The looming asset bubble

In recent years, the US Federal Reserve has flooded the global economy with trillions of dollars in fiat currency in an attempt to put a lid on the liquidity crunch facing banks. Recently revealed financial data on the Federal Reserve’s overnight loans to banks shows that it lent over $9 trillion at interest rates as low as 0.5 per cent.

The current hyper-expansionary monetary policy employed by the Fed is aimed at pumping liquidity into the US economy to the point that consumers can splurge again and the manufacturing and services sectors can be resurrected to their former glory.

While sound in theory, these US dollars are flooding not only local but global markets. Herein lie the biggest problems. Asset bubbles arise when too much money is chasing too few assets and the current monetary expansion is doing just that: creating too much money, and easy money at that.

This easy money is promoting speculation and fuelling prices in commodity markets, which in turn is leading to inflation in global markets – bad news for consumers already facing recessionary pressure.

Currency speculation has also garnered a lot of attention and created volatility and higher turnover in foreign exchange markets. The net effect of this on business is that it results in unpredictable revenue projections and with the dollar at the centre of it all, the dollar-price of assets is rising.

The resulting effect is that there is no real rise in value of the underlying asset but when valued in terms of the dollar these assets start to look as if they have appreciated. Since crude-oil is primarily priced in US dollars, it has experienced a gradual upward momentum, further exacerbating risks of global inflation.

Most recently, oil settled at two-year highs despite a weak economic climate. Gold too is at all-time record highs, based on speculative demand  driven primarily by fear and uncertainty.

The per ten-gram price of the precious metal in the local market was recorded at a fresh peak of Rs38,717 on Saturday.

While it is hard to say which way the global economy will turn, one thing is certain: the money supply needs to be contained soon to bring back valuations to their rightful levels and shun speculation.

The writer is heading Online Strategy and Development at Express Media and can be contacted at [e-mail]

Published in The Express Tribune, December 6^th, 2010.