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August 01, 2009 at 04:00 AM
The Obama Bubble
The late 1990s were marked by a stock market bubble, when “irrational exuberance” boosted the value of technology shares in stock portfolios and created an economy-wide wealth effect. Americans began spending lavishly on the assumption that everyone could become rich merely by investing some money on Wall Street.
Looking back, it is sometimes hard to believe that serious people counted the number of clicks a website got and used “clickology” analysis to justify sky-high valuations of start-ups that had no history or revenues.
Soon after that Clinton-era bubble burst, another bubble began to emerge. Investors were by now wary of fly-by-night companies and the Nasdaq Composite Index, which traded above 5,000 in March 2000, regained only half that level by late 2007. Instead, the new bubble centered on the housing market and used financial engineering to extend mortgages to an ever-widening group of homeowners. Rising house prices created another wealth effect while consumers borrowed against growing equity in their homes to finance spending. The Bush-era bubble lasted longer and ran deeper, and when it finally burst it nearly brought down the entire global financial system.
In his election campaign, Barack Obama rightly criticized the ephemeral bubble economy. Indeed, in retrospect it seemed ridiculous to expect people with low incomes and part-time or no jobs to be able to afford onerous mortgage payments over 30 years, and to award securities backed by such mortgages the AAA rating.
But no sooner did the Obama team settle in Washington than it began inflating a bubble of its own, which became fully established by mid-June. In just three months, U.S. stocks gained a third of their value; the Global Dow index did even better, rising 50 percent. Investors also drove up risky emerging Eurobonds and oil and non-oil commodities. Oil prices doubled from their December nadir, and metals gained around 40 percent.
None of this was supported by economic fundamentals. Even though some analysts envisioned growth returning in late 2009, economic data in most major economies showed that the situation through May was still getting worse — albeit slower than in the disastrous first six months of the crisis. It is not clear what forces could spur new growth. In the United States, in particular, job losses still continue and more than 10 percent of homeowners holding mortgages are either late on their payments, in default or in foreclosure.
Even OPEC has expressed concern over continued oil price increases in an environment of sluggish oil demand.
Plenty of Liquidity
Instead, the boom in financial markets and the rally in commodities have been triggered by excess liquidity in the global banking system. The U.S. Treasury has provided more than $700 billion in cash to banks, insurers and finance companies through its Troubled Asset Relief Program and other programs. The Federal Reserve added around $1 trillion in new reserves to the banking system, effectively printing money, while U.S. consumers, who were saving, on average, no more than $50 billion a year in 2005-2007, put aside some $200 billion between October and March.
The U.S. government has been the worst offender in throwing money at the banking sector, but other governments have done much the same thing. The banking system is now choking with liquidity. The authorities have hoped that the money could jump-start bank lending. However, without a strong economic rebound, demand for credit remains depressed. The world is suffering from excess capacity. In the United States, capacity utilization stands below 70 percent, a record low. The auto industry has 40 percent excess capacity worldwide.
U.S. consumers, the driving force of global demand growth, can’t be expected to keep borrowing and spending. Even those who still have jobs have become circumspect as the jobless rate inches toward 10 percent.
