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James Bullard is the President of the St. Louis Federal Reserve Bank. While all eyes have been on Janet Yellin the past several days, Bullard was in New York City this morning, speaking to representatives of the European American Chamber or Commerce. Aside from his address, he made a comment to reporters that, as Lincoln said in his Gettysburg Address, “The world will little note, nor long remember.” Lincoln was wrong. I hope that I am too, which is why I am reporting his simple remarks, so you may note and remember.
Bullard warned that the risk of asset price bubbles is growing as the U.S. economy is improving. He said that “As the economy improves … and we continue to have low rates, that’s a fertile environment for creation of asset bubbles in the future.” In my experience, when people hear the three words “in the future,” they tend to dismiss the rest of what has been said. That is why the rest of what he said is so important: “So I would start to put more weight now on that as a risk than I would have last year or the year before.”
People generally understand that a bubble occurs when prices become over inflated without the catalyst of demand. Demand, however, is not just a catalyst. It should also be, according to the rules of supply and demand, a reason for rising prices. So, in effect, a bubble occurs when prices increase even though there is no basis in demand.
Bullard’s concern, at least in part, has to be that one of the major causes of asset price bubbles is low interest rates. When rates are low, savvy investors move their investments into higher-yielding assets – such as stocks. I find Mr. Bullard’s quietly-stated message to be significantly ominous in its import.
The major factor causing Bullard’s concern seems to be the January jobless rate, which fell to 6.6%. The jobless rate is one of the factors for which the Fed has established a threshold to signal the need to begin raising interest rates. That threshold is a jobless rate of 6.5%.
I am going to repeat here what I have said many times before, that the jobless rate is an unreliable number in and of itself. It has no significant connection to reality and it is being used surreptitiously for reasons other than for what it was created to do. The true unemployment rate, which is much more difficult to calculate, is much higher than the reported rate.
So here’s the problem. What does the Fed do if the jobless rate falls below 6.5%? It’s established guidance is that it will begin to raise interest rates. If interest rates begin to increase and continue to do so, investors will begin moving their money. Right now, the bulk of that money is invested in the stock market. When that money moves, especially if it moves quickly, that bubble that we have been experiencing on the LSE, NYSE, and other exchanges is going to burst.
In closing, I am going to do something that I rarely do. I am going to make a prediction. I project that, should the U.S. jobless rate fall below 6.5%, the Fed will declare the number to be as meaningless as it really easy and either adjust the threshold or eliminate it as a factor altogether. It is, in my opinion, the most likely and most feasible scenario to give them a reason to not raise interest rates. But, you never know.
Nonethess, I suggest that we all take note and not forget Bullard’s subtle warning.
