Saturday, February 1, 2014

Emerging Markets: Another Asset Bubble Popping

The emerging markets asset bubble is popping.  Financial markets in China, Brazil, Turkey, Russia, and India have been falling, with no end in sight.  Commodities prices have declined.  And the major stock markets--in Japan, Europe and the U.S.--have been dragged down in consequence.  All because the Fed began to reduce its quantitative easing program.

We've been here before.  Fed easy money policies contributed to the tech stock craze of the late 1990s and the real estate and mortgage bubbles of the 2000s.  Those earlier bubbles popped when the Fed began to withdraw accommodation.  You have to wonder whether the Fed will ever learn:  long periods of accommodative policies inevitably create asset bubbles somewhere, and when the accommodation is reduced, the bubble will pop.  Painfully, since there is no other way for an asset bubble to pop. 

When tech stocks, and then real estate and mortgage markets, crashed, recession and unemployment followed.  The results included, among other things, higher and higher levels of unemployment and greater inequality of income and wealth over the past 15 years.  When the Fed repeatedly uses its very blunt monetary weaponry to combat economic slowdowns, the rich get richer and everyone else stagnates or declines. 

What will the Fed do in response to the emerging markets downturn?  Initially, nothing.  It will hope that the positive momentum that has emerged in the U.S. and to a limited degree, in Europe, will be enough to maintain overall global economic equanimity.  But if the decline extends for several more months (particularly in major stock markets), expect the Fed to rethink its stance and get the monetary printing presses revved up again.  As we have discussed before (see, fiscal policy will be darn near nonexistent this year.  Fed easy money policy is the only way for the federal government to combat economic distress.  And even if more money printing means yet another asset bubble a few years down the line, and more income and wealth inequality, the only choices nevertheless remain easy money or easy money.  The Fed's policies are the only game in town.

One might lament that the Fed never seems to learn that too much accommodation leads to yet another asset bubble that pops, causing distress and dislocation that leads to more accommodation, which only continues the cycle.  But the problem is the Fed has little choice.  Congress and the White House mostly stare at mirrors and ask who is the fairest of all.  The business community waits for the federal government to stimulate the economy, reduce its risks and heighten the potential for profits.  The Fed personifies moral hazard:  the rest of the world has learned that, when push comes to shove, the Fed will act.  So there's no need for anyone else to step out front and center and take the lead. 

How do we break this vicious cycle?  Well . . . uh . . . there was once a time--long, long ago--when the private sector would lead the way out of recessions.  Businesses would start to expand, banks would start to lend, investors would start to take risks.  But how likely is that to happen now? 

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