First, a large block purchase of stock in a given company is indeed going to drive the value of that stock over its fundamental value. The stock will certainly become overvalued from the purchase. Continued purchases can maintain the price of the stock at that overvalued level. This is true regardless of who the buyer is. In this scenario, the stock is overvalued relative to its fundamental value, but the price of the stock is still determined by supply and demand - the block purchase simply increased the demand (or rather, technically
was the increased demand) and drove up the stock price.
When the Fed makes asset purchases, this is what it is doing. So yes, Fed open market operations drive up the price of the assets which it is buying, above the fundamental value. The asset becomes overpriced relative to its fundamental value. However, the price of the asset is still determined by fundamental economic principles that equilibrate price via supply and demand. When the Fed stops asset purchases, or starts selling off these assets, the price of the assets, due to economic laws, will decline.
I am not disagreeing with any of the above. In fact, it is what I am arguing. It is also exactly what the Fed intended when it implemented QE. Purchasing of bonds drives up bond prices, which drives down yields. That was the Fed's goal. Tapering of bond purchasing, halting bond purchasing, and/or selling of bonds, drives down the price, and therefore drives up yields. This is the entire point of QE.
What I am arguing against is you using the term "bubble" to explain this phenomenon. A bubble is a very distinct economic phenomenon, it isn't just a word you can use casually. It has a specific definition and specific qualifications that define it. It is a phenomenon whereby the usual laws of economics actually are violated. Supply and demand is how prices equilibrate normally. This is called a
negative feedback mechanism. Another way to describe it is a stable equilibrium. Bubbles, in contrast, are driven by a positive feedback mechanism. In a bubble, people jump on board to ride the bubble up, and the prices just keep increasing. We're all familiar with the tech bubble or the real estate bubble. It's quite obvious how these phenomena are different from a simple overvaluation of a stock above its fundamental value. It was an entire system built around ever-increasing, accelerating prices, until the whole thing became unstable and fell apart.
Overvaluation doesn't mean that a bubble exists. Stocks constantly trade above or below their fundamental values. A bubble is a specific event in which overvaluation leads to
even more overvaluation, and even
more, and
faster until it pops.
It's obvious why Fed operations haven't created a bubble, because we can look at asset prices and see that this isn't happening at all. Fed purchases drive up the price of the assets to a new level, but they don't create increasing purchases, and they don't accelerate the pace of asset purchases. They simply drive up the price of the asset to a new general level.
QE isn't inflationary because it is an asset swap between the Fed and banks. It essentially just swaps the assets with Fed credit in the banks' Fed accounts. The "cash" that the Fed used to purchase the assets just sits in the bank's reserve account. It never enters the economy and therefore, from a money supply standpoint, isn't inflationary at all.
