Why we’re not about to witness the death of the global bubble economy

Patrick Artus

AN ABNORMAL amount of liquidity is still afloat in today’s global markets, amounting to an unprecedented estimate of 27 per cent of global GDP. And whatever the troubles facing some emerging markets in recent months – apparently in the face of the Fed taper – this important ratio of global liquidity to GDP is not expected to decrease significantly any time soon.

Since the second half of the 1990s – and spectacularly so since the onset of the 2008 financial crisis – leading central banks’ highly-aggressive monetary policies have resulted in this dramatic increase in global liquidity. Additionally, international capital flows have intensified and there has been a vast accumulation of foreign exchange reserves in emerging countries and Japan.

Clearly, a new monetary regime is afoot, but it’s not leading to the credit growth that was intended, or a return to inflation. In fact, despite the widespread assumption among market players that “hot money” flows are reversing – with the Federal Reserve finally implementing the first stage of tapering this month, and with its decision this week to cut monthly asset purchases by a further $10bn (£6bn) to $65bn in February – bubbles are still brewing on an international scale and distortions continue to appear.

And even if the Federal Reserve were to completely end its asset-purchasing programme, other sources of monetary creation remain – from the Bank of Japan under its governor Haruhiko Kuroda, from some emerging countries, and from oil exporters. Examining the consequences of this continuous – and not least considerable – rise in the ratio between global liquidity and GDP since the late 1990s is therefore crucial.

Of most concern is the self-sustaining nature of ultra-expansionary monetary policies. In several OECD countries, these policies have given rise to excessive debt and mounting asset prices. As with the stock market bubble in the late 1990s, as well as the real estate bubble seen from 2002 to 2008, the consequent recessions – due to excess debt – have time and again been corrected by even greater expansionary monetary policies.

Coupled with this is the impressive rise in the amount of international capital flows. Indeed, when these capital flows have led to the appreciation of emerging countries’ exchange rates, those countries have accumulated a large amount of foreign exchange reserves to curb currency appreciation, which results in further liquidity. The creation of central bank money begets additional money creation in both OECD and emerging markets.

But where is the return of credit growth and inflation? The natural expectation for these policies is rapid credit growth (as happened between 2002 and 2007) and, as a result, inflation. Yet it’s difficult to see much sign of these today.

First, the high level of global debt strengthens the need to deleverage, so even highly-expansionary monetary policies cannot jump-start credit. In fact, global credit is increasing at considerably slower rates than those seen before the 2008 crisis.

Second, we should not forget that, at least on a global level, there is a massive distortion of income sharing in favour of companies to the detriment of wage earners. This reflects the nominal loss of bargaining power for the latter. The chronic weakness of wages in relation to productivity rules out any significant return of global inflation.

So if the rise in global liquidity (relative to GDP) continues and leads neither to credit growth nor a return of inflation, what will be the likely result? All signs are pointing to a lasting rise in asset prices relative to the usual level compatible with the situation in the real economy.

This means we should continue to expect a high valuation of equities and price-to-earning ratios, booming property prices, abnormally low real interest rates, and unusually low risk premia for sovereign, bank, and corporate bonds, which have been experiencing a downward trend since 2012.

And on a wider level, the world could find itself stuck in a “bubble economy” in terms of asset prices – given the high amount of global liquidity in relation to production, and the fundamental fact that today’s situation is generating neither credit nor inflation.

Patrick Artus is chief economist at Natixis, the French wholesale investment bank. He is also a member of the Council of Economic Advisers to the French Prime Minister and professor of economics at the University of Paris Panthéon-Sorbonne.