In the past three months, global asset prices have rebounded sharply: Stock prices have increased by more than 30 percent in advanced economies and by much more in most emerging markets. Prices of commodities — oil, energy, and minerals — have soared; corporate credit spreads (the difference between the yield of corporate and government bonds) have narrowed dramatically, as government-bond yields have increased sharply; volatility (the “fear gauge”) has fallen; and the dollar has weakened as demand for safe dollar assets has abated.
But is the recovery of asset prices driven by economic fundamentals? Is it sustainable? Is the recovery in stock prices another bear-market rally or the beginning of a bullish trend?
While economic data suggests that improvement in fundamentals has occurred — the risk of a near depression has been reduced; the prospects of the global recession bottoming out by year end are increasing; and risk sentiment is improving — it is equally clear that other, less sustainable factors are also playing a role. Moreover, the sharp rise in some asset prices threatens the recovery of a global economy that has not yet hit bottom. Indeed, many risks of a downward market correction remain.
First, confidence and risk aversion are fickle, and bouts of renewed volatility may occur if macroeconomic and financial data were to surprise on the downside — as they may if a near-term and robust global recovery (which many people expect) does not materialize.
Second, extremely loose monetary policies (zero interest rates, quantitative easing, new credit facilities, emissions of government bonds and purchases of illiquid and risky private assets), together with the huge sums spent to stabilize the financial system, may be causing a new liquidity-driven asset bubble in financial and commodity markets. For example, Chinese state-owned enterprises that gained access to huge amounts of easy money and credit are buying equities and stockpiling commodities well beyond their productive needs.
CORRECTION
The risk of a correction in the face of disappointing macroeconomic fundamentals is clear. Indeed, recent data from the US and other advanced economies suggest that the recession may last through the end of the year. Worse, the recovery is likely to be anemic and sub-par — well below potential for a couple of years, if not longer — as the burden of debts and leverage of the private sector combine with rising public sector debts to limit the ability of households, financial firms and corporations to lend, borrow, spend, consume and invest.
This more challenging scenario of anemic recovery undermines hopes for a V-shaped recovery, as low growth and deflationary pressures constrain earnings and profit margins and as unemployment rates above 10 percent in most advanced economies cause financial shocks to re-emerge, owing to mounting losses for banks’ and financial institutions’ portfolios of loans and toxic assets. At the same time, financial crises in a number of emerging markets could prove contagious, placing additional stress on global financial markets.
The increase in some asset prices may, moreover, lead to a W-shaped, double-dip recession. In particular, thanks to massive liquidity, energy prices are now rising too high too soon. The role that high oil prices played last summer in tipping the global economy into recession should not be underestimated. Oil above US$140 a barrel was the last straw — coming on top of the housing busts and financial shocks — for the global economy, as it represented a massive supply shock for the US, Europe, Japan, China and other net importers of oil.
DEFICITS
Meanwhile, rising fiscal deficits in most economies are now pushing up the yields of long-term government bonds. Some of the rise in long rates is a necessary correction, as investors are now pricing a global recovery. But some of this increase is driven by more worrisome factors: the effects of large budget deficits and debt on sovereign risk, and thus on real interest rates; and concerns that the incentive to monetize these large deficits will lead to high inflation after the global economy recovers from next year to 2011 and deflationary forces abate. The crowding out of private demand, owing to higher government-bond yields — and the ensuing increase in mortgage rates and other private yields — could in turn endanger the recovery.
As a result, one cannot rule out that by late next year or 2011, a perfect storm of oil above US$100 a barrel, rising government-bond yields and tax increases (as governments seek to avoid debt-refinancing risks) may lead to a renewed growth slowdown, if not an outright double-dip recession.
The recent recovery of asset prices from their March lows is in part justified by fundamentals, as the risks of global financial meltdown and depression have fallen and confidence has improved.
But much of the rise is not justified, as it is driven by excessively optimistic expectations of a rapid recovery of growth toward its potential level and by a liquidity bubble that is raising oil prices and equities too fast too soon. A negative oil shock, together with rising government-bond yields — could clip the recovery’s wings and lead to a significant further downturn in asset prices and in the real economy.
Nouriel Roubini is professor of economics at the Stern School of Business, New York University, and chairman of RGE Monitor.
COPYRIGHT: PROJECT SYNDICATE
In a summer of intense political maneuvering, Taiwanese, whose democratic vibrancy is a constant rebuke to Beijing’s authoritarianism, delivered a powerful verdict not on China, but on their own political leaders. Two high-profile recall campaigns, driven by the ruling party against its opposition, collapsed in failure. It was a clear signal that after months of bitter confrontation, the Taiwanese public is demanding a shift from perpetual campaign mode to the hard work of governing. For Washington and other world capitals, this is more than a distant political drama. The stability of Taiwan is vital, as it serves as a key player
Yesterday’s recall and referendum votes garnered mixed results for the Chinese Nationalist Party (KMT). All seven of the KMT lawmakers up for a recall survived the vote, and by a convincing margin of, on average, 35 percent agreeing versus 65 percent disagreeing. However, the referendum sponsored by the KMT and the Taiwan People’s Party (TPP) on restarting the operation of the Ma-anshan Nuclear Power Plant in Pingtung County failed. Despite three times more “yes” votes than “no,” voter turnout fell short of the threshold. The nation needs energy stability, especially with the complex international security situation and significant challenges regarding
Much like the first round on July 26, Saturday’s second wave of recall elections — this time targeting seven Chinese Nationalist Party (KMT) lawmakers — also failed. With all 31 KMT legislators who faced recall this summer secure in their posts, the mass recall campaign has come to an end. The outcome was unsurprising. Last month’s across-the-board defeats had already dealt a heavy blow to the morale of recall advocates and the ruling Democratic Progressive Party (DPP), while bolstering the confidence of the KMT and its ally the Taiwan People’s Party (TPP). It seemed a foregone conclusion that recalls would falter, as
The fallout from the mass recalls and the referendum on restarting the Ma-anshan Nuclear Power Plant continues to monopolize the news. The general consensus is that the Democratic Progressive Party (DPP) has been bloodied and found wanting, and is in need of reflection and a course correction if it is to avoid electoral defeat. The Chinese Nationalist Party (KMT) has not emerged unscathed, either, but has the opportunity of making a relatively clean break. That depends on who the party on Oct. 18 picks to replace outgoing KMT Chairman Eric Chu (朱立倫). What is certain is that, with the dust settling