At last week’s Congressional confirmation hearings, Fed chairman Ben Bernanke was asked what he thinks of Nouriel Roubini’s assertion that the Fed is fuelling asset bubbles again.
Bernanke replied: “Mr Roubini is very pessimistic about the economy”. As Dave Rosenberg of Gluskin Sheff pointed out, that wasn’t the question. And anyway, even if he’s pessimistic, does that make him wrong?
Bubble trouble is now the new topic du jour in cafes around the world. It seems only yesterday we were worrying about the collapse of global banking, depression and deflation. Now we’re worried about the US dollar carry trade and the return of excessive bank bonuses and covenant-lite loans again.
Say what you like about free market capitalism, it can turn on sixpence and it can always give you something to worry about.
Tony Boeckh, the founder of Bank Credit Analyst newsletter, and one of the wisest, least excitable commentators around, says, first, that “valuations are not yet in bubble territory”, and second that “although this may not be a bubble yet, we are certainly on track for one.”
“Liquidity expansion will continue to drive the cycle for the foreseeable future, creating risk of a violent correction particularly in emerging markets, gold and other commodities.”
Boeckh says the Fed can see the froth, but doesn’t care: “It will err on the side of excess liquidity in order to deal with the more sensitive problem of high unemployment.” Furthermore, letting banks and consumers rebuild their balance sheets through reflation in the value of their assets is good for everyone in the short term.
At the heart of the problem is the fact that the world’s reserve currency is in oversupply and falling in value because the central bank that controls its value is engaged in a marathon battle against recession and unemployment.
Previous recessions during the past 40 or so years of floating exchange rates have been more or less deliberately engineered to protect the currency and the value of US money. Rising interest rates and tight money in the US, resulting in a strong US dollar, have allowed emerging nations to build export economies and current account surpluses.
This time the financial system and the economy spontaneously combusted and the US central bank is in the role of inflator rather than deflator, and the Fed has made it clear this will continue well into 2010 and beyond if necessary.
As a result the US dollar is weak and central banks everywhere else are being forced to accommodate US monetary policy to try to stop their currencies appreciating against the dollar. Bubbles in real estate and shares are inevitable in those circumstances and central banks in those countries are faced with the opposite dilemma to the US: trying to protect themselves from asset bubbles while preserving employment.
Only Australia has the courage (craziness?) to ignore that problem and tighten monetary policy.
Aussie central bankers tut tut about the fate of manufacturing industry with the currency appreciating, but they have made a conscious choice: anti-bubble over full employment.
And with unemployment apparently peaking at less than 6% because of fiscal stimulus spending, the Reserve Bank of Australia clearly feels it is has the political room to move.
Other central banks are not so lucky – especially China’s. The mother of all fiscal stimuli has not removed the imperative to keep a cap on the currency and to maintain economic growth at more than 8%.
Some countries, such as Brazil, are trying capital restrictions to artificially control capital inflows and protect themselves from asset bubbles. But these things rarely work.
The inevitable result is that bubbles will develop in 2010, especially in emerging markets, and that the global markets will become more volatile and dangerous. Dubai was a foretaste of what’s to come.
Many panics will be unjustified and short-lived – like the one that followed Dubai World’s debt moratorium – some will require a fundamental reassessment of future prospects.
And bubbles can be hard to pick: “bubble” is often just the name someone applies to a rally that they missed; if you’re on it, it’s a bull market.
This article first appeared on Business Spectator.
James was the editor and publisher of SmartCompany and LeadingCompany for five years. He is now the Australian Financial Review‘s companies & markets editor, and a former BRW editor.
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