Ben Bernanke&#39;s 1938 Parallel

Bloomberg offers up an interesting historical parallel to our current situation, in which stocks are soaring, but government debt yields practically nil.

For the first time in seven decades, Treasury bills are paying no interest while stocks continue to appreciate -- a divergence in U.S. financial markets that might be perilous if Federal Reserve Chairman Ben S. Bernanke didn’t know all about 1938.

That’s when the Standard & Poor’s 500 Index climbed 25 percent even as bill rates tumbled to 0.05 percent from 0.45 percent. As 1939 began, stocks began a three-year, 34 percent decline after the Fed increased borrowing costs prematurely to stymie inflation that never materialized.

The apparent contradiction between stocks and Treasuries has been debated hotly, but the smart money see it as a liquidity issue:

“The question is what are you going to do with all the money that has been created?” said James Hamilton, a former visiting scholar at the Fed who teaches at the University of California, San Diego. “It’s not a contradiction at all to see very low short-term yields and at the same time have people trying to buy stocks. They are both reflecting that same force.”

The currency argument is bolstered by the fact that not only are both Treasuries and stocks rallying, but they're rallying in a symmetrical manner. This chart came from David P. Goldman, who has long argued that everything is being driven by currency expansion right now.