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Global Financial Crisis

The global asset bubble will burst – the only question is when, and how bad it will be

Andy Xie says we are seeing little concern about the swollen asset bubble, even though stock prices are higher than just before other crises and China is looking to slow the credit expansion that has propelled growth. It’s time to watch for signs of a coming contraction

PUBLISHED : Saturday, 06 January, 2018, 10:16am
UPDATED : Saturday, 06 January, 2018, 7:26pm

Since the global financial crisis of 2008, all major economies have kept interest rates at or close to zero and maintained large fiscal deficits. A decade of massive, synchronised monetary and fiscal stimulus has led to the greatest asset bubble in history, to the tune of about US$100 trillion, nearly 1.5 times the world’s GDP.

Even though the US stock market is more expensive than in 1929 or 2000, and China’s property valuation higher than Japan’s a quarter of a century ago, fear-driven sell-offs have been rare and brief, leading to the belief that high asset prices are the new normal. Massive amounts of financial and business activities, especially in tech, are predicated on high asset prices going higher.

The unusual longevity and resilience of high asset prices are largely because government actions, not herd behaviour in the market, are force-feeding the bubble. Government actions will lose their grip only when growth expectations crash or inflation flares up. Neither is a major risk for 2018. Hence, 2018 won’t kill the speculators of the world.

But 2018 will teach them a lesson or two. High-risk assets such as internet stocks and high-end properties will struggle like never before in the past decade. US interest rates will rise above inflation for the first time in a decade. And China is tightening, especially in the property sector, out of fear of a life-threatening financial crisis. The interaction between the US Federal Reserve’s quantitative easing and China’s credit targeting has been the liquidity super machine. China accounts for about half of global credit growth. Credit creation in commodity economies has been dependent on China. The property sector roughly accounts for half of China’s credit growth. Yet, China’s monetary expansion may slow to half the average of the past decade.

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The asset bubble demands that the excess liquidity-money supply rises faster than GDP to sustain it. This year may see global money supply line up with GDP. The Fed is likely to raise interest rates from the current 1-1.25 per cent and take the level to 2.5 per cent in 2018. This is still low compared with the 4.5-5 per cent nominal GDP growth rate. But the US stock market is more expensive than in 1929 or 2000. When the interest rate surpasses inflation, it will become wobbly.

On the other hand, numerous so-called “unicorns” are looking to cash out of the market before it crashes. When the liquidity tide is not rising, every initial public offering dilutes the bubble. When enough speculators see this, the market may experience violent turbulence.

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Policymakers are caught between a rock and a hard place. The structural problems that led to the 2008 crisis are still here. The global economy grows ever more dependent on asset bubbles. If the global asset bubble bursts, the economy will slide into recession. Hence, when a market wobbles, as it probably will in 2018, policymakers will come out to soothe market sentiment and may even temporarily reverse the tightening.

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Today’s world is full of speculators. The incredible monetary expansion of the past three decades has richly rewarded speculators. Every crash along the way was bailed out quickly by governments. The world has not experienced a genuine cleansing. Hence, three generations of speculators are stacked on top of each other. It doesn’t take much to get them going. Furthermore, today’s speculators are mostly gainfully employed as money managers and bet with other people’s money. Their incentive is overwhelmingly for staying in the game. This is why the dance between policymakers and speculators has been so effective and smooth in propping up defective economies.

The incredible monetary expansion of the past three decades has richly rewarded speculators

While 2018 may not be the end, it will happen some day. A likely trigger is inflation. Central bankers have found the excuse to support asset inflation by citing the lack of inflation in the real economy. This is due to China joining the World Trade Organisation. Some 800 million Chinese workers joined and become gravity for the global labour market. Even when China reached full employment, it started asset bubbles to tax the household sector and turned the revenue into subsidising investment and production. China has since been trapped in the equilibrium of goods deflation and asset inflation. While China does this, global inflation is unlikely to flare up.

Global inflation will finally arrive when China stops funding overinvestment and revalues its currency to empower consumers. When we see China appreciate its currency by 20-30 per cent quickly, the global asset bubble will pop.

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If China keeps doing what it is doing, capital efficiency will keep falling at home and all over the world. Global growth will slow further from the anaemic levels since 2008. When the fear of stagnation takes hold, enough speculators may want to cash out while they can still fill their wallets, and the bubble will pop.

Lastly, a US dollar collapse is possible. If so, it will take everything down with it. The global imbalance has been patched up with excess dollar printing. The people who are willing to hold dollars are in East Asia and the Middle East, because the US is viewed as a superpower and the dollar is the global reserve currency. When that faith falters, for example when US domestic politics becomes total chaos, the dumping of over US$10 trillion could ensue.

The current world is a kind of make-believe. People gain their faith in the fantasy from the last trend. When they wake up, it will be ugly.

Andy Xie is an independent economist