The Next Asset Bubble

January 29, 2009

The shoe that still has not fallen is the bursting of an asset bubble in fixed income securities.  Bond prices are unsustainably high, and yields are too to last forever.  As with other bubbles like those in new investment technology, real estate and equities, the one in fixed asset extremes is a global phenomenon, and a return to normal market conditions is unlikely to occur without considerable pain.  The best analogy for a typical financial asset bubble’s deflation is a blow-out, not a slow leak.  Unlike earlier bubbles which helped created recessions, the one in long-term interest rates will hinder recovery from the present one.

The figures below represent period averages of ten-year sovereign bond yields in the United States, Germany, Britain and Japan.

  U.S. Germany Britain Japan
1990-2000 6.57% 6.46% 7.91% 3.66%
2001-2008 4.40% 4.14% 4.69% 1.43%
Today 2.97% 3.26% 3.68% 1.28%


Previous efforts to consolidate public finances have been blown apart by the current needs for fiscal pump priming on an enormous scale.  Low rates are only possible because of the worst outlook for growth in over 70 years. As pieces fall into place for recovery, the threat of sharply rising long-term interest rates also will probably rise.  Japan, interestingly, provides an example suggesting this danger may be over-rated.  Japanese inflation and money growth never got strong again.  The flip-side of that coin is that potential Japanese growth was damaged permanently.  Japanese real GDP is in fact expected to drop more sharply in 2009 than U.S. or Euroland GDP, even though the bad banking assets in Japan were cleansed several years ago.  Japan still struggles with chronic low-grade deflation, and its economy showed no tolerance for rising interest rates during a 5-year uninterrupted economic expansion earlier this decade.  Japan’s fixed income asset bubble never burst, but the economy also never transitioned to sustained domestic demand-led growth, either.

From the standpoint of restoring the prior long-term trend of growth, the Great Recession might be worse than the Great Depression.  It took a world war without precedent to snap the U.S. economy out of its stupor once and for all.  An equivalent conflict now, involving weapons of mass destruction, is an unthinkable scenario and would not lead to the same aftermath as World War 2.  U.S. GDP expanded 3.6% at an annualized rate in the fifty years to end-1999.  It will take some game-changing development that cannot be imagined at the moment to replicate anything near that performance during the first half of the 21st century.

Copyright 2009 Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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