The FOMC released its latest monetary policy statement on August 1, 2018.  As was expected, it did not change its target for the federal funds rate.  It is still in the range of 1.75% to 2%.

The FOMC statement did change a little from last time, stating that “the labor market has continued to strengthen and that economic activity has been rising at a strong rate.”  In the June statement, it read that “economic activity has been rising at a solid rate.”

I guess “strong” is better than “solid”, or so say the analysts.

While the Fed is currently seen as essentially doing nothing, it is doing something.  In fact, it is doing something that it has not done often in its history.  It is deflating the monetary supply.

In the implementation notes of the latest statement, it says that the Fed will continue to roll over the maturing debt for Treasury securities that exceeds $24 billion and mortgage-backed securities that exceeds $16 billion.  In other words, it is equivalent to selling off $24 billion in Treasury securities and $16 billion in mortgage-backed securities.  The Fed is draining its balance sheet by $40 billion per month.  Over the course of several months, this starts to add up to real money, even in terms of the federal government and the Federal Reserve.

You probably won’t read that in a lot of places.  But, yes, the Fed is currently deflating.  This after its unprecedented monetary inflation from 2008 to 2014 where the adjusted monetary base grew by nearly five times.

In the FOMC statement, it says that inflation remains near 2 percent.  Therefore, nearly everyone thinks things are going rather smoothly.  However, we shouldn’t let that fool us.

In the late 1920s in the lead up to the Great Depression, consumer price inflation was low and relatively stable.  This gave the false impression that there were no giant bubbles.  This told the central planners that there was no overheating, as they like to term it.

Yet, the stock market plunged anyway.

Now, there are many reasons why the Great Depression was so severe and lasted so long.  This was due to the continuous interventions of Hoover and Roosevelt.  But the initial bursting of the stock market bubble was largely because of the loose monetary policy that came before it, which misallocated resources.

I am not predicting the next Great Depression.  But I do think there is a major bubble in stocks.  This isn’t to say that the bubble can’t go on for a while longer.  It’s just that we shouldn’t be fooled by the relative calm, including the stable consumer price inflation numbers, that everything is fine.

There have to be misallocations from the previous monetary inflation and the continued low interest rates (backed by the Fed).  It is just a matter of when these misallocations correct and how severe it will be.