Welcome to the year of the bubble.
It may seem an odd assertion at a time when many key economies are in, or on the verge of, recession. Yet near-zero interest rates in Washington, Tokyo and Frankfurt have a way of wreaking havoc with markets and human psychology. It’s not a reach to say we have a bubble in bubbles.
The forces that will make for an interesting 2011 go beyond monetary policies. A variety of market-shaking bubbles might inflate before our eyes—some in asset markets, others in flawed perceptions. Here are eight.
Hot money. It’s terrific that the MSCI AC Asia Pacific Index jumped 14% last year, far outpacing MSCI’s broader indexes. It would be better, though, if the gains had more to do with fundamentals and less with ultra-low rates.
The Bank of Japan’s largesse has long seeped overseas to boost stock, bond and property prices near and far. The so- called yen-carry trade—borrowing cheaply in yen and using the funds for riskier bets overseas—was the forerunner of a similar dollar trade. Federal reserve policies sent tidal waves of liquidity towards Asia in 2010. It could reach disastrous proportions, leaving a trail of ruin in its wake.
Decoupling theory. The bubble here is the unsustainable belief that Asia can grow rapidly no matter what happens among the biggest economies. Don’t bet on it. It’s great that China is growing 9.6% and that India is zooming along at 8.9%.
Nothing, though, would serve Asia better than a rebound in growth in the US, euro zone, Japan and the UK, which combined make up $34 trillion in annual output. Asia has done a stellar job staying afloat since Wall Street’s collapse in 2008. Developing economies may be able to live for a couple of years without the majors. Good luck keeping up that performance in the year ahead.
Food prices. A 3 January Times of India headline raised a question in many an Asian mind: Can government do nothing legally to check prices? The answer is: not much.
The United Nations’ Food and Agriculture Organization predicts that the global cost of importing foodstuffs totalled $1.026 trillion in 2010, compared with $893 billion in 2009. We haven’t seen anything yet. Imbalances in supply and demand and regional trade rigidities will accelerate the trend, swamping developing nations with the most basic of problems: filling the bellies of those powering their economic rise.
Income inequality. Surging prices of everything from food to transportation pushed Indonesian inflation to a 20-month high in December. The trajectory of everyday prices is a fast-developing setback to Asia’s efforts to narrow its gaping rich-poor divide.
Rising costs for cooking-oil, rice and fish may mean little to the average Goldman Sachs staffer. To a family living on $3 a day and already spending two-thirds of income on food, they are devastating. Rising wealth disparities could foreshadow a year of tensions, as failed harvests and inflation cause famines, riots, hoarding and trade wars worldwide. The bubble here would be one in human suffering.
Wacky weather. Australia’s experience tells the story. A few months ago, drought was imperilling its economic outlook. Today, floods that some are characterizing as biblical have economists calculating the implications for commodity prices.
Forget temperatures and focus on the increasing frequency of freaky weather patterns from Miami to Mumbai. Now, economist Dennis Gartman, who writes a Suffolk, Virginia-based newsletter, says investors should sell the Australian dollar against the euro as flooding threatens exports of coal and wheat. Funny how it takes mother nature to make anyone bullish on the euro.
Currency reserves. Why any economy needs $2.7 trillion of them is beyond me. And it’s not just China that is trapped into adding to its currency stockpile to keep its existing holdings from losing value. Japan has more than $1 trillion, while Taiwan, South Korea, Hong Kong, Singapore and Thailand have a combined $1.3 trillion. Talk about an unproductive use of wealth—and a risk that’s growing by the day with no easy fix in sight.
Geopolitical risks. Leave it to Kim Jong-Il to remind investors that the biggest surprises aren’t coming from economic or corporate reports, but rogue regimes like Kim’s in North Korea. Expect Pyongyang’s provocations to increase exponentially in frequency and seriousness.
Also expect a bull market in territorial disputes. Faced with growing uncertainty, governments are desperate to placate the masses. The desire to unify the home population may lead to growing rifts between neighbours. Those seeking shelter from these brewing storms explains why gold is almost $1,400 an ounce.
Group of 20. Any optimism that European officials can avert disaster might be seen as irrational. The same goes for the belief that China can grow about 10% annually forever or that Japan’s leaders can defeat deflation. The real perceptions bubble is that a disparate grouping of 20 nations can tame out-of-whack markets and imbalances that were decades in the making. The year ahead might turn any, or all, of these accepted wisdoms on their head.