Even though the American stock market keeps hitting new nominal highs on an almost day-to-day basis, the economy is slumping along at a slower pace. This disconnect was caused by a substantial Fed experiment in capital stimulation.
Through the combination of seemingly endless maintenance of zero interest rates and the injection of some $1trillion a year of synthetic money into fixed-income markets, the Fed is hoping that the boom it is creating on Wall Street will lead to a boom on Main Street. In reality, this a very dangerous economic gamble of enormously high stakes. As we have seen in the recent past, financial bubbles can leave catastrophe in their wake.
In October 2013, Professor Robert Schiller, the renowned Yale economist, was awarded a Nobel Prize together with two others for research into asset bubbles and resulting values. In a recent interview in the German newspaper, Der Spiegel, he said, “I am not yet sounding the alarm. But in many countries stock exchanges are at a high level and prices have risen sharply in some property markets. That could end badly. I am most worried about the boom in the U.S. stock market. Also because our economy is still weak and vulnerable.”
However, there are many in the financial establishment who disagree with the professor, including, most interestingly, Professor Karl Case, the co-creator of the famous Case-Shiller Home Price Index. Most markets either believe that current share prices are fully justified by corporate metrics or they believe the Fed has expertise, and the ability, to prevent an ugly sell-off if things turn out badly. This debate has become the defining conversation as we head into the end of the year. However, those who believe that QE will produce positive results to compensate for the risks are finding their position to be increasingly difficult to defend. At the International Monetary Fund’s November annual conference in Washington, Mr. David Wilcox, reputed to be one of the Fed’s most important economic advisors, offered insight into some problems facing QE. In essence, he maintained that the Fed’s QE-3 program is producing only very limited results in terms of U.S. economic growth. At the same time, he seemed to hint that unlimited QE could create serious financial market distortions.