Bubble of Bubbles Due to Asset Inflation:Morgan Stanley Says Bubbles Will Likely Burst Soon

Andy Xie of Morgan Stanley says the global economy has been in a bubble of bubbles for over a decade, due to constant inflation of the money supply and low interest rates.

The world may be in the middle of the biggest bubble in history. The bubble (e.g., property, stock, commodities) could exceed 50% of global GDP in value. The key cause of the bubble is that the major central banks failed to lower inflation targets to account for the combination of productivity acceleration due to IT and the new upward stickiness in wages due to the influx of three billion people into the global economy since the mid-1990s.

The major central banks mistakenly released too much money in the past decade, justifying it with the low inflation relative to the recent past. The monetary excesses have led to the rapid expansion of asset valuation relative to income. The global economy has become dependent on the demand spillover from asset inflation.

The bubble began in the 1990s as a part of the stock-market run-up:

Something unusual happened in the mid 1990s: the ratio of the US stock market capitalization to its GDP began to surge above its normal range. Mr. Greenspan made his famous speech on the ‘irrational exuberance’ in the stock market in 1996. The market shivered briefly but resumed climbing. It culminated in early 2000 when the listed stocks in the US exceeded 160% of GDP in value – more than twice the historical normal level.

And then, because money supplies were still growing, people started buying real estate instead of stocks, leading to the rapid increases in housing prices:

After the tech bubble burst, US housing value began a similar upward move in relation to the US GDP. The ratio of US housing value to GDP could exceed 160% this year, up from 120% in the 1990s. The average of this ratio was 105% between 1950 and 1999 and the highest level during this period was 130% in 1989, right before the S&L crisis.

The source of the bubbles was asset inflation:

The fundamental changes in the 1990s severed the short-term relationship between money supply and inflation. Indeed, the monetarist explanation for inflation championed by Milton Freidman was discarded in the 1990s as inflation rates failed to respond to surging money supplies.

However, money did cause inflation in asset markets.

Asset inflation has fueled the consumer boom as people borrow against (and/or count on) the rising asset values to finance growing consumption. And Morgan-Stanley's Andy Xie thinks it is all about to come crashing down or maybe slowly slithering down:

The end of the global bubble economy may be near. Mr. Greenspan recently recognized the role of the Fed’s monetary policy in the US housing boom, its associated consumption boom and the US savings shortfall. The Fed may be in a campaign to pop the bubble. The global economy could experience a big downturn or many years of slow growth to correct the past excesses.

There is much more at the original site. [Thanks to MA for the pointer.]

Update: For a similar perspective, see this piece from The Economist.