Something unprecedented is happening in the global financial markets all over again. We are seeing asset-price bubbles building in commodities, real estate and equities barely a year after the world suffered its worst recession since the Great Depression. History tells us that after a severe recession, asset prices take a long time to recover. But this time around, asset prices are rising back to the pre-Lehman levels very fast. Driven by massive liquidity, the financial economy is yet again running way ahead of the real economy. Some Wall Street leaders are worrying about this rather strange phenomenon.
For instance, the speculative trading volumes in oil have now hit an all-time high, almost close to the levels that existed before the collapse of Wall Street firms last September. Daily trading volumes in oil are about 16 times the actual underlying demand. In normal times, oil trading volumes were about 4 to 6 times the underlying demand. Real estate prices in cities such as Mumbai, Hong Kong, Shanghai and Singapore are also inching closer to their 2008 peaks. Equity prices have run up quite high in most emerging markets in the past six months, even if we are witnessing a slight correction now.
More importantly, the balance sheets of Wall Street firms are yet again getting leveraged higher on the back of rising asset prices. Their asset size had gone up to 30 times their capital base before the Wall Street crisis last year. The leverage came down to about 13 times after the crisis had played out. Now they are rising again to about 17 times their base, according to analysts. So, are we getting back to square one, is the question that must be asked seriously.
Have we forgotten all the lessons we were supposed to learn after the Lehman collapse? One had thought the one benefit of the global financial crisis was that it would force economic agents to acquire new knowledge in regard to what might happen in the future. For both governments and central bankers, the past has ceased to be an accurate guide for determining future policy.
There is absence of new knowledge when we begin to repeat mistakes and do not come with alternate modes of solving complex problems. Are governments and central bankers thinking differently so far in their response to the global economic crisis. Unfortunately, it does not seem so. The leadership of the US and EU also seem devoid of new ideas in this regard. The G-20 has created mechanisms to examine asset bubbles. But the G-20 is already getting overtaken by events.
In some ways, policy makers and central banks have done the only thing they could think of?inject massive fiscal and monetary stimuli. But this is old knowledge. Even Keynes may have protested at the manner in which his core ideas are being implemented these days. Animal spirits cannot be revived by unbridled government spending and throwing money at near zero interest rates. Capitalism was never meant to be premised on money having no price at all! We had Japan following a virtually zero interest rate policy in the nineties and the economy never recovered for years. Its growth rate stagnated at around 1% for decades together.
It is feared that the US may also be falling into a long-term liquidity trap characterised by a sub-par growth over a long period. This is inevitable unless the policymakers in America come up with some radically new ideas. In this context, RBI governor D Subbarao recently said that not much has been done by nations to debate the fundamental imbalances in the global economic system which could, in fact, have been the primary cause of the Wall Street financial crisis. This imbalance essentially made the US merrily borrow from the rest of the world to support its consumption. Of course, in the past year or so, some of this imbalance was partly correcting with the US current account deficit dropping and its savings rate going up. But that is not enough. The paradigm needs to change.
The US needs to recover its real growth impulse by becoming a prime exporter of high technology goods?it is no more competitive in the manufacturing sector?if it wants to substantially reduce borrowing from the rest of the world. Some of the bigger emerging economies must simultaneously take US?s share as an absorber of world imports. US can no longer act as the world?s super market. Consumption demand has to gradually decentralise and disperse to other economies.
If the US fails to do this, it will again end up using finance capital as a steroid to create an illusion of growth. Wall Street banks help in creating this illusion of growth, which eventually ends in a series of asset bubbles across the world. You don?t sustain long-term growth with pure finance capital play. Finance capital works only when complemented by dynamic elements of the real economy. This was the biggest lesson of last year?s crisis. Another crisis will surely occur if world leaders fail to recognise this.
mk.venu@expressindia.com