[NYTr] 'Rolling bubble' threatens world economy

[All the News That Doesn't Fit]

sent by Riaz K. Tayob (activ-l)

ABC Australian Broadcasting - Jul 23, 2007
http://www.abc.net.au/pm/content/2007/s1986049.htm]


PM - 'Rolling bubble' threatens world economy: economist

PM - Monday, 23 July , 2007  18:35:34 

Reporter: Stephen Long 

MARK COLVIN: For years there were warnings about a housing bubble in
the United States and parts of Australia. Now it's burst in the US,
with devastating consequences.

Some argue that private equity buyouts are giving rise to a similar
bubble.

But a senior OECD official argues these are all part of one giant 
bubble, which threatens the world economy.

Former Reserve Bank economist Adrian Blundell-Wignall is Deputy
Director of Financial and Enterprise Affairs at the OECD.

He says there's a "rolling bubble" of excess money sloshing around the 
globe, shifting from market to market.

It's being inflated by a series of distortions in the world economy.

And unless they are dealt with, he predicts the bubble will eventually 
burst with serious consequences.

On a visit to Sydney, Adrian Blundell-Wignall spoke exclusively to our 
Economics Correspondent Stephen Long, who prepared this report.

STEPHEN LONG: Adrian Blundell-Wignall is part of a diaspora of 
economists from the Reserve Bank of Australia now working overseas.

At the OECD in Paris in recent months, he's written a number of 
influential papers: one on the causes of the private equity boom, 
another prescient piece on hedge funds and their exposure to risky
debt. At heart, he sees a common cause - too much money chasing too few
assets.

ADRIAN BLUNDELL-WIGNALL: I think the big issue is there's just so much 
liquidity sloshing around the world economy, coming from a whole
variety of sources. I mean, words like sovereign funds come to mind,
you know, our own Future Fund is like a sovereign fund, but when you
compare that to Sovereign Funds like the Chinese Foreign Exchange
Reserves, other foreign exchange reserves, the reserves of the oil
producing countries who are benefiting from the huge increase in the
price of oil.

All of this money together with very low interest rates in some parts
of the world, zero interest rates in some countries, has meant that
there's just a huge amount of liquidity sloshing around and trying to
find a home.

STEPHEN LONG: Adrian Blundell-Wignall says that excess liquidity is 
moving from market to market fuelled by cheap credit, driving up asset 
prices. He calls it a rolling bubble.

ADRIAN BLUNDELL-WIGNALL: So when you have that sort of a situation, you 
get these rolling bubbles.

One of the first beneficiaries of the low global cost of capital was
the mortgage kind of boom and the housing boom in the US and other
places. Of course, we're beginning to see the, the unwinding of that at
the moment.

We've seen it going into private equity where we've had a huge boom in 
private equity. And as the yields have started to rise of recent times, 
some of those deals are beginning to be pulled. And I suspect that we 
may see a bit of a popping of that bubble as well.

But that liquidity is still there - the mechanisms giving rise to that 
liquidity are still in place - and so what that means is that you get 
these rolling bubbles.

Where does the money go next, is the issue.

STEPHEN LONG: He says the rolling bubbles are being inflated by a
series of distortions in world markets, which have created a surplus of
cheap credit.

ADRIAN BLUNDELL-WIGNALL: The key thing in globalised financial markets 
you really have to understand is there's no such thing as a domestic 
monetary policy that doesn't matter for the rest of the world. Because 
if you're making interest rates very low in Japan, or making liquidity 
strongly available in places like China, then in globalised financial 
markets the mechanisms are there, through derivatives and swaps and so 
on and so forth, to basically take advantage of those low interest
rates and low costs of borrowing around the world.

This is where this big liquidity bubble is actually coming from.

STEPHEN LONG: Among the distortions he identifies are negative real 
interest rates in Japan and China's currency, which the Government has 
kept at an artificially low rate. Manipulating the currency has allowed 
China to sell goods cheaply overseas and accumulate huge foreign 
currency reserves, which in term have flowed back into the world's bond 
markets, driving down the cost of borrowing for business.

But this OECD economist says it's unsustainable.

ADRIAN BLUNDELL-WIGNALL: The Chinese currency is a really good example. 
I mean, those reserves now are over $1.3-$1.4 trillion. Every time 
people try to invest in China - direct investment or whatever - that 
puts upwards pressure on the Chinese currency, and because the Chinese 
authorities intervene in the foreign exchange market, what that means
is it's like printing money.

STEPHEN LONG: But the rolling bubble won't stop rolling yet.

ADRIAN BLUNDELL-WIGNALL: I think you have to say that as paradoxical as 
this sounds, that it hasn't been, it hasn't been good enough to be 
really bad yet. You can see that in things like, say, the mega cap 
stocks around the world, in America for example, the top 10 stocks in 
the US market - they've done virtually nothing in the last. in the last 
five years.

But so far that liquidity hasn't made a really big impact on the very 
large cap stocks, and of course until it does, you know that it's 
probably not over.

While liquidity's very strong, and before you see any sign of inflation 
picking up in the world economy - which always spells the death knell 
for markets, and you still haven't really seen any sign of that yet - 
that it probably goes on for some time.

STEPHEN LONG: How long, no one knows.

But unless the distortions inflating the rolling bubble are dealt with, 
Adrian Blundell-Wignall fears it will end badly, and the bigger the 
bubble, the louder the bang.

MARK COLVIN: Stephen Long.