From the Archive: An Exuberance All Too Familiar Amid a Modern Monetary Bubble

Part II of Volume I, Issue I

Go long a company that sounds like something Elon Musk mentioned in a tweet (but wasn’t)? Signal Advance Inc. just soared 12-fold. Lend money to a software maker to buy Bitcoin? A Microstrategy Inc. convertible bond is up 50% in four weeks. Back up the truck on bullish options after the Nasdaq 100 doubled in 24 months? Wednesday was the fourth-busiest day ever for call trading in the U.S. (the other three were last year).

Throw a dart, hit a winner, so it has lately seemed. Emboldened by Federal Reserve stimulus, vaccines and the psychological conditioning that arises when no bad patch lasts, everyone from retail newbies to institutional managers is rushing to cash in…

- Bloomberg, January 2021

The amount of financial assets relative to real assets is dangerously high, which could lead to a ‘bank run’-type move from financial assets to real assets.

- Ray Dalio, January 2022

---

Editor’s Note: This is a reprint of Part II of the inaugural Volume I, Issue I of The Macro Value Monitor, which was originally published in January 2022. Part I, The Dawn of Quantitative Easing, and the Boom and Bust at Rue Quincampoix, can be found here. A PDF version of the Macro Value Monitor is also available.

---

The preceding account of the Mississippi Bubble, related from the perspective of the Banque Royale, should sound all too familiar today. The speculative fervor that had been building in recent years reached a truly fever pitch in 2021 as the Federal Reserve expanded its balance sheet at the fastest pace in its history. However, as was the case in early 1720, not-so-subtle signs of erosion in the sentiment fueling the bubble were in plain sight as 2021 drew to a close.

Not all financial bubbles have been fueled entirely by monetary expansion — some have been genuine speculative manias. During the Tulip Mania a century before the Mississippi Bubble, the Bank of Amsterdam did not increase Holland’s money supply like the Banque Royale did in 1719, but tulip bulb prices soared astronomically for other reasons. Similarly, while the Federal Reserve did play a role in fomenting the 1929 bubble and the tech bubble in the 1990s, those periods were fueled primarily by intense speculation surrounding new-era technologies. Monetary policy added fuel to the exuberance, but there was much more to those episodes.

Yet speculative periods which are primarily the result of large increases in the money supply tend to follow a regular progression, one that has been repeating for over three centuries, right up to the present day. Initially, the increase in the money supply fuels a genuine expansion of business and economic activity. This can have a tremendous impact on sentiment, which can then have a genuinely positive impact on real economic opportunity and growth. The positive feedback loop that takes hold can make it seem as though all that was ever needed was more money and more credit in order to increase everyone’s prosperity.

It especially feels this way as risk assets boom in response to the increased money supply, but before the lagged effects of a large monetary inflation begin to take hold throughout the rest of the economy. If the story only ended right there . . .