Understanding Monetary Policy and It’s Relationship with Stock Prices

by RichFelon

Many of you just took significant losses in your portfolio over these last 3 weeks (some all year), and sadly there is more to come. What is driving this sell off? A change in monetary policy.

Scrolling through the daily chat I often find people discussing QE, even though few understand it. QE stands for quantitative easing and was first introduced in the US by Fed Chair Ben Bernanke as a response to the Great Financial Crisis (GFC). QE(1) started in March 2009 and lasted til March 2010. The purpose of QE was to raise asset prices. During the GFC (2007-2008) many assets lost significant value. Included in these assets were homes, stocks, and bonds. These same assets were used as collateral in the financial system. By raising asset prices, the Fed and Treasury (these two are not independent) believed many banks could avoid margin calls, margin calls that banks couldn’t afford and would result in the fire-sale of the collateral at market price.

This does not mean QE serves only a singular role. QE is now used to inflate asset prices (triggering the famous wealth effect), monetize deficits, lower interest rates, and increase employment. The Fed is currently tapering our 4th round of QE, which has resulted in the Fed having a balance sheet of just under 9T. This balance sheet is often referenced when you hear people say the Fed prints money. MMTers claim this money is “bank reserves”.

The Fed and the Treasury are addicted to QE. We are only stopping QE temporarily as a way to control inflation. Inflation was never transitory and will continue well into 2023 (I will make another post about this). QE5 will be here in another year or two, and I suspect it will be at least 160B. Red or blue, the Federal Government loves to spend money it doesn’t have. This is where QE comes in and monetizes the deficits.

I have been cash gang for months and am buying beaten down stocks. There are still many bubbles left to pop.

Tdlr: QE enacted by the Fed raised asset prices to bubble levels. Smart investors have sold and are waiting for stocks to fall before buying back in as the Fed tapers. Monetary policy is the most important principle in determining stock prices.