Amidst the turmoil in the U.S. equity markets, it’s helpful to pull back and review the history of the Fed’s actions–something we’ve been chronicling in real-time in the Lara-Murphy Report. As the chart indicates, it was crystal clear that the Federal Reserve blew up asset bubbles with its multiple rounds of Quantitative Easing (QE) following the financial crisis. Now that the Fed is letting its balance sheet shrink, it’s no wonder that the markets are plunging.
(Note that I’ve fiddled with the ranges on the two y-axes to get a nice fit, but other than that I didn’t tinker with the plots.)
As the chart illustrates, there was a very tight connection between the Fed’s total assets (red line) and the S&P 500 index (blue line), from late 2008 up until Trump was elected. This was why Carlos and I were saying all throughout the Obama years that the alleged economic recovery and the booming stock market were built on quicksand; they were merely artifacts of the Fed pumping trillions of dollars of liquidity into the financial sector.
Now it’s true, the stock market started rising steadily when Trump was elected. I have no problem attributing that jump in equity prices as due to “fundamentals,” meaning that investors reevaluated the tax and regulatory situation when they had been expecting a Hillary Clinton Administration, and concluded that corporate profits would be higher under Trump.
However, as the Fed has been letting its balance sheet shrink–in what I’ve dubbed “Quantitative Hardening” or QH–we should expect the stock market to come down as well. To be clear, my view isn’t based merely on two lines plotted on a chart. It is informed by my understanding of Austrian business cycle theory, in which artificially low interest rates lead entrepreneurs to make “malinvestments,” i.e. to fund projects that appear profitable in the false prices of the boom, but for which the economy does not have genuine savings to bring to completion.
To better understand what’s driving the economy, and to discover how you can use Nelson Nash’s “Infinite Banking Concept” (IBC) as part of a defensive strategy, check out the free samples and subscribe to the Lara-Murphy Report.