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.
Instead, the banks are using their excess liquidity to buy financial assets — and, for now, repeating handsome returns on their investment. Not surprisingly, they want to get the government off their backs once more. In June, 10 large U.S. banks got a go-ahead to repay $68 billion in TARP money to the U.S. Treasury. They can now speculate without the government looking over their shoulder and, since the government has given them a carte blanche by telling them that they are too big to be allowed to fail, the consequences of taking on new risks are minimal.
The two previous bubbles at least provided some economic utility. High-tech shares took off in the 1990s against the background of a genuine revolution in information technologies. The Internet bubble — and its deflation — was a good illustration of Joseph Schumpeter’s thesis about capitalism and its creative destruction. When the smoke cleared, the way we live, work, shop, receive information and play was transformed by computers, mobile telephony and the Internet. Dozens of new global brands became household names.
Similarly, the real estate bubble boosted the ranks of homeowners both in the United States and in many other countries around the world, expanding the international middle class. Despite the strain of recession, a majority will hold on to their homes. Moreover, consumer demand from the United States allowed a number of countries in Asia, Latin America and Eastern Europe to build modern industrial infrastructure and to enter the ranks of industrial nations.
The nascent Obama bubble is totally different in that it is based on no rational economic foundation. Some market watchers have claimed that stocks and commodities had been sold off too drastically in the October-March period. But if, as we have been told, the world is suffering the worst slump since the Depression, market prices should come down to reflect this fact. However, at its March nadir, the Dow only briefly dropped below its 2002 lows. Ironically, that nadir, at around 6,400, is approximately where the Dow stood when former Fed chairman Alan Greenspan made his famous “irrational exuberance” remark in December 1996, warning about a bubble on Wall Street.
Similarly, oil prices are now already well above the current dollar average that prevailed during the entire post-war period. During periods of economic downturns, oil prices were closer to $30 to $40 per barrel in current dollars.
The Obama bubble is actually two interconnected bubbles. The liquidity that is now inflating bubbles in stock and commodity markets has been provided, mostly, by the U.S. government. Moreover, whatever positive signs there have been in the real economy have also come from public sector spending. The Federal government, for example, has been funding public works and transferring money directly to state governments. Abroad, foreign governments have also provided money for public works, cut taxes and paid direct subsidies to consumers.
However, Washington had been running fiscal deficits even before the advent of the current recession. To get more money, the government has had to step up its borrowing on a massive scale. The budget deficit is projected to reach $1.85 trillion in the current fiscal year and in 2009-2012 Federal deficits will average $1.2 trillion annually. Even the world’s largest economy and the supplier of the global reserve currency can’t sustain such a pace of debt accumulation indefinitely and keep soaking up such a huge proportion of global savings.
The Obama Administration hopes that government spending will jump-start the private sector. Perhaps the bubble in stocks will generate another wealth effect and send U.S. consumers to the shopping malls, but it seems doubtful. Just look at the labor-market math: The president claims that his fiscal stimulus plan has already saved about 150,000 jobs and promises to add 600,000 more jobs during the summer. However, the economy has lost 6 million jobs since December 2007 — and the labor force has increased by an additional 2 million in the meantime. This means that the total projected jobs gain, achieved at such a tremendous cost, will provide less than 10 percent of the jobs needed to return employment to pre-recession levels.
In late May and early June, yields on U.S. Treasuries spiked, foreshadowing an imminent strain on financial markets. The twin bubbles in stocks and in bonds can’t go on inflating without infringing upon each other. Some time — probably in the second half of 2009 — one or both of them will burst, ushering in the next stage of the current economic slump.
Alexei Bayer runs KAFAN FX Information Services, an economic consulting firm in New York; reach him at [email protected]. His monthly “Global Economy” column in Research has received an excellence award from the New York State Society of Certified Public Accountants for the past six years, 2004-2009.