OCTOBER will mark the 30th anniversary of the 1987 financial crash. It is already nine years after the slump of 2008 and this July marks the 20th anniversary of the Asian financial crisis.
In memory of those bleak times, expect many blogs and acres of newsprint predicting that the end of the bull market is nigh. The current buzzwords are “monetary normalisation”, ie, fears that central banks will raise interest rates and spoil the proverbial party.
Since the crash of 2008 and early 2009, when equities were either dumped or ignored, the S&P 500 index has soared by a whopping 240 per cent. The compound rate of around 12 per cent a year excludes reinvested dividends, so total rewards were far beyond the dreams of market participants in the early years of the boom.
Since unusual monetary laxity, notably quantitative easing (QE), has been the primary reason for the boom, it has been dubbed the “unloved bull market” and has generally been mistrusted by many an expert. Instead of watching breathless predictions on financial channels, hindsight may well be a better tool to assess potential opportunities and dangers.
In the Quarterly Journal of Austrian Economics, Brendan Brown, chief economist at Mitsubishi UFJ Financial Group and senior research fellow at the Hudson Institute, shows how monetary disorder spawned asset price inflation during the past 100 years. The paper demonstrates how central bankers, especially the US Federal Reserve Bank, have repeated mistakes time and time again.
Dr Brown has detected two kinds of asset price inflation in shares, property, commodities, art and collectibles. The “boom type” emerges under conditions of flourishing investment opportunity, and a “depression type” forms when the overall economic situation is quite weak. “A giant monetary experiment features sometimes in the boom type of asset price inflation and always in the depression type.” In other words, easy money and credit have fuelled asset price inflation that has inevitably ended in busts.
Boom asset inflation is characterised by irrational exuberance in which capital gains fuel speculative narratives, reinforcing confidence and buying that boost markets to new heights. The depression types feature a “hunt for yield” driven by a famine of income on safe assets.
As the markets gain upward momentum and begin to take off, the behaviour and reasoning of traders and investors become irrational. Examples include an unresearched gamble in equities, because interest on savings is virtually zero; embracing speculative stories instead of being sceptical; cognitive bias, ie, believing that what happens today will be repeated far into the future; this time it is different; fear of being outside the crowd; following the price line on a chart in the mistaken belief that the line, which is a mere line, will continue upwards.
This is the so-called momentum theory, until the momentum (or line) stops and then turns the other way. These are just some of the behavioural tendencies that also encourage fraud, eg, the Madoff Ponzi scheme and Enron.
The extent of mindless official repetition decade after decade – central bank ease and irrational exuberance followed by irrational depression – is deeply disturbing. Boom-type asset price inflation includes: 1925 to 1928 amid optimism in the US and Germany, leading to 1929 crash; mid-1960s under president Lyndon Johnson’s administration, leading to bear market in 1968 and 1969, further monetary ease and rally and another severe crash in 1973 and 1974; then boom 1984 and 1986 and crash of 1987; the boom and tech bubble of 1995 to 2000 and contraction, culminating in 9/11.
The depression-type asset price inflation examples include: investors hunting for yield during World War I; then 1921 to 1923 after a recession in the US; 1935 to 1936 in the Great Depression years; 1990 to 1992 when the Greenspan Fed responded to a recession by pumping in money and holding down interest rates; monetary easing in 2000 to 2002, the forerunner to the boom and then bust of 2008. The current asset price inflation is the depression type which will end at some unpredictable future date.
The economic danger of asset price inflation is that business people postpone job-creating long term investment decisions on fears that a future crash could cause a downturn. An irrational rush for certain assets also causes malinvestment, ie, misallocation of resources, leading to bankruptcies, closures, bank failures and bailouts and job losses.
© Copyright Neil Behrmann
This article was first published in The Business Times, Singapore
Jack of Diamonds, the sequel to Trader Jack- The Story of Jack Miner will be published in early this year. Neil is also author of anti-war children’s novel Butterfly Battle- The Story of the Great Insect War. The updated 2015 Waterloo commemoration version of Butterfly Battle is on Kindle and e-books. Reviews are on neilbehrmann.net and Amazon and more reviews are welcome. If the books are purchased direct on this site, a proportion of the proceeds will go to low cost charities