A critical element for investors to consider is that the Fed is not forward thinking when it comes to monetary policy. Indeed, if we reflect on the last 15 years, we see that the Fed has been well behind the curve on everything.
First and foremost, recall that Alan Greenspan was concerned about deflation after the Tech Crash (this, in part is why he hired Ben Bernanke, who was considered an expert on the Great Depression).
Bernanke and Greenspan, both fearing deflation (Bernanke’s first speech at the Fed was titled "Deflation: Making Sure It Doesn't Happen Here"), created one of the most extraordinary bouts of IN-flation the US has ever seen.
From 1999 to 2008, oil rose from $10 per barrel to over $140 per barrel. Does deflation look like it was the issue here?
Over the same time period, housing prices staged their biggest bubble in US history, rising over three standard deviations away from their historic relationship to incomes.
Here are food prices during the period in which Greenspan and then Bernanke saw deflation as the biggest threat to the US economy:
The message here is clear, the Greenspan/ Bernanke Fed was so far behind the economic curve, that it created one of the biggest inflationary bubbles in history in its quest to avoid deflation.
Indeed, by the time deflation did hit (in the epic crash of 2007-2008), the Fed was caught totally off guard. During this period, Bernanke repeatedly stating that the subprime bust was contained and that the overall spillage into the economy would be minimal.
Deflation reigned from late 2007 to early 2009 with the Fed effectively powerless to stop it. Then asset prices bottomed in the first half of 2009. From this point onward, generally speaking, prices have risen.
The Fed, however, continued to battle deflation in the post-2009 era, unveiling one extraordinary monetary policy after another. They’ve done this at a period in which stocks and oil have skyrocketed:
Home prices bottomed in 2011 and have since turned up as well (in some areas, prices now exceed their bubble peaks):
Which brings us to today. Inflation is once again rearing its head in the financial system with the cost of living rising swiftly in early 2014.
Rents, home prices, food prices, energy prices, you name it, they’re all rising.
And the Fed is once again behind the curve. Indeed, Janet Yellen and Bill Evans, two prominent members what is now the Yellen Fed (Bernanke stepped down in January), have both recently stated that inflation is too low. They’ve also emphasized that rates need to remain at or near ZERO for at least a year or two more.
Investors should take note of this. The Fed claims to be proactive, but its track record shows it to be way behind the curve with monetary policy for at least two decades. Barring some major development, there is little reason to believe the Yellen Fed will somehow be different (Yellen herself is a huge proponent of QE and the Fed’s other extraordinary monetary measures).
Which means… by the time the Fed moves to quash inflation, the latter will be a much, much bigger problem than it is today.
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