many choosing to buy assets despite recognizing the valuation risks and bubble
indicators.
How many times have you heard the phrase "well, it seemed like a good idea at
the time" or its more verbose equivalent, "I knew the risks, but thought
implicitly that macro growth would paper over the cracks"?
While it is possible that lofty valuations can be justified by growth that
meets or beats previous expectations, the risks are almost inevitably slanted
towards disappointment rather than elation. That is because most asset bubbles
are monetary creations, rather than economic ones. In other words, the excess
availability of credit or money almost without exception explains asset
bubbles.
Barely two weeks ago, an open warning was issued from a rather
unlikely source, from a bank in China, the world's fastest-growing major
economy. I reproduce part of the Bloomberg article that appeared on September
10:
Bank of China Ltd, which led the nation's $1.1 trillion lending
spree in the first half, said ample liquidity has caused "bubbles" in stocks,
commodities and real estate. "The potential risk is that a lot of liquidity
goes to the asset market," Vice President Zhu Min said in an interview in
Dalian today. "So you see asset bubbles in commodities, stocks and real estate,
not only in China, but everywhere."
China's record credit expansion, which helped the country's economy expand 7.9%
in the second quarter, has raised concerns that bank loans have been diverted
and used to buy stocks and real estate, fueling unsustainable gains in equity
and property markets.
"There's no way for the real economy to absorb so much liquidity," said Liu
Yuhui, a Beijing-based economist at Chinese Academy of Social Science.
"Policymakers in China and around the world are well aware of the harm that
could do, but they are unwilling to sacrifice short-term growth and wean the
economy from addiction to the stimulus policies."
... Bank of China advanced 1 trillion yuan [US$146 billion] of new loans in the
first six months, more than any other Chinese lender and the gross domestic
product of New Zealand. The Beijing-based bank, the nation's third-largest,
said last month it plans to slow credit growth in the rest of the year and
improve loan quality.
The point is that China has the least to
worry about in terms of asset bubbles, not because they don't exist (they very
much do) but because surpluses in fiscal and current account terms can be
re-circulated to absorb banks' losses at a future stage.
If there isn't a prospect of avoiding asset bubbles in a fast-growing economy
like China with the current levels of stimulus, imagine what is happening in
countries with lower structural growth opportunities such as the US and Western
Europe. More to the point, think of what kind of an economic miracle would be
needed to justify today's asset prices in these countries.
Lastly, that Europe is bouncing back.
The last battleground of the Keynesians is the supposed recovery in Western
Europe that "justifies" the same course of action (strong government
intervention, higher social welfare, rising taxes and so forth) in the
Anglo-Saxon orbit. This notion would be fully supported if there were any quick
bounce in European economies.
Certain economic indicators of late have been "massaged" to produce the
illusion that some European economies are doing a lot better than they actually
have been - car sales in Europe supported by a "cash for clunkers" scheme
similar to the one in the US is a frequent example. Another is the stability
(but not the trend) in retail sales - no big surprise really; the level of
government welfare payments against high tax rates implies that gross
disposable income in the economy doesn't change dramatically over the short
term.
Now we have cracks showing on the periphery of Europe, in particular in
Portugal, Italy, Greece and Spain. Correspondent Ambrose Evans-Pritchard, in a
September 24 Daily Telegraph article, "Spain tips into Depression", makes the
following points:
The Madrid research group RR de Acuna & Asociados
said the collapse of Spain's building industry will cause the economy to
contract for the next three years, with a peak to trough loss of over 11% of
GDP. The grim forecast is starkly at odds with claims by Premier Jose Luis
Zapatero, who still says Spain's recession will be milder than elsewhere in
Europe.
RR de Acuna said the overhang of unsold properties on the market, or still
being built, has reached 1,623,000. This dwarfs annual demand of 218,000, and
will take six or seven years to clear. The group said Spain's unemployment will
peak at around 25%, comparable to the worst chapter of the Great Depression.
Spanish workers typically receive 50% to 60% of their former pay for 18 months
after losing their job. Then the guillotine falls. Spain's parliament has
rushed through a law guaranteeing 420 euros [US$612] a month for long-term
unemployed, but this will not prevent a social crisis if the slump drags on.
Separately, UBS said unemployment will reach 4.8 million and may go as high as
5.4 million if the job purge in the service sector gathers pace. There is the
growing risk of a "Lost Decade" akin to Japan's malaise after the Nikkei
bubble.
Roberto Ruiz, the bank's Spain strategist, said salaries must fall by 10% in
real terms to regain lost competitiveness, replicating the sort of wage squeeze
seen in Germany after reunification ...
Spain has been in
sharp focus of late, ever since a series of unflattering portraits of the
country's banks was made public. Research produced by a group called Variant
Perception was widely circulated in the investment community; it makes the
fairly significant point of calling the bluff from Spanish banks on their true
level of capital.
As goes Spain, so shall other European economies, including but not limited to
Portugal, Italy, Greece, France and Belgium. That's another case where the
collective look on the faces of Keynesians will resemble that of the proverbial
coyote in the Roadrunner cartoons.
Disclaimer: As with all my analyses of stock and bond market movements,
this one too comes with a health warnings namely to highlight the not
insignificant peril associated with readers attempting to follow the advice of
a pseudonymous writer such as myself without taking adequate precautions such
as consulting with an appropriate adviser who understands your circumstances;
or failing to find any such adviser to use your common sense.
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