Speculators will get their fingers burned, just like their yen carry trade counterparts
By ANTHONY ROWLEY 05 November 2009
Those of a nervous disposition would probably have been better off not reading various economic reports, or even sections of the financial press, that have appeared this week. Those who did so must be wondering what new horrors may be developing on the international financial and economic scene - just when they thought it safe to emerge from under the debris of the last one.
The week got off to an ominous start when New York University professor and economics guru Nouriel Roubini suggested in the Financial Times that a gigantic asset bubble is inflating under the influence of the ‘mother of carry trades’ as investors borrow cheap US dollars and use them to finance speculation in stocks and other financial assets.
Seeding crisis
This is sowing the seeds of a new financial crisis, he suggested.
Prof Roubini may occasionally engage in hyberbole in order to get his audience’s attention but his warning was echoed by the Institute of International Finance which said that there was ‘a need to guard against another significant asset bubble’ as asset price reflation takes off. Then, the World Bank too flagged the risk of ‘new asset price bubbles’ developing.
What is going on, and how can it be that just one year after the world suffered what was supposed to be the mother of all asset bubbles, leading to the sub-prime mortgage crisis and related financial system chaos, we are apparently looking at the danger of yet another such episode, one of perhaps even bigger dimensions?
The answer is that financial liquidity has been pumped into the global financial system as central banks have sought to keep banking and other institutions afloat and as governments have sought to reflate their economies through fiscal stimulus. This fuel for quick recovery could spark a conflagration at some point.
Fiscal stimulus has had the effect of boosting economic activity in places such as China where it has been directed towards infrastructure building and other real-economy applications.
But monetary easing, via the provision of abundant financial market liquidity and near-zero interest rates, has not always been absorbed in real-economy applications.
In former times, this might have simply caused a so-called ‘liquidity trap’ to develop - the ‘pushing on a piece of string’ phenomenon described by economist John Maynard Keynes, whereby instead of creating new economic activity, money just sloshes around in the system with few people wanting to borrow or invest the stuff in the face of poor demand.
Nowadays, however, we have a whole industry of fund managers with its legions of foot soldiers whose business is to find somewhere to park the untold billions of investment dollars they collect in various forms.
These are the people who eagerly mop up financial liquidity, especially when it is available, as at present, for next to nothing in a (near) zero interest rate environment.
In recent months, fund managers have piled into emerging markets, especially those in Asia. The result, as the IIF noted, is that credit growth in emerging markets has accelerated to ‘high double-digit rates’ as capital inflows to these markets jumped by an all-time record of US$53 billion in the first nine months of this year, pushing equity prices up by an average 63 per cent to above pre-crisis highs.
But what happens when US dollar interest rates begin to move away from their current lows, as Prof Roubini suggested they must before very long? Those who have used the US currency to finance carry trade-type speculation will get their fingers burned (as happened to yen carry trade speculators last year) and at that point both stock and bond markets - emerging and mature - could implode again.
What is incredible is that investors (speculators) appear to be taking for granted the indefinite continuance of monetary and fiscal stimulus on the current scale, in the same way that they took for granted the continuance of the securitisation-driven financial asset bubble that inflated in the US and elsewhere before bursting.
Some central banks - notably those in Australia, Israel and Japan have already begun monetary tightening in one shape or another and India too is preparing to do so. Others, including the US, will follow suit, sooner or later, and that will be where the music stops - yet again.
Adding to the ominous news this week, the International Monetary Fund published a report on the fiscal health of the world, and it did not make for particularly comfortable reading. Among advanced economies, the report said, the level of outstanding government debt to GDP is set to reach nearly 120 per cent by 2014 - roughly double what it was a year or two ago.
Governments are courting the danger of a ‘snowballing’ of their debt as economies continue to rely on fiscal stimulus and as the cost of servicing government debt grows in line with the level of its accumulation.
Governments need to devise exit strategies, the IMF said, while the World Bank reminded them that ‘fiscal and monetary stimulus alone cannot sustain domestic demand for a sustained period of time’.
Keynesian mode
What all this amounts to is that portfolio investors are piling into stocks and other assets, not because the market has sensed real recovery, but on the assumption that ‘we are all Keynesians now’ and that the public purse can sustain a level of asset prices and economic activity that the private sector failed to sustain after the sub-prime crisis.
Clearly, it can not.
As the World Bank noted, what we have seen is an economic ‘rebound’ rather than a real recovery in the global economy. Governments and central banks provided a trampoline on which collapsing banks and financial markets could rebound, and crashing economies stabilise. This too cannot continue.
Only China has the ability to go on much longer pumping up its economy with fiscal stimulus, but this cannot save the world.
As more governments and central banks begin withdrawing fiscal and monetary stimulus next year, markets could be confronted with the truth that they have not just been too far ahead of the game in forecasting recovery but that they themselves have become the only game whose recovery is an established fact.
And even that has been underwritten largely by monetary stimulus. When will they ever learn?
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US$ carry trade set to be next bubble horror
Speculators will get their fingers burned, just like their yen carry trade counterparts
By ANTHONY ROWLEY
05 November 2009
Those of a nervous disposition would probably have been better off not reading various economic reports, or even sections of the financial press, that have appeared this week. Those who did so must be wondering what new horrors may be developing on the international financial and economic scene - just when they thought it safe to emerge from under the debris of the last one.
The week got off to an ominous start when New York University professor and economics guru Nouriel Roubini suggested in the Financial Times that a gigantic asset bubble is inflating under the influence of the ‘mother of carry trades’ as investors borrow cheap US dollars and use them to finance speculation in stocks and other financial assets.
Seeding crisis
This is sowing the seeds of a new financial crisis, he suggested.
Prof Roubini may occasionally engage in hyberbole in order to get his audience’s attention but his warning was echoed by the Institute of International Finance which said that there was ‘a need to guard against another significant asset bubble’ as asset price reflation takes off. Then, the World Bank too flagged the risk of ‘new asset price bubbles’ developing.
What is going on, and how can it be that just one year after the world suffered what was supposed to be the mother of all asset bubbles, leading to the sub-prime mortgage crisis and related financial system chaos, we are apparently looking at the danger of yet another such episode, one of perhaps even bigger dimensions?
The answer is that financial liquidity has been pumped into the global financial system as central banks have sought to keep banking and other institutions afloat and as governments have sought to reflate their economies through fiscal stimulus. This fuel for quick recovery could spark a conflagration at some point.
Fiscal stimulus has had the effect of boosting economic activity in places such as China where it has been directed towards infrastructure building and other real-economy applications.
But monetary easing, via the provision of abundant financial market liquidity and near-zero interest rates, has not always been absorbed in real-economy applications.
In former times, this might have simply caused a so-called ‘liquidity trap’ to develop - the ‘pushing on a piece of string’ phenomenon described by economist John Maynard Keynes, whereby instead of creating new economic activity, money just sloshes around in the system with few people wanting to borrow or invest the stuff in the face of poor demand.
Nowadays, however, we have a whole industry of fund managers with its legions of foot soldiers whose business is to find somewhere to park the untold billions of investment dollars they collect in various forms.
These are the people who eagerly mop up financial liquidity, especially when it is available, as at present, for next to nothing in a (near) zero interest rate environment.
Surging credit
In recent months, fund managers have piled into emerging markets, especially those in Asia. The result, as the IIF noted, is that credit growth in emerging markets has accelerated to ‘high double-digit rates’ as capital inflows to these markets jumped by an all-time record of US$53 billion in the first nine months of this year, pushing equity prices up by an average 63 per cent to above pre-crisis highs.
But what happens when US dollar interest rates begin to move away from their current lows, as Prof Roubini suggested they must before very long? Those who have used the US currency to finance carry trade-type speculation will get their fingers burned (as happened to yen carry trade speculators last year) and at that point both stock and bond markets - emerging and mature - could implode again.
What is incredible is that investors (speculators) appear to be taking for granted the indefinite continuance of monetary and fiscal stimulus on the current scale, in the same way that they took for granted the continuance of the securitisation-driven financial asset bubble that inflated in the US and elsewhere before bursting.
Some central banks - notably those in Australia, Israel and Japan have already begun monetary tightening in one shape or another and India too is preparing to do so. Others, including the US, will follow suit, sooner or later, and that will be where the music stops - yet again.
Adding to the ominous news this week, the International Monetary Fund published a report on the fiscal health of the world, and it did not make for particularly comfortable reading. Among advanced economies, the report said, the level of outstanding government debt to GDP is set to reach nearly 120 per cent by 2014 - roughly double what it was a year or two ago.
Governments are courting the danger of a ‘snowballing’ of their debt as economies continue to rely on fiscal stimulus and as the cost of servicing government debt grows in line with the level of its accumulation.
Governments need to devise exit strategies, the IMF said, while the World Bank reminded them that ‘fiscal and monetary stimulus alone cannot sustain domestic demand for a sustained period of time’.
Keynesian mode
What all this amounts to is that portfolio investors are piling into stocks and other assets, not because the market has sensed real recovery, but on the assumption that ‘we are all Keynesians now’ and that the public purse can sustain a level of asset prices and economic activity that the private sector failed to sustain after the sub-prime crisis.
Clearly, it can not.
As the World Bank noted, what we have seen is an economic ‘rebound’ rather than a real recovery in the global economy. Governments and central banks provided a trampoline on which collapsing banks and financial markets could rebound, and crashing economies stabilise. This too cannot continue.
Only China has the ability to go on much longer pumping up its economy with fiscal stimulus, but this cannot save the world.
As more governments and central banks begin withdrawing fiscal and monetary stimulus next year, markets could be confronted with the truth that they have not just been too far ahead of the game in forecasting recovery but that they themselves have become the only game whose recovery is an established fact.
And even that has been underwritten largely by monetary stimulus. When will they ever learn?
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