I just wrote a piece about Stan Druckenmiller’s misinterpretation of the US monetary system and how he seems to think we’re on the verge of turning into Greece. Although I disagree with that piece of the interview, I should also clarify that I agree with something else he said. Paul Krugman took offense to this comment by Mr. Druckenmiller:
“instead of taking a recession and having the cleanup…they needed an offset. So they created the housing bubble. So now by hindsight, everybody says, ‘Well, you had these horrible Wall Street actors,’ and I’m sure there were quite a few horrible Wall Street actors. And I don’t doubt that they were part of the problem. In fact, I know they were part of the problem. But I also know it was negative real interest rates for 12 outta 20 years that enabled these actors to do the things they were doing and incented, yes, incented them to go out and gamble the way they were gambling.”
I don’t think Druckenmiller is far off really. We’re the same breed of macro thinker in that we see things from the financial market trenches and not the walls of Princeton. And Fed policy over the last 30 years has had a largely destabilizing effect in that it often targets nominal wealth via “wealth effects” and a keen focus on the stock markets. Alan Greenspan was just quoted saying:
“the stock market is the key player in the game of economic growth.”
This is one of the flaws of the way monetary policy impacts the real economy. It is largely designed around this idea of a “wealth effect” and boosting nominal prices in order to create the illusion that people are better off than they really are. The stock market is not a “key player in the game of economic growth”. The stock market is a secondary market that represents the summation of inneficient thoughts by a group of half intelligent apes who are trying to outguess eachother regarding the future cash flows of underlying corporations. When a stock goes up 20% in a day it does not mean the actual underlying corporation is necessarily 20% better off or that the economy is 20% better off. It just means that a bunch of traders think that company will be 20% better off. The stock market, by definition, is not realized wealth. Everyone cannot cash out their chips in the stock market at once to go to Wal-Mart. So, designing your spending habits around the value of your home or your stock portfolio can often be disastrous as these asset price values are “there one day” and can be “gone the next”.
Anyhow, I think Fed policy and the monetarist perspective on much of this can be highly destabilizing by creating this sort of ponzi effect where asset prices don’t always reflect the fundamentals of the underlying corporations. It’s not a coincidence that we’ve have 30 years of this sort of policy and also experienced the two largest nominal wealth bubbles in American history during this period. So, I guess Druckenmiller gets a lot more right than I probably gave him credit for in the last piece….