Bubble Trouble
The current generation of decision makers was raised in a string of bubble economies. This environment has greatly influenced their sense of balance between a bubble economy and growth. Every time a bubble bursts, they can save the economy by creating another bubble, so they have no fear of bubble economies fueled by low interest rates.
A prominent policymaker from the US recently stated that concerns about an Internet bubble reflected a confidence in the regained strength of the American economy. This is a common misconception amongst policymakers. All surveys report a high level of nervousness among the American people. In fact, the Internet bubble has nothing to do with the confidence at large, but merely emphasizes the dire situation the financial system is in.
The continuous chain of bubbles in the last 20 years was due to the fact that policymakers repeatedly used low interest rates to save speculators. Meanwhile, the speculators seem to firmly believe that growth solves all economic woes. As a result, even though the bubble could burst again, leading to an
economic downturn, they believe they can solve their economic problems by creating another bubble. Furthermore, politicians serve relatively short terms, so they are inclined to simply delay the problems until their successors take office.
If inflating a new bubble solves the problems caused by an old bubble bursting, then we would be in paradise. Everyone would be extremely rich, and would not have to work. Clearly, no such world exists.
Inflation and bubbles are both monetary phenomena. We could offer all sorts of explanations on the specific causes of a bubble’s formation, but the truth is that without loose monetary policies, a bubble cannot possibly form. Inflation and bubbles compete for money in the market. When inflation is low for some reason, such as the outsourcing over the past 20 years, an excess supply of money will prompt the formation of a bubble. When there is no way to keep inflation rates low in the short run, then the bubble cannot be sustained as its funding gets cut off.
This time, the biggest bubble lies in government bonds, which have been seen as the safest investment, and since the world is still in an economic hole, a lot of money has been going into this type of asset. In my opinion, given that inflation has
been on the rise around the world, fear of bond devaluation will eventually take over, specifically in the last quarter of 2012. DOUBLE DIPPING
Just as it did last summer, the global economy is now winding down again. With a quarter of American homeowners having negative equity in their houses, the US housing market is taking another nosedive. As there is no immediate hope of recovery, they would be keen to hand their property back to the mortgage banks, and free themselves of debt. As the banks collect more houses, the housing market continues to slide, fearing a liquidation of the banks’ entire housing inventory. The adjustment isn’t all technical ?C the total US property value is still at 110% of GDP, despite a 30% drop from its peak, compared to previous cycles where it bottomed out far below 100%. In some smaller cities, residential land is down 90% from its peak value, compared to 1% for similar cities in China. Europe’s sovereign debt crisis has reappeared, a problem that was never fully solved. The money supplied to Greece and other member states by the EU was only enough to resolve their immediate liquidity problems, without addressing their ability to pay off their debts over time. While the only solution is for Greece to default, the EU fears a contagion effect
spreading to other countries, and is still waiting for a miracle. This latest crisis won’t be the last.
Japan is in the middle of a severe recession, with the March earthquake and tsunami destroying much of its productivity, and it will take a long time to recover. Hope of a quick turnaround is keeping the yen from devaluing, though this hope will soon vanish. As Japan increases imports for its reconstruction, its trade deficit will continue to worsen, making a sharp devaluation in the yen in the second half likely. Emerging economies’ tightening of policies to curb inflation has been ineffective for two reasons. Firstly, the Fed still maintains a loose policy, spurring inflation in commodities, which emerging economies have no means to respond to. Secondly, because emerging economies raise their interest rates slower than inflation grows, their real interest is still negative, further fueling inflation. More tightening is necessary, but this would raise market concerns about its impact on economic growth.
It seems the whole world is on a downward spiral, and economic data this summer will likely be very poor and shocking, letting fear take over the financial market again. WHO CAN RESCUE THE MARKET?
A month ago, I mentioned the possibility of QE 3, which was criticized by many as impossible. Once the market started dwindling, it seemed possible again. I believe QE 3 is possible only if oil prices drop another 25%. Once oil prices are low enough, the Fed can then introduce another stimulus package. As in other countries, inflation is eating away any income growth in the US. The Fed still rejects the idea that its policy is ineffective in virtually every aspect, creating bubbles, hindering structural changes, and hampering consumption. It continues to stimulate its currency in hopes of reviving its economy. As the economy continues to worsen, one can only wonder how the Fed will respond this time.
If the Fed takes any action, stock prices will rise, and people will feel better for a short while. The Fed’s stimulus plans will cause oil prices to skyrocket, thus erasing any gains from rising stock prices. So no matter what the Fed does, they’re headed for disaster.
If Europe can solve its debt crisis once and for all, it will regain its confidence. It’s certain that Greece will default, but dragging this out will only affect the financial market. Once a solution is drafted, the losses are calculated for Greece’s bondholders, and the amount of refinancing required from the
Bubble Trouble
