Are Bubbles Set To Burst?

FT.com / Business / US

Be braced for a bust as bubbles look set to burst By Marc Faber

Credit has to be given to Alan Greenspan, the Federal Reserve chairman.

He is the first head of a monetary authority who has not only managed to create a series of bubbles in the domestic economy but has also managed to create bubbles elsewhere - in the New Zealand and Australian dollars, emerging market debts, government bonds, commodities, emerging market equities and capital spending in China.

In fact, over the last 18 months, US monetary policies have boosted all asset classes. This is most unusual since it ought to be obvious that in the long run commodities and real estate inflation is incompatible with a bond bull market.

Mr Greenspan's monetary tribulations mark an achievement no one else in the history of capitalism has accomplished. It is also one investors will never forget once this credit-driven, universal bubble bursts and it will fill entire chapters of financial history books with economic and financial horror stories.

We simply don't know how the end game of the current speculative wave will be played out and when the bust will occur but a painful resolution of the current asset inflation and global imbalances is as certain as night follows day.

I used to believe that sometime in 2004 we would see the beginning of diverging trends in the performance of different asset classes, since bonds, commodities and real estate cannot continuously rally in concert.

After all, one characteristic of a strong secular bull market in one asset class is the simultaneous occurrence of a bear market in another. The commodities bull market of the 1970s was accompanied by a vicious bond bear market. The equities and bond bull markets of the early 1980s were accompanied by a persistent bear market in commodities and, in the 1990s, stocks of developed Western markets soared while Japan and emerging stock markets collapsed.

So, I was leaning towards the view that some assets would continue to increase in value in 2004 while others, such as bonds, would begin to fall by the wayside and enter longer-term bear markets. After further consideration, I am now increasingly concerned that sometime soon "everything" could begin to unravel. When interest rates rise, it is conceivable that bonds, stocks, commodities and real estate will all decline in value at the same time.

In the past I have had the tendency to dismiss the deflationist views of some reputed economists and strategists as unlikely. I now feel the current universal asset inflation and overheated Chinese economy will be followed by a serious bust and asset deflation, which will kill consumption in the US. The only question is when.

I'm at a loss as to when this bust will occur. But given the overbought condition of the US stock market, the extremely high bullish consensus (indicative of market tops in the past), the rising commodity markets and the tendency of markets to defeat central bankers who entertain the same erroneous beliefs that central planners under the socialist ideology had when they thought they could plan the best possible economic outcomes, the bust could come sooner rather than later.

Moreover, we know from the experience of Japan in the late 1980s and Hong Kong in the mid-1990s that consumption booms, driven by asset inflation, end with a colossal bust. That can result from rising interest rates, or because stagnating household incomes no longer support the asset bubble as affordability diminishes, or additional supplies coming to the market and exceeding demand.

So, given that consumption driven by asset inflation is unsustainable in the long run and always ends badly, what should the contrarian investor do?

The least desirable asset in the world is US dollar cash. The investment community can take everything in stride - even a 70 per cent decline in Nasdaq stocks. But interest rates, as low as they are now, compel people to speculate on everything from commodities, homes and bonds to equities.

Therefore, investors in the current speculative environment should be extremely defensive and not be tempted by short-term gains, which could be swiftly erased. Daily moves of 5 per cent in investment markets will become common. Nickel recently fell 8 per cent in a day, copper by 5 per cent, and the euro by 5 per cent within a week. Gold and, especially, silver may offer some protection but, once the current asset inflation bubble ends, they could also be in for a rough time.

Obviously, as I experienced in Asia in the 1990s, it wasn't important to be "asset-rich" before the crisis of 1997 but to be "cash-rich" after the crisis when financial asset values had tumbled by 90 per cent and when incredible bargains across all asset classes were available. ...Link
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