How the Fed Created a Stock Market Bubble of Epic Proportions

Photo by Towfiqu barbhuiya on Unsplash

How did we get here?

Since the Great Depression, American politicians — mostly Democrats — have voted to construct an ever-larger “social safety net” to support the poor, elderly, minorities, and those not able to care for themselves. We now have Welfare, Social Security, Medicare/Medicaid insurance, and direct cash payments to the poor through food stamps and reverse taxes (so-called “earned income tax credits”). It’s compassionate, but very expensive.

Ballooning deficits

To make matters worse, Republicans in Congress have consistently voted to lower taxes — as a way to protest the same big government programs that both they and the Democrats voted into law. Lower tax revenue has the effect of ballooning our yearly budget deficit, currently running at $3 trillion per year. The cumulative U.S. debt now stands at $30 trillion, including $5 trillion spent on programs to offset the impact of the Covid pandemic. Our debt to GDP (gross domestic product, or total economic output) ratio is now 128%, which is frightening and ruinous by any historical measure.

Enter the Fed

The Federal Reserve is the U.S.’s Central Bank. It has the power to print money to boost the economy and raise or lower interest rates. So, over the past few years, the Fed has been printing money to purchase U.S. Treasury Bonds (and mortgage-based securities, and even corporate bonds) through a program called Quantitative Easing (QE). The Fed’s balance sheet is currently $9 trillion and climbing.

What could go wrong?

First, interest rates are rising because the Fed is printing so much money (risking third-world-style hyperinflation). Food and gas prices are skyrocketing, and the inflation rate has already reached 7.5%. Home prices are rising by 18% a year. The stock market rose 27% in 2021. All this contributes to inequality because the wealthiest 10% of Americans — who hold 89% of stocks, worth $35.87 trillion — made huge gains, while the other 90% struggled to pay their bills.

The Fed is now in a box — they must raise interest rates now

However, with inflation now starting to rise, the Fed is in a box. Their mandate requires them to reverse course and bring down inflation to a reasonable level. So they’re forced to raise interest rates, stop the QE buying of U.S. Treasury Bonds, and wind down their $9 trillion balance sheet, even as higher interest payments will limit the Federal Government’s ability to continue its high levels of deficit spending.

It’s all about to come crashing down

All this money printing and deficit spending has created a speculative stock market and housing bubble of epic proportions. Once the Fed reverses direction, expect to see a 40–50% correction in the stock market and housing prices, high levels of unemployment and social unrest, and collapses in emerging markets which depend on American stability. Expect also the rise of new Putin-style autocratic rulers who promise “strong leadership” in return for absolute loyalty (competence being optional) and restrictions in personal liberty, freedom and rights — as democracy erodes.

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Rob Vermiller

Rob Vermiller

A computer scientist with a passion for AI and Cognitive Science, and author of the Programmer's Guide to the Brain.