The global economy is likely experiencing a bigger bubble than the one that unleashed the 2008 crisis, and should it burst the ensuing recession would be mammoth.
Return of the Dotcom Bubble
Wild speculation in Internet stocks brings back the bubbly days of 2000.
Facebook is trading above 100 times earnings, Amazon over 1,000. AOL and Yahoo did not go that high in the last dotcom bubble. I am sure that some clever analysts could come up with stories to sort of justify the valuation. And, of course, no one can be absolutely sure about a bubble until it bursts, which was Alan Greenspan’s justification for not acting against bubbles. I suspect that this dotcom bubble will burst in 2014, as soon as the Fed is forced to tighten.
The extremes in the new dotcom bubble tell us what the monetary condition is in the world. The real interest rate is practically negative everywhere. This is happening for probably the first time in modern history. Negative real interest rates also trigger bubbly valuation in credit, property and stocks.
Another Global Recession
The odds are that the world is experiencing a bigger bubble than the one that unleashed the 2008 Global Financial Crisis. The United States’ household net wealth is much higher than at the peak in the last bubble. China’s property rental yields are similar to what Japan experienced at the peak of its property bubble.
The biggest part of today’s bubble is in government bonds valued at about 100 percent of global GDP. Such a vast amount of assets is priced at a negative real yield. Its low yield also benefits other borrowers. My guesstimate is that this bubble subsidizes debtors to the tune of 10 percent of GDP or US$ 7 trillion dollars per annum. The transfer of income from savers to debtors has never happened on such a vast scale, not even close. This is the reason that so many bubbles are forming around the world, because speculation is viewed as an escape route for savers.
The property market in emerging economies is the second-largest bubble. It is probably 100 percent overvalued. My guesstimate is that it is US$ 50 trillion overvalued.
Stocks, especially in the United States, are significantly overvalued too. The overvaluation could be one-third or about US$ 20 trillion.
There are other bubbles too. Credit risk, for example, is underpriced. The art market is bubbly again. These bubbles are not significant compared to the big three above.
When the Fed does normalize its policy, i.e., the real interest rate becomes positive again, this vast bubble will burst. Given its size, its bursting will likely bring another global recession worse than the one after the 2008 crisis.
The disinflationary force from globalization, especially from East Asian economies driving down the prices of manufacturing goods, is the background for the serial bubbles over the past three decades. As China’s labor surplus is gone and no other country is taking over the disinflationary role, the big background for bubbles seems to be winding down. The disinflationary force for the current bubble is weak demand in developed economies, not rising productivity. This is why inflation will come to end this one.
When inflation emerges and persists, interest rates will have to rise. For example, the U.S. 10-year bond yield may double to 5 percent. Bubbles are less likely in an environment of rising interest rates. I suspect that the current bubble is the last one for a long time to come.
Detailed analysis can be found here…
Dr Andy Xie 謝國忠 is Shanghai-based independent economist specialising in China and Asia. He is currently director of Rosetta Stone Advisors and of China Boqi Environmental Science and Technology.
Dr Xie is one of the few economists who has accurately predicted economic bubbles including the 1997 Asian Financial Crisis and the more recent subprime meltdown in the United States. He joined Morgan Stanley in 1997 and was Managing Director and Head of the firm’s Asia/Pacific economics team until 2006. Prior to that he spent two years with Macquarie Bank in Singapore, where he was an associate director in corporate finance. He also spent five years as an economist with the World Bank.