Column: Trouble can be worse than bubble

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: Almost all economic indicators from everywhere in the world suggest that we have exited the worst period of the crisis that began with the collapse of Lehman in 2008. This relatively quick comeback by historical standards—the Great Depression lasted nearly a decade—is in no small part the result of some very aggressive fiscal and monetary stimulus action taken by the governments of all leading economies. Keynes, it seems, was right after all.

But, and here’s a word of caution for diehard Keynesians, like many other powerful medicines, fiscal and monetary stimuli have important, visible and perhaps harmful side effects. Cheap and abundant money, made available by close to zero interest rates in the leading developed economies, has played a crucial role in revitalising the financial sector and sections of the real sector. However, because finance picks up faster than the real economy, there will be a period when there is more liquidity floating around than the real economy can productively absorb. That’s when it goes into creating bubbles in stock markets and real estate.

There is some evidence of this already with major stock markets recovering to near pre-crisis levels without the fundamentals in the real economy warranting such a comeback. In India, the Sensex has risen some 100% over the last eight months even while the real economy continues to stutter—few firms are reporting significant improvements in their topline (improved profits are largely the result of cost-cut bottomlines)—which would be the true indicator of a recovery in demand. Similarly, real estate, particularly in emerging markets like China and India, is witnessing a sharp revival, again to near pre-crisis levels, even though the underlying demand conditions don’t justify this upward correction.

Ironically enough, just as the US Fed’s cheap money policy, in a highly deregulated financial sector framework, over the ‘golden’ Greenspan years led to the subprime bubble and the crisis thereafter, the medicine for correcting the worst effects of that very crisis may be now fuelling another tricky bubble.