Beware the driving forces behind surging asset prices

Another article for weekend reading. Beware the driving forces behind surging asset prices
By Marc Faber

• Published: June 20 2007 03:00 Last updated: June 20 2007 03:00
  
  Asset prices have soared in value everywhere in the world since October 2002. Prices of stocks, commodities, real estate, art and every kind of useless collectible have shot up. Even bond prices have until recently gone up as interest rates fell.
  
  That all asset classes increased in value simultaneously around the world is most unusual.
  
  Previous asset bubbles were concentrated in just one or a few classes: in the 19th century, canal and railway shares; in 1929, US equities; in the late 1970s, conglomerates; in 1980, gold, silver and oil; in 1989, Japan and Taiwan; in 2000, the telecoms, media and technology sectors.
  
  The beauty today is that every kind of asset is grossly inflated. How could this happen?
  
  Already ahead of 2000, the US Federal Reserve pursued an ultra-expansionary monetary policy. Then, after the March 2000 peak in the Nasdaq, the Fed eased monetary conditions massively. All asset prices soared, particularly for US homes. A subsequent boom in refinancing and home equity extraction injected an overdose of adrenalin into consumption-addicted US households. Thus, the US trade and current account deficit soared from less than $200bn in 1998 to above $800bn.
  
  In turn, the US current account deficit provided the world with the so-called excess liquidity, pushing up international reserves and the prices of assets ranging from Warhol paintings to rare violins.
  
  However, two asset classes stand out as big losers: the Zimbabwe dollar and the US dollar.
  
  The latter has been in a downtrend since 2001. Its value depends on the worst possible combination of factors: arrogant, bold and ignorant neo-conservatives; and Ben Bernanke, who prides himself by exclaiming that "we have the printing presses".
  
  Luckily, Robert Mugabe has reminded the world that the more money a government prints, the weaker its currency and the higher its inflation and interest rates will climb.
  
  Rather than travel to Beijing to lecture the very well-educated Chinese who in recent years have accumulated foreign exchange reserves of over $1,200bn, Mr Bernanke and Hank Paulson would have found it more productive to spend a few days in Harare, where they could have studied the devastating consequences of excessive money and credit.
  
  In fact, we have already reached the danger zone. It is no longer the real economy that is driving asset prices.
  
  In a credit, and hence asset price-driven economy, money supply and credit must continue to grow at an accelerating rate in order to sustain the expansion.
  
  The moment credit growth no longer grows at an accelerating rate, the economic plane loses altitude. This is now the case, not because the Fed has tightened credit but because the market has done so by tightening lending standards for mortgages because of the subprime lending collapse. Contracting liquidity and less consumption in the household sector follows.
  
  The US current account deficit no longer expands. International liquidity growth decelerates but is temporarily offset by a colossal increase in leverage through a variety of carry trades. As a result, the investment boat becomes unbalanced and vulnerable to even a very small wave sinking the ship.
  
  I only find one depressed and universally despised asset class: the dollar. But a dollar recovery should not be ruled out.
  
  Monetary conditions and international liquidity have tightened relatively, not because of Fed policies but because of market-induced illiquidity in the US household sector. In the past, these conditions of relative tightening have been US dollar supportive, but negative for asset markets.
  
  What should you do? Reduce your risk exposure. Sell emerging economies' stock markets and their currencies. For the next three to six months, shift money into short-term US Treasuries.