By Robert J. Samuelson
Monday, November 9, 2009
When Nouriel Roubini talks, the world listens. Roubini is, of course, the once-obscure New York University economist whose dire warnings about a financial crisis proved depressingly prophetic. Last week, Roubini was shouting. Writing in the Financial Times, he warned that the Federal Reserve and other government central banks are fueling a massive new asset "bubble" that -- while not in imminent danger of bursting -- will someday do so with calamitous consequences.
Here is Roubini's argument: The Fed is holding short-term interest rates near zero. Investors and speculators borrow dollars cheaply and use them to buy various assets -- stocks, bonds, gold, oil, minerals, foreign currencies. Prices rise. Huge profits can be made.
But this can't last, Roubini warns. The Fed will eventually raise interest rates. Or outside events (a confrontation with Iran, fear of a double-dip recession) will change market psychology. Then investors will rush to lock in profits, and the sell-off will trigger a crash. Stock, bond and commodity prices will plunge. Losses will mount, confidence will fall and the real economy will suffer.
"The Fed and other policymakers seem unaware of the monster bubble they are creating," writes Roubini. "The longer they remain blind, the harder the markets will fall." Haven't we seen this movie before? Well, maybe.
Like home values a few years ago, asset prices have risen spectacularly. Since its March 9 low, the Standard & Poor's 500-stock index has gained more than 50 percent. An index of stocks for 22 "emerging-market" countries (including Brazil, China and India) has doubled from its recent low. Oil, now around $80 a barrel, has increased 150 percent from its recent low of $31. Gold is near an all-time high, around $1,090 an ounce. Meanwhile, the dollar has dropped against many currencies. Half of Roubini's story resonates.
But the other half is less convincing: that prices, driven by cheap loans, have reached speculative levels. Remember that the economy seemed in a free-fall early this year. Terrified consumers and cautious companies hoarded cash, cut spending and dumped stocks. Since then, the mood and economic indicators have improved. Higher stock and commodity prices have mostly recovered the big losses of those panicky months. Today's prices are usually below previous peaks. Oil's peak was nearly $150 a barrel.
Similarly, the S&P 500, now around 1065, is a third lower than its peak on Oct. 9, 2007 (1565.15), and roughly where it was on Election Day 2008 (1005.75). By historical price-to-earnings ratios -- the ratio of stock prices to per-share profits -- these levels can be justified, if the economic recovery continues. With massive layoffs, business costs have been cut sharply. "The hope is that when consumers and companies start spending, the added sales will drop quickly to the bottom line [profits]," says S&P's Howard Silverblatt.
Nor is it clear that cheap dollar loans are promoting speculation. "In the United States and Europe, banks are reducing lending," says economist Hung Tran of the Institute of International Finance, a research organization of financial institutions. "You see hedge funds taking on less leverage [borrowed money] than in 2007." What actually happened, he says, is that as investors became less fearful, they moved funds from cash into other markets, pushing up prices. He cites outflows this year from money market mutual funds exceeding $300 billion.
Indeed, that's what the Fed wants, argues economist Drew Matus of Bank of America. Low interest rates on money market funds and checking accounts are "trying to force you to do something with" the money -- either spend it or invest it. Depression prevention means supporting consumption and asset markets.
So, Roubini's new bubble remains unproved. But this doesn't invalidate his warning. We've learned that there's a thin line between promoting economic expansion and fostering bubbles. With hindsight, lax Fed policies contributed to both the "tech" bubble of the late 1990s and the recent housing bubble, though how much is debated.
The most worrying signs of speculative excesses, says Tran, involve some Asian and Latin American developing countries. They've received sizable capital inflows (money from abroad). These have boosted local stock markets and reflect disaffection with the dollar. Their central banks -- imitating the Fed -- have also kept local interest rates low, fueling rapid credit growth. Some of their stock markets have exceeded previous highs. These countries face a dilemma. Raising rates may attract more "hot" foreign capital; keeping them low may encourage speculative borrowing in local currency.
But the dilemma arises from the Fed's low interest rates and the weak dollar. The conclusion: how deftly the Fed navigates from its present policy matters for the world as well as the United States. If it's too fast, it may kill the economic recovery; if it's too slow, it may spawn bubbles -- and kill the recovery.