Is a bubble about to burst again?

It was not so long ago that the eurozone and US seemed to be well on the road to recovery. So what happened, asks Kyran Fitzgerald.

A slump in share prices. Renewed talks of crisis in the eurozone. An increase in the cost of borrowing borne by governments on the eurozone periphery. Irish bond yields edging up a little towards the 2% mark just as the ratings agencies raised questions over the Government’s strategy of modest budgetary belt loosening.

By Thursday, that old familiar feeling was back, that sense of a bubble bursting and of crisis resumed.

Share prices on Wall Street were down by almost 7.5% on the elevated levels of mid-September while Germany’s Dax shed 15% of its value, with similar declines registered across the board in Europe.

So was this the long anticipated correction, after a long period of froth in the markets, or is there something more fundamental going on?

By the weekend, a greater sense of calm had been restored following interventions by central bankers on both sides of the Atlantic. Comments by James Bullard of the St Louis Fed, a branch of the US Federal Reserve, to the effect that purchases of assets would not be halted as scheduled appeared to trigger a strong rally. The sense is that markets have overreached in anticipation of a global recovery that now looks less likely to materialise.

While China did come out with a set of strong trade figures, there is a widespread lack of trust in the data emerging from an economy which has become such a major source of global demand — and a potential source of investment instability, many fear.

The reorienting of the Chinese economy following an investment boom without parallel in world history has produced ripple effects spreading from Australia to Germany.

Global demand for oil has been hit just as US production, driven by shale, has surged. The slump in commodity prices has been dramatic, with oil prices in dollar terms down 25%.

This decline has attracted particular notice given events in Ukraine and the Middle East.

Traders are now speculating on a possible decline in oil prices to the $80 per barrel mark before long.

Those who recall the stagflationary Seventies would certainly welcome such a development, not least because it might put some manners on Russia’s bogeyman, President Vladimir Putin.

Optimists believe falling oil prices could produce a more amenable Iran and a less bolshie Venezuela. Others warn that a sustained drop will simply lead to a postponment of shale oil projects and renewed dependence on a bunch of dodgy kingdoms and petro dictatorships.

Falling prices at a time of heavy indebtedness can be a harbinger of difficulty ahead, though the West will welcome any easing in its energy terms of trade.

This week, it emerged that prices in Sweden had fallen by 0.4% in September on an annualised basis. Deflation has reached the shores of one of Europe’s most stable countries. The German economy, too, is also stuttering as exports of many of its capital goods fall off.

This might result in a reduction in the German obsession with inflation that appears to have coloured its reaction during the euro crisis, but it could also foster greater anti-foreigner feeling within what remains Europe’s motor economy and chief financial guarantor.

Fears over the future of the eurozone have certainly re-emerged, with Greek bond yields pushing past 9%, raising concerns about another bailout. Poor demand at a major Spanish bond auction also raise eyebrows. On Friday, Greek yields fell back towards 8%, a level still considered unsustainable.

Yields on Irish 10-year bonds fell back below 1.7%, having risen much less than in the case of other peripheral countries. There are legitimate concerns that the Government might have loosened the budgetary corset a little for political reasons, but when the impact of water rates is factored in, this argument loses some of its force.

Moreover, any loosening is occurring at a time when many households remains financially stressed. House prices in Dublin, despite a strong run, remain 35% to 40% below peak levels.

Ibec director general Danny McCoy has talked of the need for the economy to achieve “escape velocity”. The trick will be in pulling this off without arousing excessive expectations.

The public-sector unions are pressing for an early end to the Haddington Road agreement. The word being used is “restoration” — recovery to the pay levels achieved by 2008. The concern is that some time next year, the Government, under pressure from panicking backbenchers, could begin to relax its hold on the public finances, at which stage the markets would really start to sit up and take notice.

Elsewhere, there is a sense of crisis deferred for now. The call has gone out, once more, for the ECB to engage in quantitative easing, but many now wonder whether QE is anything more than a short-term panacea for economies with longer term structural problems.

Some believe that QE is a culprit beyond part of the commodity price boom and that it has helped fuel a new bout of financial speculation along with the rise in shadow banking.

Richard Koo, chief economist at the Nomura Research Institute is credited with introducing QE into Japan, but he is on record as having concluded that it harms the economy in the long run. Koo believes that QE can end up boosting interest rates, thereby harming the investment so many economies require.

Koo says: “Initially, [under QE] long-term rates fall much more than they would in a country without such a policy, which means... economic recovery comes sooner. But as the economy picks up, long rates rise sharply as bond markets feel that central banks will have to mop up all the excess reserves.

“In countries that do not engage in QE, the decline in long-term rates is more gradual. But since there is no need for the central bank to mop up large quantities of funds, everyone is more relaxed once the recovery starts and the rise in long-term rates is more gradual.”

QE can be credited with lifting America out of a threatened depression, but it has produced a nasty side effect in the form of reignited asset price bubbles. Coming off QE is a bit like coming off an addictive drug. Is the US economy ready for the cold turkey experience in the event the Fed finally ends its asset purchases? And are the rest of us ready?

On Friday, Fed chairwoman Janet Yellen condemned the growth in inequality in wealth distribution that has occurred in the past generation.

Yellen was accused of being political by Wall Street commentators, but she was surely on to something.

This shift of resources from labour to capital, from employees to owners, as a result of globalisation has hit wage and salary levels at most levels, reducing demand in most countries outside the emerging economies.

Printing money may tackle deflationary forces in the short term, but it cannot tackle the economic problems resulting from a misallocation of resources. Indeed, by boosting asset prices, they may simply be aggravating those problems.


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