Despite market chatter and China’s rise, necessary preconditions for an asset bubble in the emerging world haven’t surfaced yet.
By Jonathan Anderson 29 September 2009
(Caijing Magazine) Here’s simple question on the minds of investors today: Are we heading for another global asset bubble? Or, at least, will there be an asset bubble in the emerging world?
The logic follows this way: On the one hand, we are only a year into the single biggest collapse of trade, finance and economic activity the world had seen in 70 years – and one likely to reverberate for as much as five years into the future. The last time we were here, i.e. during the Great Depression of the 1930s, financial markets fell for many years and didn’t see a real recovery until the end of World War II.
This time around, asset prices fell for some six months. And since February or March, every financial market in the world has rebounded sharply, including equities, bond prices, commodities, and emerging currencies. Even property prices – which were at the very epicenter of the global crisis – have started to stabilize and even rebound in many U.S. markets. In China and Hong Kong, housing prices are again testing new highs.
What’s going on? What’s different this time from the protracted disaster of 70 years ago? The short answer is government intervention. Finance ministries and treasuries everywhere were quick to jump in with sizeable expenditures through stimulus packages, as well as capital support for failing banks and trade institutions. Even more importantly, central banks around the world cut interest rates to virtually zero and printed as much money as needed to keep markets liquid and buy bad assets. In many cases, that led to enormous expansions in the base money supply.
As everyone knows, printed money has to go somewhere. Consumers may not be willing to spend it on real goods and services, but won’t ultra-low interest rates and supercharged liquidity expansion lead directly to the next big asset bubble? And shouldn’t we look at property prices in places such as Hong Kong – a small, open economy in the world’s most dynamic region – as the best leading indicator of a regional and global asset reflation cycle to come?
Well, we have good news and bad news. The good news is there are indeed very good theoretical arguments in favour of another asset bubble, particularly one centered in Asia. The bad news, however, is that we’re not there yet. The current asset euphoria in greater China has more to do with Chinese liquidity than with global trends. And the one, big change over the summer was that China moved from full-on monetary easing back to relative tightening. Meanwhile, we don’t quite see all the preconditions in place for a renewed regional or emerging economy-wide bubble just yet.
Let’s go through each of these points in turn. First, what do we need for an asset bubble to form? In simplest terms, we need two things: first, a stable, low-volatility, and very low interest rate funding source where liquidity is ample; and second, an equally stable, high-return region that offers much better returns in both debt and equity markets.
Do we have this in the world today? It certainly looks as if we’re going in that direction. Our best estimates for growth in the developed world -- the United States, EU and Japan -- shows a very lacklustre and anaemic expansion over the next two to three years as consumers and banks work through the mountain of debt built over the past decade, raising saving rates and delevering balance sheets in the process. In this environment, advanced nation central banks are likely to keep interest rates very low and liquidity levels very high for a good while to come. This doesn’t mean zero interest rates or no tightening per se, but it does mean a very slow and gradual move back toward “neutral” conditions.
On the other hand, if we turn to the emerging world, we find both much better balance sheets and much better underlying real growth prospects. Nowhere is this truer than in Asia, where structural savings, productivity, and the potential for domestic stimulus are the highest in the world. Just to give a sense of numbers, we estimated potential medium-term growth for the developed world at around 1.5 percent per annum in real terms, while for Asia the number is above 7 percent.
And in this environment, the Asian region is almost guaranteed to show significantly higher inflation, interest rates and earnings growth than its higher income counterparts. So why wouldn’t we see investors everywhere borrow heavily in low-yield, low growth markets (where, again, liquidity is super-ample) and invest heavily in high-growth, high-yield Asia?
In our view, these arguments make a great deal of sense. However, the bad news is that we’re probably not there yet. To be sure, global interest rates are at absolute rock bottom, liquidity levels are extremely high, and Asian economies are already recovering at a much faster pace. The problem, though, is that we don’t have the visibility we need on future growth and liquidity conditions.
What if the U.S. economy stages an unexpectedly rapid recovery next year, with the Fed hiking rates faster than expected and the dollar surging upward against emerging currencies? This could kill relative investment returns to a long-emerging market, short-U.S. “carry trade” very quickly indeed. And what if European banks or governments start to wobble next year, leading to a renewed credit crunch and a collapse of market liquidity conditions? Once again, investors playing the emerging Asian trade could be significantly hurt.
In other words, we have nearly all the preconditions in place today. But what we really need to complete the deal is greater confidence in a slow but steady global recovery scenario. And this may not occur for a few quarters down the road.
So, looking back at Hong Kong and Chinese property prices, what has been driving them up so rapidly over the last six months? Our best guess is not global liquidity inflows, but rather Chinese liquidity creation at home. After all, China is the one economy in the world where the central bank has not only printed unprecedented amounts of base money since last fall, but also ensured that commercial banks lent those resources to the broader economy.
China is the one economy in the world where we’ve seen a strong and even excessively vibrant credit multiplier at work. And China is the one economy in the world where the central bank is now tightening liquidity conditions significantly. Of course, overall new bank lending figures have remained decently high over the past few months. But the key is that the short-term commercial lending component -- in particular the availability of “non-loan” commercial bills and discounts -- has been falling visibly since July (see chart below). This is likely to have substantial ramifications for asset prices, both at home and in the immediate vicinity.
So there’s certainly nothing wrong with Asian fundamentals, and we do see good support for the argument that we could end up with a renewed asset bubble in this part of the world. However, for the next six months at least, we’re much more cautious as to where things can go.
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Plenty of Hot Air, But So Far No Bubble
Despite market chatter and China’s rise, necessary preconditions for an asset bubble in the emerging world haven’t surfaced yet.
By Jonathan Anderson
29 September 2009
(Caijing Magazine) Here’s simple question on the minds of investors today: Are we heading for another global asset bubble? Or, at least, will there be an asset bubble in the emerging world?
The logic follows this way: On the one hand, we are only a year into the single biggest collapse of trade, finance and economic activity the world had seen in 70 years – and one likely to reverberate for as much as five years into the future. The last time we were here, i.e. during the Great Depression of the 1930s, financial markets fell for many years and didn’t see a real recovery until the end of World War II.
This time around, asset prices fell for some six months. And since February or March, every financial market in the world has rebounded sharply, including equities, bond prices, commodities, and emerging currencies. Even property prices – which were at the very epicenter of the global crisis – have started to stabilize and even rebound in many U.S. markets. In China and Hong Kong, housing prices are again testing new highs.
What’s going on? What’s different this time from the protracted disaster of 70 years ago? The short answer is government intervention. Finance ministries and treasuries everywhere were quick to jump in with sizeable expenditures through stimulus packages, as well as capital support for failing banks and trade institutions. Even more importantly, central banks around the world cut interest rates to virtually zero and printed as much money as needed to keep markets liquid and buy bad assets. In many cases, that led to enormous expansions in the base money supply.
As everyone knows, printed money has to go somewhere. Consumers may not be willing to spend it on real goods and services, but won’t ultra-low interest rates and supercharged liquidity expansion lead directly to the next big asset bubble? And shouldn’t we look at property prices in places such as Hong Kong – a small, open economy in the world’s most dynamic region – as the best leading indicator of a regional and global asset reflation cycle to come?
Well, we have good news and bad news. The good news is there are indeed very good theoretical arguments in favour of another asset bubble, particularly one centered in Asia. The bad news, however, is that we’re not there yet. The current asset euphoria in greater China has more to do with Chinese liquidity than with global trends. And the one, big change over the summer was that China moved from full-on monetary easing back to relative tightening. Meanwhile, we don’t quite see all the preconditions in place for a renewed regional or emerging economy-wide bubble just yet.
Let’s go through each of these points in turn. First, what do we need for an asset bubble to form? In simplest terms, we need two things: first, a stable, low-volatility, and very low interest rate funding source where liquidity is ample; and second, an equally stable, high-return region that offers much better returns in both debt and equity markets.
Do we have this in the world today? It certainly looks as if we’re going in that direction. Our best estimates for growth in the developed world -- the United States, EU and Japan -- shows a very lacklustre and anaemic expansion over the next two to three years as consumers and banks work through the mountain of debt built over the past decade, raising saving rates and delevering balance sheets in the process. In this environment, advanced nation central banks are likely to keep interest rates very low and liquidity levels very high for a good while to come. This doesn’t mean zero interest rates or no tightening per se, but it does mean a very slow and gradual move back toward “neutral” conditions.
On the other hand, if we turn to the emerging world, we find both much better balance sheets and much better underlying real growth prospects. Nowhere is this truer than in Asia, where structural savings, productivity, and the potential for domestic stimulus are the highest in the world. Just to give a sense of numbers, we estimated potential medium-term growth for the developed world at around 1.5 percent per annum in real terms, while for Asia the number is above 7 percent.
And in this environment, the Asian region is almost guaranteed to show significantly higher inflation, interest rates and earnings growth than its higher income counterparts. So why wouldn’t we see investors everywhere borrow heavily in low-yield, low growth markets (where, again, liquidity is super-ample) and invest heavily in high-growth, high-yield Asia?
In our view, these arguments make a great deal of sense. However, the bad news is that we’re probably not there yet. To be sure, global interest rates are at absolute rock bottom, liquidity levels are extremely high, and Asian economies are already recovering at a much faster pace. The problem, though, is that we don’t have the visibility we need on future growth and liquidity conditions.
What if the U.S. economy stages an unexpectedly rapid recovery next year, with the Fed hiking rates faster than expected and the dollar surging upward against emerging currencies? This could kill relative investment returns to a long-emerging market, short-U.S. “carry trade” very quickly indeed. And what if European banks or governments start to wobble next year, leading to a renewed credit crunch and a collapse of market liquidity conditions? Once again, investors playing the emerging Asian trade could be significantly hurt.
In other words, we have nearly all the preconditions in place today. But what we really need to complete the deal is greater confidence in a slow but steady global recovery scenario. And this may not occur for a few quarters down the road.
So, looking back at Hong Kong and Chinese property prices, what has been driving them up so rapidly over the last six months? Our best guess is not global liquidity inflows, but rather Chinese liquidity creation at home. After all, China is the one economy in the world where the central bank has not only printed unprecedented amounts of base money since last fall, but also ensured that commercial banks lent those resources to the broader economy.
China is the one economy in the world where we’ve seen a strong and even excessively vibrant credit multiplier at work. And China is the one economy in the world where the central bank is now tightening liquidity conditions significantly. Of course, overall new bank lending figures have remained decently high over the past few months. But the key is that the short-term commercial lending component -- in particular the availability of “non-loan” commercial bills and discounts -- has been falling visibly since July (see chart below). This is likely to have substantial ramifications for asset prices, both at home and in the immediate vicinity.
So there’s certainly nothing wrong with Asian fundamentals, and we do see good support for the argument that we could end up with a renewed asset bubble in this part of the world. However, for the next six months at least, we’re much more cautious as to where things can go.
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