain point, the silent majority may begin to revolt as the disproportionate beneficiaries of rising stocks prices are the top 1%.
In a few months' time, the Federal Reserve’s balance sheet will cross the $4 trillion mark, up over 300% from the beginning of 2008. Meanwhile, real median household income continues to decline, indicating that the average American household is becoming poorer, adjusting for inflation. The supposed wealth effect for many is nonexistent.
It is becoming increasingly clear that the primary beneficiaries of Ben Bernanke’s wealth effect are financial assets, not median income or employment. Unfortunately, the Federal Reserve seems to have learned nothing from the aftermath of the dot-com and housing bubbles of the recent past. Like politicians, they never ever admit wrongdoing or acknowledge the negative effects or unintended consequences of their policies.
As such, you can expect the status quo to continue and more frequent bubbles to develop in the coming years. Few individual investors will benefit from these bubbles and many more will suffer in getting in near the top using leverage as they did with dot-com stocks in 1999-2000 and housing in 2005-2006. But don’t expect Ben Bernanke or Janet Yellen to assume any of the blame.
In a 2002 speech, Ben Bernanke referenced Milton Friedman’s “helicopter drop” of money as a way to fight deflation. If given the choice, I think most Americans would prefer this approach to the current policy. In today’s market, a virtual drop of Bitcoins might be the most popular of all.
No positions in stocks mentioned.
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