In the early 1600’s speculators drove the price of a Dutch tulip to levels where the bulb was worth more than a house. Of course, that mania subsided after a brief period and sanity was restored. The Reddit gang, who are waging a war against short sellers by trying to give them a python squeeze, ran out of gas. You can squeeze for a while and inflict a lot of pain, but unless you have the fire power to sustain the pressure, the victim will live to fight another day. But make no mistake about it. The short squeeze saga came very close to causing a lot of peripheral damage. Robin Hood, a newish trading platform favored by many of the newbie investors, had to go out and raise billions literally overnight to stay alive. Ditto for at least one hedge fund. It may have been a game with an inevitable ending, but the consequences were real and could have been severe.
That doesn’t mean short selling should be banned. Short sellers are the market’s vigilantes. They police and attack when disparities appear. But there are rules. They can’t short if they can’t borrow shares to complete the trade. Nor can they collude illegally. While there were accusations of bad behavior as GameStop’s stock soared in recent days before fading, there probably was little done illegally. Robin Hood lacked the capital needed, but raised it quickly. Brokers and clearing houses correctly asked speculators to put up more capital to play. That made the game more expensive and ultimately shortened its duration.
But, as I noted on Monday, the real problem here is that too much excess money is chasing too few real opportunities. That means that we are going to see more variants of these speculative waves going forward until central banks adapt different policies.
The Fed has several missions. In crisis, they provide the liquidity to keep markets functioning. That is exactly the moment when torrents of capital are needed as scared investors flee. The Fed filled that void admirably in 2008 and again last February as Covid-19’s presence sent financial markets and the economy into freefall. But panics don’t last long. Besides crisis moments, the Fed is charged with maintaining price stability and fostering economic growth. The former means, in simple English, keeping inflation at about 2%, a level high enough to trivialize fears of deflation and low enough to maintain real asset values. As for its mission to push economic growth higher, the Fed can’t make anyone spend. It can only create the environment that might encourage spending. But when fear or government regulation stops us from spending, as has happened during the current pandemic, there isn’t much the Fed can do. Dropping money out of helicopters won’t work if you are stuck inside. Even if you can run outside and catch the falling Ben Franklins, the only way you can spend it is to run back inside and buy something online. As Amazon showed last night when it reported great earnings, a lot of us did exactly that. But we didn’t go out to eat, we didn’t take an expensive vacation, and we didn’t buy a new suit or evening gown. We put it in the bank.
But as our bank account swelled, and we looked at the statement each month, we saw that money wasn’t earning us a nickel. Literally, not even a nickel. So, we looked for places to put it. Blue chip stocks that paid nice dividends was a good option. For a while we were all happy. But then we saw the guy next door who took a bit more risk. He went out and bought the Amazons and Netflix’s of this world and made even more money. So we followed him. As time passed, and the Fed kept pouring money in, we still were in savings mode. We were still stuck indoors. Our collective success with the Amazon’s led us to get a little more frisky. So we bought hot IPOs. Then we bought SPACs. And finally, last week, we chased momentum and started to squeeze the shorts.
And, as I noted Monday, while the ending of the short squeeze was inevitable, so is the creation of more and more bubbles until the Fed and other central banks decide that enough is enough.
In Congress today, crisis is required to get significant legislation passed. We got Dodd-Frank after a financial crisis. We got pandemic relief after a pandemic. In the 21st century, about the only major bills passed other than a response to a crisis were Obamacare, and the Trump corporate tax cut.
It may take a crisis to force the Fed to change. We actually came close last week. If Robin Hood was not able to raise capital quickly, the consequences of the short squeeze could have been a lot uglier. I don’t want to scare anyone and say we were at a crisis flash point. That would be a bit of an overstatement. But it could have become messier enough to draw attention beyond the showboating antics of a few obvious people in Congress we all know who never miss a moment to appear on camera. Congress will hold a few hearings to allow members their 15 minutes of righteous indignation, but nothing will happen. It won’t happen because there wasn’t a crisis.
So, we continue to live in a world where money supply is growing at 20%+, where monetary velocity (the pace at which cash moves) is at a record low, savings rates are over 13%, 2-3x normal, GDP is growing 4%+, and prices of virtually all assets are at record highs. You can call this anything you want. But it isn’t normal. We all know the phrase, “you can’t fool Mother Nature”. When the Fed decides to make one asset class grossly expensive (fixed income), money will obviously flow to other assets. If, in doing so, it expands the amount of money circulating by massive amounts, then it is inevitable that waves of new money will have unintended consequences. That means inflated asset prices and bubbles.
The short squeeze may be winding its course. Or it may shift from GameStop to something else. But as long as there are torrents of money sloshing around, and as long as the waves of speculation produce more winners than losers, then there will be more waves that attract more money. IPOs. SPACs. Bitcoin. Electric vehicles. Space travel. Hydrogen fuel cells. New cancer cures. There is no end to these stories. So far, few have been burned. Until they are, the saga goes on.
It will end. I don’t know when or how. Fifteen years ago, President George Bush trumpeted the American dream that everyone could own a home. When the financial underpinnings got too fragile, the dream became a nightmare. At some point the Fed will have to say that it isn’t going to buy $5 billion of securities every day. It told us last week that won’t happen anytime soon. It should but it won’t. However, when it does happen, investors won’t like it. They will have a tantrum. I will leave to everyone’s imagination what happens then.
Today, Blythe Danner is 78. We may all know that she is the mother of Gwyneth Paltrow, but did you know she is a Philadelphia native? Shelley Berman turns 95 today.
James M. Meyer, CFA 610-260-2220