Fed’s credit expansion plan may be sowing the seeds for the next crisis
Goh Eng Yeow 15 June 2009
It is week 15 and the stock market run-up just keeps going on. Rising share prices have become the new norm.
Traders will latch on to a silver lining if given half a chance and are arguing that the so-called big bear rally is really the start of a bullish recovery.
This marks a change from their previous view - that the global financial system might suffer a total collapse.
Yet, despite the air of normalcy, the tug of war between bulls and bears has never been fiercer.
Sure, overall trading volumes have picked up in a big way as retail investors venture back into the market in large numbers. But since the start of the month, the rally has faltered.
After gaining 46 per cent between March and May, the Straits Times Index (STI) is up only 1.8 per cent this month.
Investors are constantly looking over their shoulders, worried that they are being sucked into a giant bull trap, even as they pour more money into the market in the belief that the worst is over.
The rally has rested on the premise that the worst of the global financial crisis is finally over, and that it is safe for an investor to dip his toes into the stock market again. But the awful regional trade data fails to back such a theory.
In April, Singapore’s non-oil exports fell 19.2 per cent year on year, while Malaysia’s exports shrank by 26.3 per cent. Last week, China reported that May exports had dropped by 26.4 per cent.
More worrying are the signs that the share rally was triggered by the flood of liquidity created by central banks, such as the United States Federal Reserve and the Bank of England (BoE), as they hosed down the huge firestorm that had been raging in the global banking system.
Data released by the BoE recently goes to bolster the sceptics’ point.
Like the US central bank, the BoE has been printing money and pumping it directly into the economy by buying billions of pounds of bonds on the market.
But it turned out that the biggest net sellers of gilts - as British bonds are called - were foreign investors.
In March and April, the BoE bought £44.5 billion (S$105.4 billion) worth of gilts. But overseas investors offloaded £17.9 billion of gilts in those two months, compared with British non-banking investors who sold £8.8 billion.
So while the BoE had been hoping that the blighted British economy would be automatically boosted by the money it printed, much of the newly minted cash headed straight out of the country.
The British experience is probably being repeated on a far larger scale in the US, where the Fed has been buying billions of dollars worth of bonds each week since March. This explains why consumer spending in the US has not shown signs of improvement, while unemployment continues to climb at an alarming rate.
It may not be such a coincidence that during this period, emerging markets and commodities have caught fire. The surplus cash flying around has found its way to assets offering better returns than US government bonds.
This raises fears that the great credit expansion programme by the Fed to fight a global financial crunch might be sowing the seeds for the next crisis by brewing a gigantic bubble in regional bourses.
Certainly, history is on the side of the bears. In 1999, just as the battered Asian economies were emerging from their worst financial crisis in a generation, then Fed chairman Alan Greenspan provided banks with a huge credit line.
This was to combat the Y2K bug, which could supposedly cause the global financial system to crash. The unleashing of an enormous pool of liquidity triggered the dot.com boom, in which even dodgy Internet start-ups with flimsy business plans could attract huge valuations.
After sinking to a low of 805 during the Asian financial crisis on Sept 1, 1998, the STI climbed to a then all-time high of 2,582 on Jan 3, 2000 - a record that stood for six years. But the boom ended with a huge bust when the Fed cut the credit line it extended to banks, once its fears over Y2K receded.
The subsequent crunch caused such a big collapse in investor confidence that deflation fears emerged and Mr. Greenspan was forced to lower interest rates to 1 per cent in 2002, and kept them at this artificially low level for almost two years.
But those low interest rates ignited a new credit bubble to replace the dot.com one, causing real estate and stock market prices to surge globally.
In Singapore, the cheap credit boom fuelled a four-year surge in the STI as it climbed from 1,341 in January 2003 to 3,482 at the end of 2007, after falling for three straight years between 2000 and 2002. The party ended two years ago when vast numbers of mortgages suddenly went sour in the US as cash-strapped home owners failed to get refinancing for their loans.
So it is not surprising to find the level-headed investors among us questioning if the Fed is again blowing a huge bubble in emerging markets as it prints money at breakneck speed to combat a credit crunch back home.
Given the unhappy precedents in the past decade, there is another pressing question: What might befall emerging markets if the Fed-orchestrated party suddenly ends?
It is a sobering reminder that while evidence of a regional recovery looks solid, its props might be built on sand.
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Blowing a big bubble in emerging markets?
Fed’s credit expansion plan may be sowing the seeds for the next crisis
Goh Eng Yeow
15 June 2009
It is week 15 and the stock market run-up just keeps going on. Rising share prices have become the new norm.
Traders will latch on to a silver lining if given half a chance and are arguing that the so-called big bear rally is really the start of a bullish recovery.
This marks a change from their previous view - that the global financial system might suffer a total collapse.
Yet, despite the air of normalcy, the tug of war between bulls and bears has never been fiercer.
Sure, overall trading volumes have picked up in a big way as retail investors venture back into the market in large numbers. But since the start of the month, the rally has faltered.
After gaining 46 per cent between March and May, the Straits Times Index (STI) is up only 1.8 per cent this month.
Investors are constantly looking over their shoulders, worried that they are being sucked into a giant bull trap, even as they pour more money into the market in the belief that the worst is over.
The rally has rested on the premise that the worst of the global financial crisis is finally over, and that it is safe for an investor to dip his toes into the stock market again. But the awful regional trade data fails to back such a theory.
In April, Singapore’s non-oil exports fell 19.2 per cent year on year, while Malaysia’s exports shrank by 26.3 per cent. Last week, China reported that May exports had dropped by 26.4 per cent.
More worrying are the signs that the share rally was triggered by the flood of liquidity created by central banks, such as the United States Federal Reserve and the Bank of England (BoE), as they hosed down the huge firestorm that had been raging in the global banking system.
Data released by the BoE recently goes to bolster the sceptics’ point.
Like the US central bank, the BoE has been printing money and pumping it directly into the economy by buying billions of pounds of bonds on the market.
But it turned out that the biggest net sellers of gilts - as British bonds are called - were foreign investors.
In March and April, the BoE bought £44.5 billion (S$105.4 billion) worth of gilts. But overseas investors offloaded £17.9 billion of gilts in those two months, compared with British non-banking investors who sold £8.8 billion.
So while the BoE had been hoping that the blighted British economy would be automatically boosted by the money it printed, much of the newly minted cash headed straight out of the country.
The British experience is probably being repeated on a far larger scale in the US, where the Fed has been buying billions of dollars worth of bonds each week since March. This explains why consumer spending in the US has not shown signs of improvement, while unemployment continues to climb at an alarming rate.
It may not be such a coincidence that during this period, emerging markets and commodities have caught fire. The surplus cash flying around has found its way to assets offering better returns than US government bonds.
This raises fears that the great credit expansion programme by the Fed to fight a global financial crunch might be sowing the seeds for the next crisis by brewing a gigantic bubble in regional bourses.
Certainly, history is on the side of the bears. In 1999, just as the battered Asian economies were emerging from their worst financial crisis in a generation, then Fed chairman Alan Greenspan provided banks with a huge credit line.
This was to combat the Y2K bug, which could supposedly cause the global financial system to crash. The unleashing of an enormous pool of liquidity triggered the dot.com boom, in which even dodgy Internet start-ups with flimsy business plans could attract huge valuations.
After sinking to a low of 805 during the Asian financial crisis on Sept 1, 1998, the STI climbed to a then all-time high of 2,582 on Jan 3, 2000 - a record that stood for six years. But the boom ended with a huge bust when the Fed cut the credit line it extended to banks, once its fears over Y2K receded.
The subsequent crunch caused such a big collapse in investor confidence that deflation fears emerged and Mr. Greenspan was forced to lower interest rates to 1 per cent in 2002, and kept them at this artificially low level for almost two years.
But those low interest rates ignited a new credit bubble to replace the dot.com one, causing real estate and stock market prices to surge globally.
In Singapore, the cheap credit boom fuelled a four-year surge in the STI as it climbed from 1,341 in January 2003 to 3,482 at the end of 2007, after falling for three straight years between 2000 and 2002. The party ended two years ago when vast numbers of mortgages suddenly went sour in the US as cash-strapped home owners failed to get refinancing for their loans.
So it is not surprising to find the level-headed investors among us questioning if the Fed is again blowing a huge bubble in emerging markets as it prints money at breakneck speed to combat a credit crunch back home.
Given the unhappy precedents in the past decade, there is another pressing question: What might befall emerging markets if the Fed-orchestrated party suddenly ends?
It is a sobering reminder that while evidence of a regional recovery looks solid, its props might be built on sand.
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