Thu, Jul 17, 2003 - Page 9 News List

Double bubble to follow Greenspan's dot-com fiasco

The Federal Reserve chairman should quit now before the bursting of another bubble does further damage to his reputation

By Christopher Lingle

With investors attempting to find safe investment vehicles during the slowdown, the price of government bonds has been bid up so that interest rates have been driven down. Similarly, investors have been encouraged to buy bonds on expectations that a policy of low interest rates will be followed for the foreseeable future. As it is, the rising demand behind the bond bubble is caused by the loose monetary policy of the Fed has put excess liquidity into the system. And so it is that monetary easing has made the yields on government bonds more volatile.

Greenspan's debt bubble is not limited to the US. The market in emerging-market debt is staging a remarkably strong rally that will inevitably end in tears with a bust in debt prices. Over the past 12 months, the average rate of returns on emerging-market debt funds has been 21 percent. Rising from a low of 7.3 percentage points over US Treasuries prior to the Brazilian presidential election in October last year, average debt spreads are now about 4.3 percentage points over benchmark American government securities.

Unfortunately, these improvements have occurred without any changes in the fundamentals for the main emerging-market economies. Consider the situation in some of the most important emerging-market economies. For example, Brazil's vast domestic and external debt burden remains just as unsustainable since its economy remains mired in slow growth. And many of its Latin American neighbors have become afflicted with political instability.

In Turkey, domestic political issues have diverted energies that might have boosted reform. Meanwhile, central European economies are waiting on Godot in the form of a resilient German economy.

Emerging-market debt prices have benefited from the worsening of the overall global economic environment. This is because declining global interest rates induce investors to shift assets out of equities and into fixed income funds like the higher-yielding debt issued in emerging-market economies. In turn, bidding for debt causes prices to rise and attracts more funds due to the prospects of capital gains.

There will be an inevitable correction in prices for debt issued in emerging-market economies. It will occur when central banks tighten up on global liquidity or when the reality of the effects of the global slowdown begin to bump up against weak economic fundamentals.

Then the true legacy of the Greenspan years will come to haunt. Better that he quits now before his legacy is completely tainted.

Christopher Lingle is global strategist for and professor of economics at Universidad Francisco Marroqu in Guatemala.

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