Bad times are coming, according to Nouriel Roubini, although they may be a year or two away.
The New York University professor of economics is worth listening to since he called the U.S. housing bust and global financial crisis not only exactly right but in time to do something about it. In 2006, for example, he told the International Monetary Fund that the United States was likely to face a once-in-a-lifetime housing bust, an oil shock, sharply declining consumer confidence, and, ultimately, a deep recession.
Now the problem is what Roubini called “the mother of all carry trades” in a speech delivered via satellite to a conference in South Africa. “The risk is that we are planting the seeds of the next financial crisis.”
With U.S. interest rates near 0% and the U.S. dollar falling in value, every speculator and trader in the world who can is taking out low cost dollar-denominated loans and putting the cash into commodities, commodity stocks, emerging market currencies, emerging market stocks, and real estate.
That borrowed cash raises asset prices, earning profits for traders, and encouraging yet more traders to borrow and get in on the game.
The result, Roubini said, is that the world is seeing the creation of another round of insupportable asset bubbles. “Everybody is playing the same game and this game is becoming dangerous.”
One of the problems with a trade that everybody has on is that it’s incredibly difficult to exit. Exactly who do you sell to when everybody wants to sell? In this situation, as we’ve learned in th curent crisis, prices fall off a cliff and some markets cease to function in an absence of buyers.
You can see the building bubbles reflected in the prices of stocks and commodities since the March 9, 2009 low. The MSCI World Index of developed market stocks is up 65% as of October 26 from that low. The MSCI Emerging Markets Index is up 96%. The Reuters/Jefferies CRB Index of 19 commodities is up 32%.
I flagged this danger in my October 14 post on the worries facing investors (http://jubakpicks.com/2009/10/14/know-what-to-worry-about-and-when-if-you-dont-want-to-get-spooked-out-of-a-rally-or-get-killed-in-a-correction/ ) in the months and year ahead. The most likely event to prick these asset bubbles is the one Roubini mentioned in his speech and I noted in my post: When the U.S. Federal Reserve starts to talk about raising interest rates, traders will start to unwind their bets in order to pay down their dollar loans before the dollar starts to rise in price.
We’ve got a way to go before that happens. The Federal Reserve isn’t likely to start talking about raising rates (let alone actually doing it) until mid-2010 at the earliest, in my opinion.
Roubini puts the bust further out: The asset bubble bust may not occur for another year or two, he told the conference, and in the meantime a wave of money from the carry trade will keep inflating the bubbles.
Which, of course, will make any bust in 2010 or 2011 just that much more painful.