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Sunday, January 17, 2010

The Economist sees the bubble now

In a recent post on the Economist's blog, the quote was some say that The Economist's correct calls of the tech and housing bubbles were just a magnificent stroke of luck. At Demand Side, we see them as magnificent pieces of historical revision. Either that, or the calls were buried where we could not find them. The Economist was very late to the game. They are hurrying to catch up. But here they come.
The danger of the bounce
Jan 7th 2010
The Economist
Once again, cheap money is driving up asset prices

THE opening of the Burj Khalifa, the world’s tallest building, in Dubai on January 4th had symbolic as well as architectural significance. Skyscrapers have long been associated with the ends of financial booms. The Empire State Building opened in 1931, two years after the Wall Street crash. The Petronas towers in Kuala Lumpur were unveiled in 1998, in the depths of the Asian crisis. Such towers are commissioned when money is cheap and optimism about economic growth is at its height; they are often finished when the champagne has gone flat.

The past three decades have been good for skyscraper-building. The cost of borrowing money, in nominal terms, has fallen sharply (see chart 1). Small wonder that one bubble after another has appeared in financial markets, with the subjects of investors’ dreams ranging from emerging markets and technology stocks in the 1990s to residential housing in the decade just ended. Nor is it surprising, with money so cheap, that consumers and companies have indulged in regular borrowing sprees.

When investors borrow money in order to buy assets, they push prices even higher. But this also makes markets vulnerable to sudden busts, as investors sell assets to pay their debts. The credit crunch of 2007-08 was the result of this process, with the debts greater and the price swings more violent than at any time in the past 30 years.

Critics argue that central banks, by focusing on consumer- rather than asset-price inflation, have encouraged bubbles to grow by keeping interest rates too low. By intervening when markets fall, but doing little to curb them when they rise, they have offered investors a one-way bet.

Such critics are worried that, in their eagerness to bring the credit crunch to an end, the authorities may be making the same mistake again. Official short-term interest rates are below 1% in much of the developed world. Emerging markets, through their currency pegs, tend to import these easy-money policies, even though most of them are growing faster than the rich economies are.

Low rates have certainly persuaded investors to move money out of cash. Investors withdrew $468.5 billion from money-market funds in the course of 2009. The “carry trade”—borrowing in low-yielding currencies to invest in high-yielding ones—is back in full swing. The Australian dollar has been a popular beneficiary.

Equity markets have rebounded strongly: the MSCI world index is more than 70% higher than its March low. Even bigger gains were seen in emerging markets, with the Brazilian, Chinese and Indonesian bourses all more than doubling, in dollar terms, last year. Those rallies have by themselves helped boost economic sentiment and have brought to a halt the vicious spiral of 2008, in which falling markets forced investors to offload assets at fire-sale prices.

At the same time, in the English-speaking markets of America, Australia and Britain, the stabilisation of house prices has bolstered consumers’ balance-sheets. Again, low interest rates have been a crucial supporting factor.

Optimists argue that the markets are now in a sweet spot. The global economy is recovering, with most developed countries coming out of recession in the third quarter of 2009. The authorities, concerned about the fragility of the recovery, will be reluctant to raise interest rates in the near term. Thus investors have been given a licence to buy risky assets.


see the rest at The Economist


  1. The global economy may be recovering but the developed economies will languish for years as they are still massively debt laden. Businesses and individuals are still de-leveraging. What can the central banks do? All they can and have done is support those bubbles to enable insiders to exit out of the markets by drawing the suckers in. The Australian and US government have done that through a first time buyer subsidy. The Australian housing market is prime for a collapse.

    Look at the stock purchases and sales by US companies directors. They are exiting the market as it climbs. The Dow and S&P are still grossly overvalued. The big US banks would all have collapsed had the government kept out. In the UK if that had happened they could have broken up all the banks to create much greater competition, would have avoided the Fred Goodwin pension debacle, could have separated investment banks and commercial banks all in one go. Now we have to wait for the next major crisis to do that. The Economist, along with the rest of the media, can be be partially held responsible for the multi decade long antipathy to the word "Nationalise". Who said that the government wanted to remain in that business? They could have done as the Swedish government in nationalise the banks and then sell them off when possible. Leaving the taxpayer with little losses on the deal.

    Governments claim they hate inflation but ignore asset price inflation. They encouraged reckless behaviour by reducing capital gains taxes. You only have to see the impact on politicians by how many UK MP's made more money from property speculation than they actually did from governing the country. Then they moan about the costs of housing benefit when that is the flip side to a housing bubble. When you consider that it now takes two working people to afford a property what will sustain it going any higher, mandatory polygamy?

    Governments ignore the impact on business. High asset prices are a tax on new businesses. High property prices have caused employees to demand increase wages simply so that they can live near work. It increases the cost to a new business start up either through the amount of capital to buy a property to operate from or in higher rent. Lower entry costs would substantially reinvigorate business creation.

    Higher commodities lead to a higher cost of production and while that can encourage efficiency, it also is inflationary.

  2. Very good comment.

    We have the curious schizophrenia of collapsing real asset values in homes and factories and commercial properties and machines, which is shutting down the real economy. These prices may still be overvalued, but all the more so because they are competing with distressed sales. At the same time you have the bubbles in stocks and bonds and derivatives and financial assets.

    Is there any more need for a description of instability.

    Oh, of course, massive debt everywhere burdening households, businesses and government.

  3. Hi. Well, no, I don't think there is any more need for a discription of instability. Unfortunatelly, I don't believe the situation will get better soon as people don't seem to realize that living on debt causes more and more housing bubbles and, consequently, the financial crisis we deal with now.
    Take care,

  4. I would agree. The politicians in the US, UK and Australia are trying to support the housing bubbles through various measures. Though it might make the voters feel wealthier it has dramatic downsides. It reduces labor mobility. Far too often we hear of people rejecting jobs because it costs too much to move to a new area. It has also had an appalling effect on actual savings. When people could use their home as an ATM it meant that they did not make additional savings into pensions or other investments. With higher property costs that leads to higher rental costs and that extra rent which could be used for spending or savings is diverted to support a non productive asset.

    What is really needed is reform of capital gains taxes to reduce the incentive to speculate in bubbles. Secondly a reform of organisations that grant mortgages. These need to be solely funded from repayments of mortgages and savings. With no access to money markets. That way it is much harder to inflate property bubbles. A home is the most important purchase that people make and it should not be speculative investment as well. A ban on affordability toy mortgages would stop sub prime problems in future. Only simple repayment mortgages would be allowed. That way people will have equity in their homes and be less likely to walk away, hence reducing loan losses. Strict rules on loans to value. No more than 70% would mean that people would have to save to get a foot hold in the market. Also make mortgages based on a sole income earner. Then it stops bubble from two working people pricing out sole earners. Also even stricter rules on buy to let mortgages with maximum loan to value of 50%. This would eliminate speculators inflating bubbles in areas, and then when they go bust they leave renters homeless for no fault of their own. Though this could be modified by giving renters first right to take on the outstanding mortgage. Their housing costs might fall and the banks may not lose anything.

    Without a nations savings being absorbed by a housing bubble there would be more funds available for business investment. It appears that only a few continental European governments have realised this. France and Germany had practically no housing bubbles and have recovered better than others.