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  • Bubble, Bubble, Toil and Trouble

    Confusing times lead to conflicting concerns. Worries over current deflation run into worries about explosive inflation down the road and now there are growing worries over another global asset price bubble. All of these worries are valid, but the possible return of the asset price bubble is the newest and perhaps most serious in the near term. As with the previous bubble, however, commentators seem to be conflating the causes.

    The simple evidence of a bubble begins with the Dow Industrials pushing toward 10,000. Who knows what the right level ought to be, but a 53 percent one year jump strikes many as excessive. Commodity prices are also up significantly – oil has more than doubled in price since February while gold is up 35 percent.

    If bubbles are building, what are the causes? One candidate is the huge amount of liquidity the Fed has pumped into credit markets. This is reminiscent of the excess money creation earlier in the decade that contributed massively to the financial crisis. However, while this money creation has been enormous, with excess reserves held at the Fed now almost $1 trillion above normal, almost all remains at the Fed rather than released into the credit system. So money creation poses a threat for future inflation, but pose little risk of current bubble building.

    Beyond the US, China and Japan may be vying for the position of world’s second-largest economy but there’s no question which has the hotter asset markets or which is driving up global commodities prices. According to the People’s Bank, by the end of September Chinese broad money growth reached a blistering 29 percent year-on-year featuring a 34 percent jump in outstanding loans. In 2007, this would have been destructive monetary policy, now it’s called stimulus. And unlike the Fed’s stimulus, this is real credit creation, not reserves held at bay at the central bank.

    Another source of bubble pressures is simultaneously international and traces back Fed policy. As others have noted, banks are now borrowing from the Fed at a near zero nominal interest rate and buying all manner of assets earning positive returns. When foreigners perform this magic, they get the extra benefit of a falling dollar so they earn a profit on the exchange rate, too. Called the carry trade, the net effect is to drive down the price of risk. Recall it was the collapse in the price of risk globally that was the proximate cause of the previous asset bubble.

    This financial jui-jitsu of borrowing at zero or negative rates and investing at positive rates could also help explain why interest rates are so low. The 10-year Treasury bond has hovered below 3.5 percent for months, when a much higher rate is suggested by the state of the economy and inflation expectations. Whatever the cause, if interest rates are artificially low for whatever reason, then asset prices are almost surely artificially high and another painful correction is in the offing. The witches of Macbeth could not stir a more bitter brew.

    Co-authored by Derek Scissors.

    Posted in Economics [slideshow_deploy]

    3 Responses to Bubble, Bubble, Toil and Trouble

    1. Leon, Durango, CO says:

      This is all illegal, gangster work and Unconstitutional (if this government respected the Rule Of Law). Economic competition, the Fed loans money at 0% to Obama's friends of course. They buy up everything in sight, create an "Assets Bubble" with OUR MONEY, another crisis not for Obama to waste. Market manipulation done with the money from the Federal Reserve at zero percent interest? This is our Currency they are wrecking!

      Please, everybody, every victim of the new Communist government SUE the unlawful Representatives of government in their unlawful acts. Make the Supreme Court Rule. The government destroyed my life. Government officials are unprotected from what they do that is unlawful. The whole Obama Agenda is Communism and that form of government is illegal in this Country. Them doing it are technically in Treason, and serving Foreign Interests, but you have to go after them as citizens. Remember, Clinton fired all the Federal Prosecutors because of their political beliefs. Don't wait for the government to do it.

    2. John Tripp, Scarboro says:

      The next big scandal? Who is "managing" the precious metals market? The price of gold and silver should be on a steady rise, starting two years ago, yet it has flunctuated wildly. The demand for gold is so high the U.S. mint shut down sales last week. I have a conspiracy theory concerning the Federal Reserve Board. They are one of only a few entities with the means to effect the market so quickly. China has a need to keep our dollar strong. What I would give to be a fly on the wall of last months China summit!

    3. iodikickelt says:

      I'm newbie here, I hope to get friends at this forum

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