This is no recovery, this is a bubble – and it will
burst
Stock market
bubbles of historic proportions are developing in the US and UK markets. With policymakers
unwilling to introduce tough regulation, we're heading for trouble
Ha-Joon Chang teaches economics at Cambridge University . He is the author of 23
Things They Don't Tell You About Capitalism, and Economics: the User's Guide
Ha-Joon Chang
The Guardian, Monday 24 February 2014 / http://www.theguardian.com/commentisfree/2014/feb/24/recovery-bubble-crash-uk-us-investors
According to the stock market, the UK
economy is in a boom. Not just any old boom, but a historic one. On 28 October
2013, the FTSE 100 index hit 6,734, breaching the level achieved at the height
of the economic boom before the 2008 global financial crisis (that was 6,730, recorded
in October 2007).
Since then, it has had ups and downs, but
on 21 February 2014 the FTSE 100 climbed to a new height of 6,838. At this
rate, it may soon surpass the highest ever level reached since the index began
in 1984 – that was 6,930, recorded in December 1999, during the heady days of
the dotcom bubble.
The current levels of share prices are
extraordinary considering the UK
economy has not yet recovered the ground lost since the 2008 crash; per capita
income in the UK
today is still lower than it was in 2007. And let us not forget that share
prices back in 2007 were themselves definitely in bubble territory of the first
order.
The situation is even more worrying in the US . In March
2013, the Standard & Poor 500 stock market index reached the highest ever
level, surpassing the 2007 peak (which was higher than the peak during the
dotcom boom), despite the fact that the country's per capita income had not yet
recovered to its 2007 level. Since then, the index has risen about 20%,
although the US
per capita income has not increased even by 2% during the same period. This is
definitely the biggest stock market bubble in modern history.
Even more extraordinary than the inflated
prices is that, unlike in the two previous share price booms, no one is
offering a plausible narrative explaining why the evidently unsustainable
levels of share prices are actually justified.
During the dotcom bubble, the predominant
view was that the new information technology was about to completely
revolutionise our economies for good. Given this, it was argued, stock markets
would keep rising (possibly forever) and reach unprecedented levels. The title
of the book, Dow 36,000: The New Strategy for Profiting from the Coming Rise in
the Stock Market, published in the autumn of 1999 when the Dow Jones index was
not even 10,000, very well sums up the spirit of the time.
Similarly, in the runup to the 2008 crisis,
inflated asset prices were justified in terms of the supposed progresses in
financial innovation and in the techniques of economic policy.
It was argued that financial innovation –
manifested in the alphabet soup of derivatives and structured financial assets,
such as MBS, CDO, and CDS – had vastly improved the ability of financial
markets to "price" risk correctly, eliminating the possibility of
irrational bubbles. On this belief, at the height of the US housing market
bubble in 2005, both Alan Greenspan (the then chairman of the Federal Reserve
Board) and Ben Bernanke (the then chairman of the Council of Economic Advisers
to the President and later Greenspan's successor) publicly denied the existence
of a housing market bubble – perhaps except for some "froth" in a few
localities, according to Greenspan.
At the same time, better economic theory –
and thus better techniques of economic policy – was argued to have allowed
policymakers to iron out those few wrinkles that markets themselves cannot
eliminate. Robert Lucas, the leading free-market economist and winner of the
1995 Nobel prize in economics, proudly declared in 2003 that "the problem
of depression prevention has been solved". In 2004, Ben Bernanke (yes,
it's him again) argued that, probably thanks to better theory of monetary
policy, the world had entered the era of "great moderation", in which
the volatility of prices and outputs is minimised.
This time around, no one is offering a new
narrative justifying the new bubbles because, well, there isn't any plausible
story. Those stories that are generated to encourage the share price to climb
to the next level have been decidedly unambitious in scale and ephemeral in
nature: higher-than-expected growth rates or number of new jobs created;
brighter-than-expected outlook in Japan, China, or wherever; the arrival of the
"super-dove" Janet Yellen as the new chair of the Fed; or, indeed,
anything else that may suggest the world is not going to end tomorrow.
Few stock market investors really believe
in these stories. Most investors know that current levels of share prices are
unsustainable; it is said that George Soros has already started betting against
the US
stock market. They are aware that share prices are high mainly because of the
huge amount of money sloshing around thanks to quantitative easing (QE), not
because of the strength of the underlying real economy. This is why they react
so nervously to any slight sign that QE may be wound down on a significant
scale.
However, stock market investors pretend to
believe – or even have to pretend to believe – in those feeble and ephemeral
stories because they need those stories to justify (to themselves and their
clients) staying in the stock market, given the low returns everywhere else.
The result, unfortunately, is that stock
market bubbles of historic proportion are developing in the US and the UK , the two most important stock
markets in the world, threatening to create yet another financial crash. One
obvious way of dealing with these bubbles is to take the excessive liquidity
that is inflating them out of the system through a combination of tighter
monetary policy and better financial regulation against stock market
speculation (such as a ban on shorting or restrictions on high-frequency
trading). Of course, the danger here is that these policies may prick the
bubble and create a mess.
In the longer run, however, the best way to
deal with these bubbles is to revive the real economy; after all,
"bubble" is a relative concept and even a very high price can be
justified if it is based on a strong economy. This will require a more
sustainable increase in consumption based on rising wages rather than debts,
greater productive investments that will expand the economy's ability to
produce, and the introduction of financial regulation that will make banks lend
more to productive enterprises than to consumers. Unfortunately, these are
exactly the things that the current policymakers in the US and the UK don't want to do.
We are heading for trouble.
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