“So the Fed kept filling up the punch bowl and instead of going into inflation of goods prices, it went into an inflation of asset prices. That’s inflation in the same way, but it’s not called inflation. So if the stock market goes up and doubles, we don’t say, ‘Oh, my God—there’s been inflation!’ Or, if housing prices double, we don’t say, ‘Oh, my God—there’s been this enormous inflation.’ We say, ‘Oh, how much richer we are!’ But the problem is we’re not richer. It’s simply an illusion of richness.” (Clip from documentary, Money for Nothing)
In nominal terms, the stock market has now exceeded its two last major peaks and has shown, so far, only minor signs of slowing down. Many, like Jim Bruce, the director and producer of the documentary above, believe that much of the market’s gains are largely due to one thing: the Fed.
Ironically, as the Federal Reserve is about to celebrate its 100th-year anniversary on December 23, 2013, Bruce tells listeners in a recent Financial Sense Newshour interview that investors should probably expect a large amount of volatility next year as the Fed faces two major transitional events: unwinding its massive stimulus program and a change in Fed leadership from Ben Bernanke to Janet Yellen.
I worry to the extent that the Fed has given support to the stock market that is largely psychological…now there’s this question of how is the Fed going to take money out of the system? How is the Fed going to unwind these policies? This is all sort of the reverse of those happy days. I feel it’s going to be very difficult terrain for Janet Yellen—really for anyone to navigate; and Janet Yellen is going to do it as a new chair that’s viewed as untested; and I think if you look at the last two transitions—the transition to Greenspan and the transition to Bernanke—they were very rocky periods. So, again, I don’t want to be too pessimistic, but I just think investors should consider the risks right now that this isn’t a very easy or smooth process for unwinding QE or transitioning to new leadership at the Fed.
As with many investors, one thing that particularly worries Bruce is the danger of another bubble in the stock market and the damage such bubbles tend to unleash when they finally burst. Does the Fed worry about this too? Bruce interviewed Janet Yellen for the film and asked her this question. Here’s what he had to say:
To me, it was very interesting in talking to Janet. I think she shares some of my concerns with the dangers of asset bubbles. I think she’s someone who, after she was at the Fed in the 90s and then again at the Fed in the 2000s—she was there during both the stock and housing bubbles—and I think her having experienced those bubbles and their enormous consequences, I think she believes the Fed should be concerned about asset bubbles. But, the interesting thing is when she was interviewed for her Senate confirmation hearing recently, she said she didn’t see any risk in the stock market right now. To me, that’s the fascinating part about markets, because I think there are some very experienced people who are starting to warn about today’s valuations in stocks and are saying that it’s being driven by the Fed and yet she’s about to take over as the chair of the Fed right now and while she thinks the Fed ought to be worried about an asset bubble, she doesn’t perceive risk today—in today’s markets at today’s prices. You know, I worry about history repeating itself because if you look at 2005 just before he became Fed chair, Ben Bernanke went on CNBC saying he didn’t even believe in the possibility of a housing bubble at that time. And so I worry that the history of the Fed is that they’re not able to see problems coming in advance—they’re only able to see them afterwards when it’s too late. And so my concern is not that Janet Yellen doesn’t believe that bubbles are dangerous but that she doesn’t believe the Fed is fueling what could be a somewhat dangerous stock market right now and could only become more dangerous if it continues to move up another 10, 20, or 30 percent. She could be inheriting a problem that she doesn’t even recognize yet.
The remainder of this audio interview with "Money for Nothing" film Producer/Director Jim Bruce is available for subscribers. You can listen to it by CLICKING HERE to subscribe. In addition to hearing from money managers, institutional investors, and other experts regularly interviewed for FS Insiders, you’ll also gain access to our entire archive of past interviews.
