Bubblenomics is back with a vengeance
IT is time to worry about the next bubble – not just in the UK, but in markets all over the world. Earlier this year, I wrote a column in this space arguing that the housing market in the UK was no longer over-valued, based on historic price to earnings ratios and a range of other evidence, including the fact that yields on rented flats were higher than mortgage payments again. I spoke too soon. Since then, house prices have jumped by about five per cent, taking the trough-to-peak rise this year to around seven per cent, which is ridiculous and cannot be justified by the fundamentals. Unfortunately, this means that house prices are now clearly over-valued again, with home owners and investors convincing themselves that property is once more a one-way bet (a deeply dangerous conceit).
Not all asset classes are suffering from bubbles. British and US equities are still by and large fine. But the monetary policies that have been introduced to try and get us out of the credit crunch, property crash and economic implosion of the past two years are starting to work too well. This is true even though the recovery remains fragile and the money supply isn’t going up very fast and in some countries is actually falling.
It would be better for us to suffer very low growth or stagnation over the next couple of years rather than unsustainable growth followed by another collapse in 2012 or 2013. The global economy simply could not cope with that; some countries would go bust and others, such as the UK, would have to hyper-inflate themselves out of a sovereign debt default. Another bubble and bust would be a total catastrophe, which needs to be avoided at almost any cost.
There are several related forces fuelling the problem. Loose monetary policy in most developed countries, including of course Britain and America, is having both a direct and an indirect effect. Yields on UK gilts are much lower than they should be, with a knock-on effect on commercial bonds and equities (which are valued by discounted cash flow models for which interest rates are key). As institutions sell gilts and convert the cash into other assets, these are in turn being propped up. Then there is the indirect effect via the carry trade: investors are borrowing in dollars and buying assets in countries with higher interest rates such as Australia.
There is clearly a bubble in the Australian dollar, up by a third over the past year; the IMF and the World Bank are also warning of a return to overvalued property markets in Asia. They are right; house prices in Singapore jumped over 15 per cent in the most recent quarter, which makes no sense. There also appears to be a bubble in emerging market equities as well as gold – which just hit a record price – copper and other assets.
Red lights should now be flashing. We are re-entering the danger zone: just as the authorities created a property bubble to escape the dot.com bubble, we are now inflating a series of other bubbles to get out of the last one.
The Bank of England should start to signal that it understands this by refusing to extend quantitative easing tomorrow, even if this triggers a correction in the stock and bond markets. A careful analysis of the figures by Henderson New Star shows that there is more liquidity sloshing around the economy than the money supply figures would suggest. I fear for the future if the Bank doesn’t nip the madness in the bud.
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