Preponderance of Bubbles Could Hamper Global Economy

by: Private Sector Development

by Brian Hoyt

The editors of the Financial Times appear to be concerned about bubbles. Three out of yesterday's four op-eds are dedicated to the theme.

First, George Soros argues that the implosion of 2008 was an aggregation of a series of bubbles over the past decades, creating, in his words, a "super-bubble":

The crash of 2008 was caused by the collapse of a super-bubble that has been growing since 1980. This was composed of smaller bubbles. Each time a financial crisis occurred the authorities intervened, took care of the failing institutions, and applied monetary and fiscal stimulus, inflating the super-bubble even further.

Soros then turns to the financial system, regulation, and the money supply:

The financial system is far from equilibrium. The short-term needs are the opposite of what is needed in the long term. First you must replace the credit that has evaporated by using the only source that remains credible- the state. That means increasing national debt and extending the monetary base. As the economy stabilises you must shrink this base as fast as credit revives- otherwise, deflation will be replaced by inflation.

Next, over on the right-hand column, two senior fellows from the Peterson Institute make the case for the IMF to help Brazil tackle capital inflows, before markets start to overheat:

The Brazilian action in imposing a tax on certain kinds of foreign inflows... is important in increasing the arsenal of weapons that countries can deploy to moderate overheating of their economies. It is a good illustration of the type of measure policymakers can use to arrest incipient asset price overheating.

The authors then go on to criticize the IMF for criticizing Brazil:

The world needs a less doctrinaire approach to foreign capital flows. Helping Brazil in its decision last week rather than issuing a negative response would signal that the IMF is playing a constructive role in facilitating this shift.

Meanwhile, down below, Wolfagang Münchau offers "A polite discourse on bankers and bubbles"

I suspect strongly that we are already in another bubble in the global equity and bonds markets, and also in sections of the commodity markets. These may burst well before the world economy recovers the most recent bubble. Central banks should eventually prick them before they cause calamity.

It may not be the time yet to deploy an anti-bubble strategy. But we sure need to put one together.

If this cocktail of pundits, financiers, and academics fails to persuade the reader of the risks of upcoming bubbles, perhaps a revered head of state will?

Lee Kuan Yew, "Mentor Minister" of Singapore and former prime minister, had a marvelous discussion with Charlie Rose last week which included, among other topics, a bubble warning.

Lee argued that Ben Bernanke needs to "clean up the liquidity" in the American financial system before the United States faces a liquidity bubble, leading to inflation and a run on the dollar. From the transcript:

CHARLIE ROSE: What would you want to ask him (Obama)? What would you want to know about him?

LEE KUAN YEW: Two things. First, that the 21st century will be a contest for supremacy in the Pacific because that’s where the growth will be. That’s where the bulk of the economic strength of the globe will come from.

If you do not hold your ground in the Pacific you cannot be a world leader. A world leader must hold his ground in the Pacific. That’s number one.

Number two, to hold ground in the Pacific, you must not let your fiscal deficits and dollar come to grief. If it comes to grief in the short term and there’s a run on the dollar for whatever reason, because of deficits are too big and the world -- the financial community and the bankers and all the hedge funds and everybody come to a conclusion that you’re not going tackle these deficits and they begin to move their assets out, that’s real trouble.

CHARLIE ROSE: And there is a risk of that perception today?

LEE KUAN YEW: Absolutely, yes.

And Ben Bernanke knows that. And he has to somehow or the other clean up and soak up the liquidity. But if he does it too soon you get into another recession. But you cannot dig up enormous deficits that allows all the -- and do nothing about it, where people say this is hopeless.

I second the concerns of Messrs Soros and Lee. Just as the paper profits of the mid-2000s were largely fueled by easy money and hubris, the current market successes are based on unprecedented government liquidity provisions. The true test for policymakers is to pull back this support without bringing the recovery to a halt (which will jeopardize future growth), while at the same time not allowing the stimulus to support another bubble that will have even more severe consequences then the previous "super-bubble."

The last thing the world economy needs is an "über-bubble" which destroys America's fiscal credibility.