Fears of a new speculative boom on which
the global recovery rides are being expressed in different circles. There
are as many aspects to these fears as there are to the so-called recovery,
which include the huge profits being recorded by some major banking firms,
the surge in capital flows to emerging markets, the speculative rise in
stock markets' values worldwide and the property boom in much of Asia.
Potential victims of the reversal of this boom, however, now complain
that the source of it all is a return in the US to a policy of easy money—involving
huge liquidity infusions and extremely low interest rates—to save the
financial system and real economy from collapse, while resorting to a
fiscal stimulus to trigger a recovery. A similar policy was and is being
adopted by many other countries, even if not with the same intensity in
all cases, but the US, which was home to the most toxic assets and damaged
banks, led by a long margin.
This policy did generate the signals that suggested that economies were
on the mend. But these are also signs, argue some, of a bubble similar
to the one which generated the high profits and the credit-financed housing
and consumer-spending boom that preceded the 2008 downturn. That dangers
associated with that bubble were ignored because of the short-run growth
benefits it delivered. This one could be ignored because of the impression
of a recovery it generates. Even as satisfaction is being expressed in
some quarters about the recovery, however halting, fears of a second downturn
or double dip recession are being expressed in other circles. Thus, just
before the US President Barack Obama arrived in Beijing on his much-publicised
visit to China, that country's banking regulator, Liu Mingkang, criticised
the US Federal Reserve for fuelling global speculation by adopting a loose
money policy to save financial firms. This view was soon espoused also
by Wolfgang Schauble who criticised the US Federal Reserve's role in fuelling
the dollar carry-trade, which involved borrowing dollars at low interest
rates to invest in higher yielding assets outside the US. Investors resorting
to such trades not only benefit from the spread between the low interest
rates on the borrowing and the higher yield on their investment, but also
from the depreciation of the dollar in the interim, which requires, say,
fewer euros to buy the dollars needed to repay the original loan.
The direct and indirect links between the fiscal stimulus, a loose money
policy and the revival of bank profitability is well known. Directly,
a part of the "stimulus" involved using tax payer's money to
invest in banks or institutions like insurance giant AIG. The former kept
banks solvent even when they were writing off bad assets, while the latter
helped non-bank institutions meet commitments on failed assets, without
which banks and other financial firms would have been driven to bankruptcy.
In addition, the government had implicitly picked up a chunk of the bad
debts of financial firms seen as too-big-to-fail by offering guarantees
that sustained their value on the books of banks. The initial return to
profitability that this ensured seemed to have improved the market value
of bank equity, making it appear that the government may in fact recoup
or even make money on its investments in bank capital. But as economist
Dean Baker had noted some time back: "This is a case of money going
into one pocket but out of the other one; that's not the way that most
investors make money." No less a person than George Soros told the
Financial Times (24 October 2009) that the profits made by some of Wall
Street's leading banks are "hidden gifts" from the state, and
taxpayer resentment on this count is "justified".
But state support for the banks did not end here. The Federal Reserve
chipped in with the easy money policy mentioned above, which helped drive
short-term interest rates to near zero. In the event banks could ride
the sharp yield curve, borrowing cheap and investing in more long-term
assets that offered higher returns. Some of these, like government bonds,
were low risk investments offering returns of 3 per cent-plus, and the
net interest margin that the government was handing out to the banks was
a sure way of making them record profits.
But clearly, the banks, especially investments banks like Goldman Sachs,
were not going to stop here. Rather they chose to go further and use this
cheap money to speculate in stock, commodity and property markets, wherever
they appeared profitable. Though this was more risky, the bets were likely
to pay off for four reasons. First, even within the US the stock market
was at a low, with much-fallen price earnings ratios. Any improvement
in corporate profits as a result of the fiscal stimulus would improve
stock prices, so investing in the market was seen as safer than it was
in a long time. Second, this was true even of commodity markets like oil
and food, and there were always commodities which had not been through
that cycle and were ripe for a boom, including gold which would only rise
if the dollar weakens because of the excess dollar liquidity that was
being pumped into the global economy. Third, many emerging markets were
affected less or hardly at all by the recession, making their stock, bond
and property markets attractive destinations for investors with access
to cheap money. Finally, the rush of capital to these markets in itself
fuels a boom that attracts more capital inflows and fuels a speculative
spiral.
The consequence of these moves has been stunning profits for some financial
firms, especially Goldman Sachs, and reasonable returns for others. We
are also witnessing a return of the controversy surrounding bonus payments
and high compensation provided to managers of banks that were rescued
with tax payers' money. Moreover, financial markets that had slumped have
now revived with emerging markets witnessing a boom in some cases. Commodity
prices are also once again buoyant, and property markets outside the US
are experiencing sharp price increases. There are two ways to interpret
these trends. One is to treat them as symptoms of the end of the crisis
and the beginnings of a recovery. The other is to see them as the signs
of a new bubble. Thus far the former view has dominated.
Needless to say, the cheap money that was pumped into the system has helped
shore up real demand, which together with the fiscal stimulus has ensured
that downturn has touched bottom and some economies are showing signs
of a revival. In fact, in emerging markets and countries like China the
inflow of liquidity and the local fiscal stimulus helped partly neutralise
the adverse effects of an export slowdown on growth.
But now fears are being expressed and responses are being sought on a
number of counts. One of course is evidence of a so-called "correction"
in developed country stock markets since March this year: the S&P
500 index has risen more than 60 per cent, while the FTSE Eurofirst 300
has recorded a similar rise. But this is small compared to what is happening
in emerging markets. Brazil's benchmark Bovespa index has gained 76 per
cent this year; that is, in terms of the real, the domestic currency.
Those who converted dollars into reals and returned to dollars after booking
profits gained 139 per cent as the US currency has depreciated significantly.
Such opportunities have resulted in net inflows of a record $60 billion-plus
into emerging market equity funds, which only serves to amplify them by
driving prices further upwards. The second sign of an actual or potential
speculative boom is the reversal of price declines in commodity markets,
which though yet not alarming, revives memories of the fuel and food price
spiral of a couple of years back, which is seen by many as having been
partly driven by financial speculation. Oil for example is already trading
at around $80 to the barrel in US markets. The third is evidence of a
real estate bubble in emerging markets, especially in Asia. Thus, for
example, the Financial Times (5 November 2009) reports that in Hong Kong,
prices of apartments costing more than US$1.3m, which fell 6.2 per cent
in the third quarter of last year, and were expected to fall by a further
40-45 per cent by the end of this year, are now 30 per cent more expensive
than at their low point in the fourth quarter of 2008. Prices for private
homes in Singapore reportedly rose 15.8 per cent in the third quarter
relative to the second, and in China 37 per cent year-on-year. Finally,
there is the global surge in gold prices as investors rush into the metal
because of fears of a dollar decline. Gold is trading at around $1170
an ounce.
Put all this together and an emerging story of a new speculative boom
and a fresh bubble driven by finance capital cannot be dismissed. As a
result, there are growing fears of a second collapse. The liquidity created
by the Federal Reserve is increasing the overhang of dollars in the world
economy making investors more concerned about the likely depreciation
of the value of the dollar. If they choose to rearrange their portfolios,
which they seem to be doing, a further depreciation of the dollar is inevitable.
If the US responds to such depreciation by raising interest rates there
could be an exit of funds from global asset and commodity markets outside
the US triggering a collapse that can have collateral effects that are
damaging.
Besides this fear of a sudden capital exit, emerging market countries
are also worried about the effect that a surge of dollar inflows into
their economies is having on their currencies. The resulting appreciation
is undermining their competitiveness relative to countries that are managing
to keep their currencies pegged to the US dollar. One consequence has
been a revival of interest in capital controls, especially after Brazil
imposed a 2 per cent tax on foreign investment in equities and bonds to
dampen excess capital inflows. Some Asian economies too are contemplating
similar measures to guard their currencies and stall a speculative rush
into financial and real estate markets.
The positive in all this is that lessons from the crisis that were quickly
forgotten are being studied once more. Whether that would finally translate
into policies that reduce the probability of another bubble that can go
bust is, however, unclear.