This Time It Is Different (And the Fed Won’t be Ready…)

There’s an investment theory that pretty much trumps any theory by any legendary investment wizard whether it’s Benjamin Graham, Jesse Livermore or even Warren Buffett.

It’s known as the “greater fool theory.” 

It basically says that no asset is too overvalued if someone will pay you more than you paid for it. 

The theory comes with a mantra that, despite all the brilliant valuation models of those aforementioned gurus, says “This time it’s different.” 

It was the mantra that drove the tech market bubble to its 2000 implosion. 

It was the same idea behind the housing bubble in 2007.

But time and again, things ultimately proved that they weren’t different, and the greater fool theory prevailed. 

Truth is, the greater fool theory is something that Wall Street elites count on. When the Fed prints money, the 1% get the biggest bang for the devalued cash. Only by them pumping it into the market are the excesses — which attract the unfortunate individual victims investors — created. By the time “day traders” are climbing all over each other to jump on the next screaming hot technology company (or whatever the craze is) the end is already in the rear view mirror.

The Force Behind This Theory: The Federal Reserve

In July 1990, the US economy spun into an eight-month recession accompanied by year-long sideways bear market in stocks. In response to all this, because everything they do is in response, the Fed started pushing interest rates lower — from 9.5% to 2.7% in Dec of 1992.

Fed Funds Rate 1990-1992

Source: St. Louis Fed

By the time they had finished their easing cycle, the economy had escaped the recession and stocks (per the NASDAQ Composite) had rebounded, eclipsing previous highs by 39% (101% off the bear market low for anyone counting). Mission accomplished.

NASDAQ Composite


Over the ensuing decade, rates normalized averaging between 5% and 7.5%. Until the tech rally failed big time in late 2000. In response, the Fed again started pushing rates to their lowest levels since the 1960s until the market had sufficiently recovered.

Fed Funds Rate 2000-2004

Source: St. Louis Fed

Since then this has been the Fed’s modus operandi — keep feeding asset inflation with cheap capital. If the stock market looks good, everyone looks good! The only time the Fed would actually need to raise rates would be to cool a slightly overheated economy or deal with monetary inflation barely out of the Fed’s target range.

And for the past 30-plus years, that’s how things have worked. 

But This Time It Is Different

Make a note in your journal… This is the first time since the late 70s (over 40 years) that the Fed is facing a different challenge. This time they have to raise rates in response to actual inflation.

And not just inflation — a bout of secular inflation. 

As we’ve talked about in your past couple letters, the inflation we’re seeing today has little to do with “too much easy money in the system.”

This rout bout of inflation was sparked by a supply shock caused by the supply chain disruption brought about by the pandemic lockdowns. And then of course all the other forces driving prices higher on top of that. 

Because of all that, this time the Fed is going to be pretty much screwed when it comes to dealing with soaring prices.

And not being able to deflate prices, the only real option they’ll have will be to squeeze demand…  by sinking the US economy into a recession.

But there is a possibility for the US to come out of all this in relatively good shape. And it contains a series of steps worth watching… 

I’ll share that with you in your coming letters

Make the trend your friend…

Bob Byrne 
Editor, Streetlight Daily