It’s hard to remember the gloom and doom in India nine months ago. The Sensex had crashed along with real estate and commodities. The IMF spoke of a negative feedback loop, whereby a credit shortage caused a production shortage, which led to bankruptcies and a further credit shortage, in a vicious downward cycle.
Nine months later, the stock market has almost doubled. Real estate companies once regarded as insolvent crooks are able to raise millions of dollars. Commodity prices have shot up. Investors are behaving as though another party without end has begun. Bubbles are inflating everywhere, with no sign of caution induced by the bursting of the last bubble.
Some analysts fear that the bubbles will burst very soon. India, China and some other countries may have recovered, but western countries face a distinct risk of a double-dip recession. Housing is again in the doldrums in the US, and foreclosures continue to rise. A record number of US banks have been seized and closed down by the regulator. Commercial real estate is heading for a massive bust, endangering real estate financiers. Unemployment looks like rising to 11% or more.
Many western countries registered positive growth in the last quarter, leading to hopes that the recession has ended. But the latest data warns of the possibility of a second downward dip. Analysts fear that a double-dip recession can erode confidence and generate new panic, causing bubbles to burst across the globe.
I think the danger of that is close to zero. Markets in the West have already factored in the possibility of a double dip. Regulators everywhere are aware of and prepared for that risk. Indeed, the mad rush of dollars into emerging markets is occurring precisely because investors believe that growth prospects are far better in emerging markets than the West. Over $15 billion has flooded into India this year.
No doubt the bubbles inflating today will burst eventually. But they will continue inflating for a long time because the US will, for the foreseeable future, keep flooding the world with dollars at virtually zero interest. To check the possibility of a double-dip recession, the US Federal Reserve looks certain to follow an easy money policy for a long time. Economists like Paul Krugman are calling for a fresh fiscal stimulus to avoid a double dip. Finance Ministers in all western countries are emphasizing the need to avoid any early exit from the massive monetary and fiscal stimulus of 2008: they fear unemployment and recession much more than future bubbles. So, the flood of dirt-cheap dollars is going to continue for a long time.
Some Americans worry that this will eventually cause inflation. Maybe so, but the US Fed is far more worried about the possibility of deflation (systematically falling prices) caused by a double-dip recession. Japan in the 1990s suffered economic stagnation for a decade because of deflation, and the US is determined to avoid that path. The Fed will happily risk inflation in order to avoid deflation. So, it will keep interest rates at virtually zero for the foreseeable future.
What happens when the Fed increases money supply by over a trillion dollars, and lends at virtually zero interest? The dollar is an international currency whose impact is felt across the world. Investors and speculators everywhere know that growth prospects are much better in emerging markets than in the West. So they are borrowing hundreds of billions of dollars at dirt-cheap rates to buy stocks, real estate and commodities in emerging markets.
Hence, asset bubbles are inflating not just in India but in all emerging markets. The MSCI emerging markets index is up 71% in dollars this year, the biggest gainers being Brazil (140%), Russia (127%), Indonesia (105%), China (102%) and Turkey (90%). India is up 83%. Some Indians now worry that unsustainable bubbles are growing. The RBI may exit from its easy money policy early in 2010, as inflation is building up. But as long as a global tsunami of dollars keeps flooding into emerging markets, asset prices in India will keep rising.
In other words, investors rushing into real estate and stock markets are acting rationally, not foolishly. You may think they are myopic morons who have learned nothing from the bursting of the last bubble. In fact they fully understand that booms and busts are intrinsic parts of a market system, not aberrations that can be avoided. The secret of staying ahead is to ride the bubbles when they are inflating and get off before they burst. Right now, it’s time to ride.