The stock market is currently confounding doom-laden forecasts. But Alan Shipman advises caution.
Then bounceback might be woefully premature, given that the economy has been static or shrinking for two years and unemployment is rising again. But these days, a recovery in asset prices can contribute to economic revival as well as signalling that investors are expecting one. Many households had to tighten their belts after 2008 because the value of their assets (mainly homes and shareholdings) had fallen perilously close to (or sometimes below) the value of their debts. Because they had to save more and spend less, others found their incomes falling and jobs disappearing. The government then decided it had to curb its own expenditures to match its shrinking tax revenue, unleashing a wave of benefit cuts and state-sector job loss which gave the spiral another downward push.
When share and property prices pick up, the squeeze on household and business budgets is reduced, and the private sector can start spending its way to recovery. That seemed to be happening in the second quarter, with surveys indicating strong growth in service-sector activity, including the markets where those trending trades take place.
The BLASH backlash
So if falling asset prices were what made the recession so long and deep, why isn’t their rebound prompting wider celebration? It’s partly because, for every grateful seller, there’s a would-be buyer who’s now been priced out of the market. If you want to live in London (or anywhere in the south-east) and don’t already own something there, the new surge in asking prices is hardly reassuring.
Still more worrying is the probable reason for house and share price indices jumping so quickly from floor to roof. It began not with a revival of the activity that creates new assets, but with an injection of credit that bids up the value of existing ones. The Bank of England’s retention of a record low interest rate backed up by quantitative easing since 2009, and extra Treasury help for banks to make cheap loans via schemes like ‘funding for lending’ and ‘help to buy’, have allowed the lucky recipients a one-way bet – to Buy Low And Sell High, revving the markets as they do so.
Other central banks and finance ministries around the world have indulged in similar credit easing since 2008. Economists have long preached that low interest rates lead to high asset prices. Anyone with money, and anyone without it who can borrow, rushes to invest in things that yield a durable income flow – and whose rate of return is likely to stay above the inflation that long waves of cheap credit can also unleash. So market-watchers can see ‘bubbles’ going well beyond the major stock exchanges and estate-agents’ windows. Recent surges in American university tuition fees, Damien Hirst auction prices and debt issued by financially fragile governments like Ukraine and Hungary are also signs of a speculative frenzy caused by low-cost funds seeking improbably high returns.
There are three reasons for caution about this euphoria, even among those who were first in the market and now enjoying generous capital gains. Firstly, low-interest lending was intended to promote real investment in new production capacity. But many businesses are still having problems getting the loans they need to expand. Private investment shows few signs of sustainable recovery; and the supply of new housing isn’t rising to meet the new demand, which is why prices (especially in London) have rallied so quickly.
Secondly, this lack of real expansion means that the price rise for assets – which are claims on the income from future production – isn’t supported by actual trends in future production. Markets that climb in defiance of fundamental value inevitably fall back down to earth. Thirdly, when the inevitable price ‘correction’ occurs, many households and businesses (and banks) will be left holding assets that are worth less than their debts. The conditions for slump could then return with added force.
That bursting of the new bubbles needn’t happen this year, or anytime before the 2015 general election. The turning-point is generally expected to come when central banks are forced to start raising interest rates, either because inflation takes off or because they can’t keep swelling their own balance sheets with yield-free government debt. It’s to avert any fear of this happening in the near future that US Federal Reserve chairman Ben Bernanke has been giving reassurances that interest rates will stay at their present low level for several more years. Mark Carney, the newly arriving Bank of England governor, won’t want to buck this trend, given that the first to raise rates will inevitably be blamed for any price crash that follows.
If their strategy works, cheap credit will by then have revived the economy’s supply side as well, justifying the higher price of assets and ensuring that they avoid another drop. But the unbalanced sources of this year’s growth – driven by public and private consumption, with little revival of fixed investment cast doubt on the strength of its foundations. As government and business start to celebrate a return to GDP growth over the next year, there’s a risk that their boardroom champagne could fall suddenly flat.
Alan Shipman 21 June 2013
The views expressed in this post, as in all posts on Society Matters, are the views of the author, not The Open University.
Alan Shipman is a lecturer in Economics at The Open University. He is responsible for the modules You and your money:personal finance in context and Personal investment in an uncertain world, part of the foundation degree in Financial Services.
Cartoon by Catherine Pain