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Financial bubbles do not signify recovery

A view of a display board board on the floor of the New York Stock Exchange at the Opening Bell in New York, New York, USA, 02 January 2013. World financial markets jumped Wednesday.

A view of a display board board on the floor of the New York Stock Exchange at the Opening Bell in New York, New York, USA, 02 January 2013. World financial markets jumped Wednesday.

The US "fiscal cliff" is a disaster. American politicians have proved once again that they lack the political courage to tackle the nation's debt, which is spiralling out of control.

The Republican-controlled House of Representatives took up the Senate's bill, which earmarked tax increases without spending cuts. The tax increases will amount to US$620 billion over the next 10 years. That's $62 billion a year, which is around 6 per cent of $1 trillion in new deficit every year. The proposed $15 billion spending cut is less than 2 per cent of the new deficit.

So nothing significant has been achieved in the attempt to avert the fiscal cliff. The key point is that there is no clear plan to control future spending. When President Barack Obama took office four years ago, the federal debt stood at $10 trillion. Now it has surpassed $16 trillion.

Without a clear target to rein in the runaway spending, the federal deficit will continue to rise. The Congressional Budget Office on Tuesday issued a report indicating that the White House/Senate plan would add another $4 trillion in federal deficit over the next decade.

In Europe, EU officials have been kicking the can down the road. Two years after the Greek crisis, the debt issue has not been resolved. The US politicians are adopting the same tactic of dragging their feet on cutting back the deficit.

The financial markets have rallied over the fiscal cliff deal although it hardly addresses the fundamental question of runaway deficit. In fact, the money market managers are playing on the expectations that the global central banks will come to everybody's rescue. When tax money is not forthcoming, the central bankers will print money for them. Since the crisis of 2008, the central bankers have collectedly pumped $10 trillion into the system.

By keeping interest rates at near zero per cent and by monetising the fiscal deficit, the central bankers are pushing the money managers out of the safe havens and the bond markets. The money managers are more willing than ever to take risks in the equity markets and other riskier assets. Hence a sharp rise in the global stock markets, including the Thai stock exchange, which has made a significant gain from global funds.

But the risk is that the bond markets might go bust with central banks' monetisation and efforts to push down the yields. If the bond markets were to collapse, this scheme of debt monetisation will come to an end. Runaway inflation will ensue.

The problem is that the central banks do not have much room to operate. The US Federal Reserve's announcement of a fourth round of quantitave easing (QE4) means that it will raise its balance sheet from $2.8 trillion to $4 trillion by the end of 2013. Before the 2008 crisis, the Fed's balance sheet was around $600 billion.

The danger is clear and present, with the central banks' nurturing the financial bubbles on a global scale. Governments worldwide should not take the financial market rally as a sign of recovery. For the growth machine is wearing down, while debts and deficits are growing. The financial bubbles, fuelled by central banks' money printing, do not signal an economic recovery. The bubbles will soon have to burst.


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