Tesla. Bitcoin. GameStop. U.S. Treasury bonds. Everywhere investors look these days, they find history-making bubbles staring back at them.
The commonly cited culprit is central banks refilling the proverbial punchbowls too often and too liberally. Too much monetary liquidity chasing too few good bets is always and everywhere a recipe for runaway froth.
This is the why concerning this bubble in bubbles. More attention, though, should be on how we got here. And that means Tokyo.
Yes, the Federal Reserve is the globe’s premier bubble blower as 2021 heats up. Excessive credit from the central bank of the biggest economy that prints the reserve currency will always carry the most weight with markets, and for valid reasons.
Last week, though, Fed Chairman Jerome Powell admitted what so many economists assured us could never happen: It’s trapped at zero interest rate indefinitely with the Bank of Japan. Powell did his best not to say that, exactly. But he knows better than anyone that when the Fed says it’ll be at zero until 2023, he might as well admit it could be 2033—or well beyond.
Former BOJ Governor Toshihiko Fukui understands how Japan—and now the U.S.—got here better than just about anyone.
Fukui’s 2003-2008 tenure saw the BOJ try its hand at rate normalization. When Fukui grabbed the reins from predecessor Masaru Hayami, the BOJ was four years into its experiment with zero rates and two years into its quantitative easing era. First, Fukui ended QE. By 2006, the Fukui’s team pulled off the first of two 25 basis-point rate hikes.
The empire was quick to strike back. Immediately, lawmakers, CEOs, bankers and investors blamed Fukui’s brake-tapping moves for soft demand across the economy. By 2008, the first move by Fukui’s successor, Masaaki Shirakawa, was to cut rates back to zero.
The official excuse was fallout from the “Lehman shock,” but really it was Japan Inc.’s addiction to free money. Without realizing it, the corporate and political establishments got so used to zero rates. It became a necessary ingredient for success. As borrowing costs disappeared, crushing public and corporate debts appeared less burdensome. Banks grew to enjoy cheap credit and the effect zero-to-negative yields had on balance sheets.
Ultraloose BOJ policies, meantime, took the onus off elected officials to implement destabilizing reforms. They made it easier for exporters to avoid difficult restructuring decisions. They papered over cracks across all sectors. That fueled any number of asset bubbles—not least of which a Nikkei 225 Average near 30-year highs even as Covid-19 devastates the real economy.
Janet Yellen has her own version of this story. Back in late 2015, long before Yellen was named Treasury secretary, Yellen was running the Fed when its raised rates for the first time since 2006. The derision that step generated wasn’t all that different from what Fukui experienced years earlier.
The Yellen Fed received rhetorical attacks from future President Donald Trump. In February 2018, a year into the Trump regime, Yellen was replaced by Powell. He moved quickly to slash rates back to zero and revive the QE policies Yellen had dismantled. Powell, though, pushed Fed policies into new uncharted territories, propelling Wall Street toward record highs.
Since Covid-19, Powell shifted the Fed into gears higher than monetary economists thought were possible. By May 2020, the Fed’s balance sheet swelled to $5.3 trillion, roughly equivalent to the BOJ’s.
The trillions of dollars of asset purchases added even greater fuel to rallies in stocks, U.S. government bonds, gold, cryptocurrencies, electric vehicle giants like Tesla, real estate and many unlikely investments—including GameStop, Blockbuster video and other Reddit chat-room-driven rallies.
By going the way of the BOJ, the Fed is making odd speculative tangents seem like momentum trades. The BOJ, of course, has long since made the occasional pyramid scheme feel like a winning value investment. That will happen when a central bank effectively nationalizes the stock markets by becoming a top-10 shareholder in almost half the market via exchange-traded funds.
The Fed, though, is supersizing the strategy. It’s also increasing the odds it gets trapped. The more monetary authorities commandeer private markets, the more they reward mediocrity among CEOs and boards. The more you overwhelm markets with liquidity, the harder it will be to plot an exit.
In 2006, Fukui thought Japan was ready to live without a monetary intravenous—just as Yellen decided in Washington a decade later. In 2021, though, the BOJ and Fed are adding even more life-support tools to even bigger IV doses. That’s fueling bubbles anywhere you look as central banks go the Tokyo route.