Friday, January 8, 2010

Bubble warning

This is a timely warning. There is a growing discomfiture with the fact that the recent surge of economic activity throughout the world is a false dawn.

It is a false dawn simply because such economic activities are fueled by government economic stimulus packages based on fiscal deficit policies.

The question is, whether the private sector is recovering fast enough to take over the economic momentum from the governments. I suspect that in Malaysia and elsewhere, the answer would be a resounding "NO!".

Another aspect is the extremely low interest rate regime in Malaysia and elsewhere which is fueling asset bubbles. Singapore is clearly experiencing an asset bubble of sorts due to low interest rates. People will shift their savings portfolio from fixed deposits to property. Surely, that is not the type of economic activity that is sustainable. This is merely the migration of savings portfolios. It is not green shoots that are sprouting.

Malaysia, as I have said previously, is not in such a desperate situation as many more advanced economies. But, we are not in a cocoon. We are not immune. Therefore, policy makers and investors need to be extremely wary in the coming months.

Read on:

Markets are too dependent on unsustainable government stimulus. Something’s got to give...

THE effect of free money is remarkable. A year ago investors were panicking and there was talk of another Depression. Now the MSCI world index of global share prices is more than 70% higher than its low in March 2009. That’s largely thanks to interest rates of 1% or less in America, Japan, Britain and the euro zone, which have persuaded investors to take their money out of cash and to buy risky assets.

For all the panic last year, asset values never quite reached the lows that marked other bear-market bottoms, and now the rally has made several markets look pricey again.


Central banks see these market rallies as a welcome side- effect of their policies. In 2008, falling markets caused a vicious circle of debt defaults and fire sales by investors, pushing asset prices down even further. The market rebound was necessary to stabilise economies last year, but now there is a danger that bubbles are being created.


Aside from high asset valuations, the two classic symptoms of a bubble are rapid growth in private-sector credit and an outbreak of public enthusiasm for particular assets. There’s no sign of either of those. But the longer the world keeps its interest rates close to zero, the greater the danger that bubbles will appear—most likely in emerging markets, where growth keeps investors optimistic and currency pegs import loose monetary policy, and in commodities.

Central banks have a range of tools they can use to discourage the growth of bubbles. Forcing banks to adopt higher capital ratios may curb speculative excesses. As Ben Bernanke, chairman of the Federal Reserve, argued this week, the rise in American house prices could have been limited through better regulation of the banks. The most powerful tool, of course, is the interest rate. But central banks are wary of using it to pop bubbles because it risks crushing growth as well. And, with the world economy in its current fragile state, they are rightly unwilling to jack up interest rates now.

But even if governments judge that the risks posed by raising rates now outweighs that of keeping them low, investors still have plenty of reasons to worry. The problem for them is not just that valuations look high by historic standards. It is also that the current combination of high asset prices, low interest rates and massive fiscal deficits is unsustainable.

Interest rates will stay low only if growth remains slow. But if economies grow slowly, then profits will not rise fast enough to justify current share prices and incomes will not rise far enough to justify the prevailing level of house prices. If, on the other hand, the markets are right about the prospects for economic growth, and the current recovery is sustained, then governments will react by cutting off the supply of cheap money later this year.

It doesn’t add up

But the more immediate risks may be posed by fiscal policy. Many governments responded to the crisis by, in effect, taking the debt burden off the private sector’s balance-sheets and putting it on their own. This caused a huge gap to open up in government finances.


donplaypuks® said...

Like Einstein's earth shattering theses of 1905 & 1915 which changed our perception AND knowledge of physics and the Universe, Economics needs a new Guru and Theory (not hypothesis and snake oil remedies)!

For too long now, Economics has been mismanaged by the proponents of that 1 card trick - monetarism which fcuks around with interest rates!

Western (and Eastren) Economists really have no clue as how to get out of this mess and Bernanke will fare no better (in a another term) in leading USA out of it - he's too busy cooking the books so that an audit will not show up all the fraud and teeming and lading the Fed us been up to.

I, a nobody, have no answers either. But if we start with honesty and sincerity as our cornerstone and eschew double speak and Greenscam/Bananacake waffle, I bet we will outdo all these doctrinaire Economists!

We are all of 1 race, the Human race

walla said...

With time it gets increasingly harder to replicate past success using the same formula simply because others would also have wised up to the methods.

When we started as a nation, there was much to do like how it is when moving into a new house.

As the population increased, jobs in agriculture, construction and manufacturing grew in tandem with the population.

With money in hand and more people on the land, property prices increased which sloshed liquidity by capital gains which prodded the growth of the stock market which created wealth out of thin air and groomed the services sector further.

But there comes a time when growth hits a patch and starts to decelerate, reaching the plateau of the sigmoid curve.

Even before that happens, new growth curves must be quickly started to continue the momentum or the economic engine will splutter.

The ability to quickly find and start new growth curves is the mark of an economically progressive nation.

That ability depends on internal capabilities:

policies, brains, investments and markets.

We are now at a cusp where all four elements are at a tide which means it will get harder to generate a new growth curve that is based on fundamental strengths of marketable production, whether of goods or of services.

The policies are not flying, the brains have left, the investments are laughable and the markets are shrinking.

Maybe that explains why these days we could only respond with theology.

We have been feeding the economic engine with the wrong RON-typed fuel. Now smoke belches from its innards, polluting both air and mind.

A pall hangs over the country now. A schism has appeared. Costs are up. Factory lights are down. Rain has come. Peace is gone. The leaders are tremulous. The people are not listening anymore. Everyone is fedup about something. People are looking over their shoulders. CEOs have run out of words. Business is surreal. Handicaps are up. Blogging is slowing.

But soon the cymbals will clang their new year songs even as red packets will be thinner. Over kuaci and tea, tales will be told, memories recaptured, pasts stone-washed, futures pre-sighed.

Bubbles are born from and pricked by irrational hope, dashed.

Perhaps one should revisit Russell's "A Free Man's Worship"...

'Freedom comes only to those who no longer ask of life that it shall yield them any of those personal goods that are subject to the mutation of time.'


To standards, add rationality.

These days both seem much needed.

...donplaypuks has outstanding mind.

...nothin' on tv again.

...runnin' outa e-real-estate to preview.

Anonymous said...

It looks likely that it is not so easy to get out of the monetary black hole created by the financial crisis.

Money, that abstract entity invented by humans, can be created or destroyed. In the last year or so, many trillions have been destroyed. Governments are furiously creating money to fill the void created by the destruction of money by enlarging their national debt.

However, creating huge amounts of money instantly could create monetary and asset bubbles.

Has the world economy really recovered? Read this article by
Paul Krugman

"As you read the economic news, it will be important to remember, first of all, that blips — occasional good numbers, signifying nothing — are common even when the economy is, in fact, mired in a prolonged slump."

"Unfortunately, growth caused by an inventory bounce is a one-shot affair unless underlying sources of demand, such as consumer spending and long-term investment, pick up."

"So the odds are that any good economic news you hear in the near future will be a blip, not an indication that we’re on our way to sustained recovery. But will policy makers misinterpret the news and repeat the mistakes of 1937? Actually, they already are."