Earlier this week I cited a short list of things that could derail America’s economic expansion in 2018, including larger-than-expected interest-rate hikes by the Federal Reserve and a major stock-market correction. Writing in the Washington Post, Bob Samuelson says that “the clearest danger comes from sky-high stock prices.”
The fear is that we’re experiencing another bubble — or multiple bubbles — that will eventually burst. In a recent New York Times piece, published in mid-December, former IMF and Salomon Smith Barney economist Desmond Lachman argued that “global asset prices are once again rising rapidly above their underlying value,” just as they did prior to the 2007–09 financial crisis.
In fact, said Lachman, the problem is worse today than it was a decade ago: “While in 2008 bubbles were largely confined to the American housing and credit markets, they are now to be found in almost every corner of the world economy.”
When will they collapse? It could happen relatively soon, because “the years of low interest rates and avid central bank government bond buying that spawned the bubbles now appear to be drawing to an end.”
Lachman is certainly among the more pessimistic of economic forecasters. Yet he’s hardly alone in worrying about elevated asset prices.
On Monday, Bloomberg’s Adam Haigh published the following report:
“Analysts are ratcheting up their forecasts for U.S. corporate profits at the fastest pace in more than 10 years, according to the research firm Bespoke Investment Group. And that’s happening, unusually, right in the run-up to an earnings-season kick-off. While the upgrades could be taken as a positive reflection on the economy’s outlook, in the past such bullish analyst sentiment has served as a precursor to a market decline.”
The good news is that, compared with 2008, “the financial system has much thicker buffers against loan losses and is more closely regulated,” as Wall Street Journal columnist Greg Ip noted on Wednesday. “Credit growth isn’t excessive,” Ip wrote, and “even if stocks fell, that wouldn’t necessarily destabilize the financial system.”
Yet Ip also added a few very important caveats.
First: “It doesn’t take a crisis for an asset bust to hurt. The 1990s tech stock run-up fueled a surge in investment and spending via higher wealth and easier financing conditions. When the bubble burst in 2001, that surge reversed, dragging the economy down. The damage was contained because the Fed quickly slashed interest rates by nearly 5 percentage points. Today, it can at most cut them by 1.5 points.”
Second: “If dangerous excesses are simmering in the financial system, they may not appear until the boom goes bust.”