Intellectual Thoughts by Sanjay Panda !!!!!: Another Bubble likely


Sunday, January 10, 2010

Another Bubble likely

A year ago investors were panicking and there was talk of another great Depression. Now the share prices in all most all the economies are 70-100 % higher than their respective lows of 2009. This was mostly due to interest rates of 1% or less in America, Japan, Britain and the euro zone, which have persuaded investors to take their money out of cash and to buy risky assets.

Central banks see these market rallies as a welcome side- effect of their policies. The market rebound was necessary to stabilise economies last year, but now there is a danger that bubbles are being created. Apart from high asset valuations, the other symptoms of a bubble are rapid growth in private-sector credit and an outbreak of public enthusiasm for some particular assets. The longer the world keeps its interest rates close to zero, the greater the danger that bubbles will appear and its most likely in emerging markets specially China.

The remedies could be forcing banks to adopt higher capital ratios which will curb speculative excesses apart from the interest rate which clould me a major tool to curb speculation. But central banks are wary of using these measures to pop bubbles because it risks of crushing growth as well. Current scenario of high asset prices, low interest rates and massive fiscal deficits seems unsustainable.

Interest rates will stay low only if growth remains slow. But if economies grow slowly, then profits will not rise fast enough to justify current share prices and incomes will not rise far enough to justify the prevailing level of house prices. On the other hand, if the markets are right about the prospects for economic growth, and the current recovery is sustained, then governments will have to react by cutting off the supply of cheap money.

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