You can say this about staunch critics of the Federal Reserve: They're very determined.
While you might think that rising economic activity, falling unemployment and a five-year bull market in stocks would silence the doubters, they are as vocal as ever – and still warning of calamity ahead.
At issue is the Fed's decision to hold its key interest rate near zero per cent for years and buy vast quantities of bonds using a program known as quantitative easing, which artificially held down borrowing costs.
Many economists and investors credit these bold moves for rescuing the U.S. economy and restoring confidence to a shaken world.
The critics, however, contend that the economic benefits of Fed policy aren't clear. What is clear, they say: The Fed drove investors into a speculative fervour that is inflating yet another asset bubble.
The Fed is now in the midst of tapering its monthly bond purchases, and will likely end the program later this year. As well, it has begun to mull its first rate hike, perhaps six months after quantitative easing ends, as Fed chair Janet Yellen mused recently.
However, far from taking a warmer view of the Fed, a couple of its most vocal critics remain in full critical mode. Largely their criticism rests on a single point: Investors will pay dearly for the Fed-induced market gains of recent years.
In a recent Fortune Q&A, Jeremy Grantham, co-founder of global asset manager GMO, suggested that the Fed is simply manipulating stock prices in the hope of creating a wealth effect, where consumers feel richer: "But why would you want to get an advantage from the wealth effect when you know you are going to have to give it all back when the Fed reverses course?"
The thinking is that just as Fed policy drove stock prices higher, the reversal of that policy will bring them back down – perhaps after the S&P 500 rises another 25 per cent, to 2350, in a speculative surge.
"The next bust will be unlike any other, because the Fed and other central banks around the world have taken on all this leverage that was out there and put it on their balance sheets," he said. "We have never had this before. Assets are overpriced generally. They will be cheap again. That's how we will pay for this. It's going to be very painful for investors."
John Hussman, of Hussman Funds – and now as famous for missing the five-year bull market as he was for avoiding the bear markets of 2000 and 2008 – is equally dismissive. In his latest note to clients, he too challenged the notion of a wealth effect from rising stocks.
"As Milton Friedman and Franco Modigliani demonstrated decades ago, consumers do not alter spending in response to variations in volatile forms of income, but instead consume based on their assessment of their probable 'permanent income' over the long-term," he said. "Equity prices are anything but smooth or permanent."
Although the Fed can't create a wealth effect through stock prices, it is responsible for the current state of market euphoria, reflected most recently in absurd valuations on initial public offerings, he says. Mr. Hussman singled out last week's IPO of King Digital Entertainment PLC, maker of the Candy Crush Saga game, which valued the company at more than $7-billion (U.S.).
"Granted, IPO speculation is nowhere near what it was in the dot-com bubble, when one could issue an IPO worth more than the GDP of a small country even without any assets or operating history, as long as you called the company an 'incubator,'" Mr. Hussman said.
"Still, three-quarters of recent IPOs are companies with zero or negative earnings (the highest ratio since the 2000 bubble peak), and investors have long forgotten that neither positive earnings, rapid recent growth, or a seemingly 'reasonable' price/earnings ratio are enough to properly value a long-lived security."
Ms. Yellen, over to you.
David Berman