A Fed with no fear of inflation

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Morgan Stanley's Ruchir Sharma wrote an excellent op-ed in the FT ....He identifies the major flaw of the current system of inflation targeting: namely that secular global deflationary forces have pushed CPI inflation well below their c.2% targets, resulting in super-stimulative monetary policy. And although that can do little to drive CPI inflation up, it creates housing and financial market bubbles that the central bankers choose to ignore and which typically now precede recessions. For everyone loves an asset price bubble — until it bursts! (Albert Edwards at SocGen)

The ratio of stock market capitalization to corporate profits (before tax) at 22.3 is fast approaching the record high of the Dotcom mania in 2000.

Stock Market Capitalization/ Corporate Profits Before Tax

Compare 10-Year Treasury yield minus nominal GDP growth (pink) from 1960-1980 to the following two decades and then to 2000-present.

10-Year Treasury Yield - Nominal GDP Growth

Paul Vocker kept Treasury yields above GDP growth during his time at the Fed (1979-1987). This was continued by Alan Greenspan (1987-2006) but he blinked in 1998 and the Fed has grown increasingly dismissive of inflation risks since then. The only spikes above zero prior to 1979 and after 1998 are when there are sharp falls in GDP.



We are witnessing a stock market bubble equal to the Dotcom mania of the late '90s and the Fed is doing all that it can to support it! Risk remains elevated and investors should exercise caution.

Quote for the Week

The lesson of history, then, is that even as institutions and policy makers improve, there will always be a temptation to stretch the limits. Just as an individual can go bankrupt no matter how rich she starts out, a financial system can collapse under the pressure of greed, politics, and profits no matter how well regulated it seems to be.

~ Carmen M. Reinhart, This Time Is Different: Eight Centuries of Financial Folly


Colin Twiggs is director of The Patient Investor Pty Ltd, an Authorised Representative (no. 1256439) of MoneySherpa Pty Limited which holds Australian Financial Services Licence No. 451289.

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