John Rapley, Contributor
LAST WEEK, London's Economist reported that the value of the world's housing stock had increased some 50 per cent in just three years. This far outpaced the planet's growth rate, raising questions of where all this money appeared from.
There are various possible explanations for this development - the continued urbanisation of the planet or the development of property markets in Third World countries come quickly to mind. But another possibility is that the stock-market bubble of the late 1990s never deflated. It just blew into real estate markets.
When the bubble burst in 2000, the U.S. Federal Reserve Board slashed interest rates to prevent America falling too far into recession. Historically, low credit costs brought investors around the world rushing into the US real estate market.
REAL ESTATE
As U.S. real estate prices inflated, rich Americans then snapped up properties in Europe and elsewhere. This, in turn, fed bubbles that had already begun to emerge in the real estate markets of several industrial economies.
Has the bubble returned? On the one hand, valuations on the world's major stock markets have returned to saner levels. Bond markets are another matter. U.S. Treasury bonds are now available at negative real rates. This has helped to keep interest rates unusually low.
For the last couple of years in the U.S., it has therefore been economically illogical to save. It has also been illogical not to spend wildly on credit. The returns on bank savings are risible, whilst the costs of debt are insignificant.
However, there are real dangers in this ultra-loose monetary policy. On the one hand, as he nears retirement Fed Chairman Alan Greenspan can once again say that he staved off a deep recession and put the U.S. economy back on a robust growth path. But at what cost? With Americans borrowing freely and saving scarcely, it has fallen to the rest of the world to provide the credit. So far, the planet has done just this, and the U.S. is now sucking in most of mankind's savings. But will this arrangement continue?
Despite the rising talk of the return of a bubble, interest rates in the U.S. remain at levels which continue to encourage the sort of spending that will keep driving up asset values. This is chiefly because Asian central banks are pumping money into U.S. securities.
DEMAND
They are doing this primarily because they want to maintain demand for the dollar, in order to depress the value of their own currencies. By keeping their own currencies cheap, they are hoping to maintain strong U.S. demand for their exports, thus keeping their economies healthy.
In effect, the world is lending Americans money to buy their goods, and is then investing the resultant profits in the U.S. The result is that the rest of the planet now owns an unprecedented share of the U.S. economy. Indeed, the American government has become a virtual client of a few Asian banks.
How long can this arrangement continue? Possibly for a while: the Chinese and Japanese now have so much of their money invested in the U.S. that they have to keep pumping money stateside just to preserve their investments.
However, the foundations of this peculiar global economy are starting to look shaky. As they pump money into the US, these central banks are further depressing interest rates, which will likely fuel the bubble. American stock, bond and real estate markets show no signs of cooling down; the rest of the world's major markets are following them.
However, it is all based on an uncertain premise: that interest rates need not adjust upwards too rapidly because the world's central bankers have lanced the inflation-beast. If this is so, then our growing wealth means we are all still reaping the gains of the belt-tightening and painful adjustments of the late twentieth century.
Look for a portent tomorrow morning, when the U.S. Department of Labour releases its consumer price report. Inflation has been rising in the U.S. So far, however, this has been blamed on short-term cyclical fluctuations, in particular the price of oil. If tomorrow's figures indicate that inflation is actually on a solid upward path, it will become hard to keep interest rates low much longer. And if they rise, a huge bubble could yet burst.
John Rapley is a senior lecturer in the Department of Government at UWI, Mona.
