The Biggest Bubble is About to Burst! What Would the Fed Do?

The biggest bubble in history

Commenting on the phenomenon of the excessive inflation in stocks, Michael Harnett, Chief Information Officer of the Bank of America, said that long-term low-interest rates have made the collapse of the whole system inevitable. Since the launch of QE1, the US stock market has risen 269%!

Also, the “e-Commerce” bubble composed of Amazon, Netflix, Google, Twitter, eBay, and Facebook rose by more than 1000% from the low point in the financial crisis in 2009, and now it has become the largest ever bubble.

How did this bubble come from?

There may be countless contributors and factors behind this huge bubble, but the Fed has become a widely-recognized culprit. Many analysts and economists even regard the Fed’s stimulating behavior as the primary factor that has led to a sharp rise in stock market valuations and excessive speculation.

Don’t forget that the global financial crisis that happened 12 years ago was an inevitable consequence of the bursting of subprime mortgage and other debt bubbles. The bursting of the bubble caused market panic, investors withdrew high-risk speculative bets such as stocks, real estate, and junk bonds, and funds of trillions of dollars fled in panic.

Twelve years later, the Fed seems to be repeating the same mistakes. The Fed’s actions and its implied meaning have fueled a bubble in the U.S. corporate credit market. As a result, the three major stock indexes repeatedly broke new records, and at the same time, the scale of debt has swelled again. However, the growth rate of real collaterals seriously mismatched with the growth rate of debt, which could eventually cause a burst of the bubble.

The options and time left for the Fed are running out

Fortunately, the Fed seems to be aware of the “overdue”. In the January resolution, the Fed announced that it would adjust the scale of repurchase operations in the first half of the year, eventually slowing down the rate of debt purchases. The Federal Reserve Bank of New York announced the new arrangement of repurchase operations on Thursday, saying it would reduce the scale of overnight repo operations from Friday and continue to shrink the scale of liquidity injection.

As can be seen from the Fed’s balance sheet, the size of its assets has remained unchanged for eight weeks. The problem is that the bubble still exists, and it is destined to burst. The Fed has two options right now. It could either reduce its rate of injecting liquidity and allow 25% to 30% of speculative excess returns to slowly evaporate and bear the consequences of market decline, or leave it alone until the stampede occurs and the market crashes. What would the Fed choose between them? Let’s wait and see.