Janet Yellen appeared before the Senate last week in the first step toward her apparent crowning as the new head of the Federal Reserve. The Senate Banking Committee asked a few tough questions but in general it was a love fest and no wonder. Quantitative easing has helped no group more than the politicians and the federal government they direct. The Fed is buying basically all the new debt spewing forth from the federal government’s balance sheet allowing politicians of all parties the freedom to concentrate on playing politics rather than the hard work of actually accomplishing something that might help the economy. With Yellen promising that QE will go on until the economy gets much better – something that seems farther away by the day – why rock the boat?

Yellen downplayed the possibility that Fed policy is blowing bubbles again saying that she doesn’t “see evidence at this point, in major sectors of asset prices, misalignments. Although there is limited evidence of a reach for yield, we don’t see a broad build up in leverage, where the development of risks that I think at this stage poses a risk to financial stability.” I guess if nothing else we can rest assured that Mrs. Yellen has attended the required Fed seminar on how to speak in public without anyone understanding what the hell you’re talking about. She was surely comforted by a report from McKinsey and Co. this last week that absolved the Fed of any responsibility for rising stock prices. The report concluded that QE has had no effect on stock prices and instead has had a distributional effect that has largely benefitted government.

Well, yes there has been a distributional effect as even Mrs. Yellen acknowledged in her testimony. Asked if QE has harmed savers, she said yes, “low interest rates harm savers, it’s absolutely true” but if they just thought about it for a bit they would realize that QE has helped them in other ways such as retirees being able to find a part time job to replace the interest income the Fed has taken away. In other words, who you gonna believe? Me or your lying interest payment? The McKinsey report helpfully quantified the effect and as I said before the biggest beneficiary was the US government which has seen a benefit of $900 billion in lower interest payments. Non financial corporations benefitted to the tune of $310 billion while banks got a boost of $150 billion. Households on the other hand lost a total of $360 billion in interest payments and insurance and pension funds (which benefit individuals) lost another $270 billion.

It is hard to reconcile a nearly $500 billion boost to corporation’s bottom lines with the conclusion that QE has had no effect on stock prices. It might help one understand the McKinsey report to remember that they once called Enron “one of the most innovative companies in America”. The report also debunked the idea that there has been a large shift to stocks from low yielding alternatives if you believe that dismissed means the same as debunked. Equity mutual fund and ETF inflows are set to reach nearly a half trillion dollars this year, more than the last 4 years combined. I guess McKinsey thinks that would have happened regardless of Fed policy.

I suppose there are arguments for both sides of the bubble debate but we are certainly seeing some worrying signs. Stock IPOs and new bond offerings are flying off the shelves, speculative stocks are leading the market and art auctions are setting records. Over the last two weeks we’ve seen a Francis Bacon tryptich sell for a record $142 million and a Warhol sell for $105 million. Commenting on the recent rise in prices an advisor to collectors said,

“Art seems to be a place where many ultra high net worth individuals feel comfortable parking large amounts of money. Money is cheap for them to borrow and they are looking for the strongest returns they can get.”

No build up in leverage you say, Mrs. Yellen? Cheap money is doing today what it has always done – inflate prices. It may not show up in the Fed’s preferred measure of inflation but last I checked money could be spent on a lot of things that aren’t included in the CPI, questionable art included (I’m talking about the Warhol). The Fed and Mrs. Yellen are making the same mistake they made during the dot com bubble and the housing bubble. They are assuming that since their inflation isn’t showing up in consumer prices that everything is just fine. And it will be right up to the point where it isn’t and then they’ll be scrambling to explain how this happened again.

Mrs. Yellen doesn’t see bubbles right now and that shouldn’t be surprising since the Fed has missed every one they’ve inflated. Every bubble we’ve experienced over the last 30 years from junk bonds to internet stocks to houses was a direct result of monetary policy and the Fed didn’t recognize any of them until after the fact, if even then. I’m not sure how high stock prices have to go before our new Fed chairperson would become alarmed but the market seems intent on finding out. Stocks were up again last week and it surely wasn’t from any improvement in the functioning of the economy or the outlook for corporate profits.

Janet Yellen will probably be confirmed as the next chair of the Fed. What that means for us as investors is that monetary policy will remain easy through QE and artificially low interest rates for a long time to come. Maybe she’s right that we aren’t in a bubble right now but if cheap money played a role in inflating the last two bubbles – and there seems little doubt that it did – we are surely headed in that direction. Yellen, in her testimony last week, said that “when there’s a lot of saving and not very much investment, which is where we are now, the natural forces of the economy are pushing interest rates down. It is these forces we are trying to cope with.” She’s fighting the good fight against savers with every tool at her disposal. Why can’t I get the phrase “tilting at windmills” out of my head?

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For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, Joe Calhoun can be reached at: jyc3@4kb.d43.myftpupload.com or   786-249-3773. You can also book an appointment using our contact form.