“The events of the past decade demonstrate the enormous human costs of asset price bubbles and crashes.” – San Francisco Fed President John Williams, September 2013
And yet, here we are again. The Federal Reserve has now enabled the creation of a third equity bubble in hardly more than a decade. It has enabled this, in part, by intentionally targeting equity prices in a vain attempt to create a “wealth effect” that economists have known for decades does not exist – as consumers spend based on their view of lifetime “permanent income” and not based on fluctuations in volatile assets. The Fed has also enabled this, in part, by ignoring the inverse relationship between government/household deficits and corporate profit margins (which make equity valuations seem only modestly elevated on the basis of temporarily bloated earnings, even while stocks remain steeply overvalued on cyclically normalized measures). This week, the Federal Reserve is likely to make a small step toward addressing this mistake.