In a recent tweet I made the following comment:
“Bursting implies force>than constraint, collapse implies constraint>than its force”
In a recent blog post I discussed the large build up of money supply in the US (this is pretty much replicated across the globe) and the fact that money supply in excess of nominal GDP growth is likely asset focussed. My point in this tweet was that a bubble either bursts, or deflates, or collapses under its own weight.
I believe that the current bubble risks collapsing under its own weight…
The current asset price bubble is a monetary phenomenon caused by large increases in money supply growth over and above nominal GDP growth. Increasing income inequality, rising debt levels and slowing output growth is the constraint on this increasing asset focus and the reason for the divergence that created the bubble.
Higher debt and equity levels and lower growth require lower interest rates (lower required rates of return on assets) and/or higher monetary demand to support asset values. The differential between economic growth and asset values (supply x price) cannot keep expanding.
We saw a collapse of an asset bubble between 2007/2009 as debt defaults came back through the banking system. But this collapse was stemmed by the various central bank supports at the time, low interest rates and various waves of monetary support (QE).
A stable economic relationship between asset prices and supply and economic growth is fostered via growth in output and commensurate growth in money supply. An increase in growth leads to an increase in incomes which funds consumption, savings, investment and production…so the usual flow goes from economic growth into asset prices….growth in output finances both demand for output and demand for assets part of which will be met from an increase in supply and part from an increase in price due to a)an increase in return and b) an increase in monetary demand relative to supply of return.
In the absence of a change in the rate of return on capital and a change in the preferred allocation of assets, for a given supply of assets, the prices of both output and assets should move more or less in tandem.
Unfortunately we have not just had an excess allocation of money supply towards assets over the last 20 or more years, but we have also had an unjustifiable accumulation of debt to fund both consumption and asset purchases….It is this accumulation of debt (much of which is not recorded as an excess over GDP as it has financed consumption of output) that has complicated the asset bubble risk…i.e we are not just talking about the inflation of equity values but the inflation of the supply and the price of debt…
The financial and economic crises still in fact continue in the form of low economic growth and asset price support operations. The flow from output alone cannot support its relationship with asset prices which is why the Federal Reserve is so keen to see employment rise and income growth accelerate…as income growth accelerates not only will GDP growth rise to better relate to asset values but the monetary flow from incomes will rise to supplant the stimulus provided by QE as well as to finance the intended expenditure of wealth. At the moment QE is all about creating synthetic demand flows for assets in the hope that all that arises from higher asset values occurs…i.e. spending part of the increase in wealth..
The trouble is what growth rate of GDP do we need to justify current asset markets (price x supply)? Moreover, it is not just wage growth and economic growth but income inequality that needs to be ameliorated to get the flows and stock into order.
Significant accumulated monetary and asset excess in a weak GDP paradigm is likely to make accumulated assets much more sensitive to changes in interest rates.