The Malta
Conventional wisdom has it that it is very difficult to identify a
financial bubble in real time and that it is only with the benefit of hindsight,
learning from the effects of the burst bubble, that the existence of the bubble
can be proven.
Take the technology bubble of 1999/2000. When technology share prices were sky-rocketing, feeding on themselves to reach dizzy highs, even level-headed people like US Fed chairman Alan Greenspan who, in 1996 when prices were much lower had warned of irrational exuberance, got carried away by the enthusiasm and started justifying the new asset price levels on the basis of the leap in productivity brought about by the application of new technology. With hindsight it is clear that it would have been far more prudent if the Fed had started tightening monetary policy much sooner to avoid asset prices getting so much ahead of themselves.
Greenspan defends his record by arguing, quite feebly in my opinion, that by the time one recognises the existence of the bubble, there is little that can be done to gently deflate the situation and one should focus on nursing the wounds and pain of the burst bubble rather than try to prevent the bubble from bursting. His record of bringing down Fed Funds USD interest rates from 6.5 per cent in January 2001 to one per cent by June 2003 is his explanation of how to nurse the bubble aftermath. The determination currently being shown to take back the USD interest rates to a high neutral rate at a fast pace is, in Greenspan’s view, a confirmation of the success of containing the damage to the US economy caused by the bursting of the technology bubble.
The Bank of England seems to have learnt the lesson well and during last year tightened monetary policy by several step increases inUK
Bringing the argument to the domestic scene, how is it that asset prices of real estate and quoted equities continue to gallop forward at a time when the economy is navigating somewhere between crisis and stagnation? Is the Central Bank ofMalta
In real time it is difficult to tell, although experienced hands would tell you that there are many indicators which indicate the existence of such a bubble. But a bubble need not burst if the membrane that captures the pressurised air is sufficiently robust and flexible, if measures are taken not to continue adding to the pressure and if there is no single event which acts as a pin prick to the bubble.
In general, I think that the bubble in property and equity prices could be managed without disastrous effects, as the membrane of our savings resources is still strong and flexible.
However, not to risk its unpleasant rupture the stance of monetary policy has to be changed to take into account the undue rise in asset prices. Moderate, measured interest rate hikes should start being taken to gradually reduce the pressure building inside the bubble.
Control of the one-event that could prick the bubble is difficult, as one cannot quite foresee what such a one-event could be.
However certain recent experience on the local equity market should raise an eyebrow, if not both, and moral suasion and good PR should be used to ensure that we prevent the development of a one-event which could prick the bubble. The gradual rise, on very thin trading, of one particular low cap equity in the last few trading sessions of 2004, comfortably raising year-end valuations, only to be undone by equally thin trading in the first few sessions of 2005, smells like bed and breakfast accommodation for accounting window-dressing purposes. This cannot be healthy for the market.
Equally discomforting is the meteoric rise in equity prices of companies being prepared for privatisation, in particular Bank of Valletta. Bank of Valletta’s shares price is now trading at almost double the price earnings ratio of its sector average on international markets. Unless Bank of Valletta can persuade interested bidders that it can double its profits within a short time span, the government is going to find it difficult to find genuine interested bidders.
And if there are serious bidders at the current price level, I would seriously question whether the quality of their judgement merits their being trusted with a bank which has a huge influence on the workings of the economy or whether there could be hidden asset-stripping motives to justify the payment of the inflated price.
And, extending the argument, how is one to know if we have an economic crisis? The Prime Minister keeps speaking with both sides of his mouth in pleading with the social partners to subscribe to a social pact which restores national competitiveness and then denying that we have anything resembling an economic crisis.
Unlike a financial bubble, it is much more possible to identify an economic crisis in real time. If the economy has not grown at all these last four years, if productive investment is scarce, if debt is growing much faster than the economy, if employment opportunities are scarce and many graduates are having to accept jobs much below their status, then it looks like a crisis, it smells like a crisis, it behaves like a crisis – obviously it is a crisis.
The financial resources of the private sector and low interest rates on bank deposits make it easier for the crisis to be financed rather than solved but as a by-product it produces asset price inflation, which is also pretty evident.
The Prime Minister should accept that our ability to finance the crisis and delay the process transforming it into a full-blown collapse, does not mean that we are solving the crisis. We are merely wasting resources to delay the explosion but not to avoid it. If we cannot even accept this, we cannot even start to hope for a true solution.
Take the technology bubble of 1999/2000. When technology share prices were sky-rocketing, feeding on themselves to reach dizzy highs, even level-headed people like US Fed chairman Alan Greenspan who, in 1996 when prices were much lower had warned of irrational exuberance, got carried away by the enthusiasm and started justifying the new asset price levels on the basis of the leap in productivity brought about by the application of new technology. With hindsight it is clear that it would have been far more prudent if the Fed had started tightening monetary policy much sooner to avoid asset prices getting so much ahead of themselves.
Greenspan defends his record by arguing, quite feebly in my opinion, that by the time one recognises the existence of the bubble, there is little that can be done to gently deflate the situation and one should focus on nursing the wounds and pain of the burst bubble rather than try to prevent the bubble from bursting. His record of bringing down Fed Funds USD interest rates from 6.5 per cent in January 2001 to one per cent by June 2003 is his explanation of how to nurse the bubble aftermath. The determination currently being shown to take back the USD interest rates to a high neutral rate at a fast pace is, in Greenspan’s view, a confirmation of the success of containing the damage to the US economy caused by the bursting of the technology bubble.
The Bank of England seems to have learnt the lesson well and during last year tightened monetary policy by several step increases in
Bringing the argument to the domestic scene, how is it that asset prices of real estate and quoted equities continue to gallop forward at a time when the economy is navigating somewhere between crisis and stagnation? Is the Central Bank of
In real time it is difficult to tell, although experienced hands would tell you that there are many indicators which indicate the existence of such a bubble. But a bubble need not burst if the membrane that captures the pressurised air is sufficiently robust and flexible, if measures are taken not to continue adding to the pressure and if there is no single event which acts as a pin prick to the bubble.
In general, I think that the bubble in property and equity prices could be managed without disastrous effects, as the membrane of our savings resources is still strong and flexible.
However, not to risk its unpleasant rupture the stance of monetary policy has to be changed to take into account the undue rise in asset prices. Moderate, measured interest rate hikes should start being taken to gradually reduce the pressure building inside the bubble.
Control of the one-event that could prick the bubble is difficult, as one cannot quite foresee what such a one-event could be.
However certain recent experience on the local equity market should raise an eyebrow, if not both, and moral suasion and good PR should be used to ensure that we prevent the development of a one-event which could prick the bubble. The gradual rise, on very thin trading, of one particular low cap equity in the last few trading sessions of 2004, comfortably raising year-end valuations, only to be undone by equally thin trading in the first few sessions of 2005, smells like bed and breakfast accommodation for accounting window-dressing purposes. This cannot be healthy for the market.
Equally discomforting is the meteoric rise in equity prices of companies being prepared for privatisation, in particular Bank of Valletta. Bank of Valletta’s shares price is now trading at almost double the price earnings ratio of its sector average on international markets. Unless Bank of Valletta can persuade interested bidders that it can double its profits within a short time span, the government is going to find it difficult to find genuine interested bidders.
And if there are serious bidders at the current price level, I would seriously question whether the quality of their judgement merits their being trusted with a bank which has a huge influence on the workings of the economy or whether there could be hidden asset-stripping motives to justify the payment of the inflated price.
And, extending the argument, how is one to know if we have an economic crisis? The Prime Minister keeps speaking with both sides of his mouth in pleading with the social partners to subscribe to a social pact which restores national competitiveness and then denying that we have anything resembling an economic crisis.
Unlike a financial bubble, it is much more possible to identify an economic crisis in real time. If the economy has not grown at all these last four years, if productive investment is scarce, if debt is growing much faster than the economy, if employment opportunities are scarce and many graduates are having to accept jobs much below their status, then it looks like a crisis, it smells like a crisis, it behaves like a crisis – obviously it is a crisis.
The financial resources of the private sector and low interest rates on bank deposits make it easier for the crisis to be financed rather than solved but as a by-product it produces asset price inflation, which is also pretty evident.
The Prime Minister should accept that our ability to finance the crisis and delay the process transforming it into a full-blown collapse, does not mean that we are solving the crisis. We are merely wasting resources to delay the explosion but not to avoid it. If we cannot even accept this, we cannot even start to hope for a true solution.
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