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Bubble warning

Markets are too dependent on unsustainable government stimulus. Something’s got to give
Now the MSCI world index of global share prices is more than 70% higher than its low in March 2009. That’s largely thanks to interest rates of 1% or less in America, Japan, Britain and the euro zone, which have persuaded investors to take their money out of cash and to buy risky assets.For all the panic last year, asset values never quite reached the lows that marked other bear-market bottoms, and now the rally has made several markets look pricey again.
The American market is around 25% below the level it reached in 2007. But it is still nearly 50% overvalued on the best long-term measure.
Central banks see these market rallies as a welcome side- effect of their policies. In2008, falling markets caused a vicious circle of debt defaults and fire sales by investors, pushing asset prices down even further. The market rebound was necessary to stabilise economies last year, but now there is a danger that bubbles are being created.
 
Two classic symptoms of a bubble are rapid growth in private-sector credit and an outbreak of public enthusiasm for particular assets. Butthe longer the world keeps its interest rates close to zero, the greater the danger that bubbles will appear—most likely in emerging markets.
Central banks have a range of tools they can use to discourage the growth of bubbles. Forcing banks to adopt higher capital ratios may curb speculative excesses. The most powerful too is the interest rate. But central banks are wary of using it to popbubbles because it risks crushing growth as well.
The current combination of high asset prices, low interest rates and massive fiscal deficits is unsustainable.
 
 
Many governments responded to the crisis by taking the debt burden off the private sector’s balance-sheets and putting it on their own.
Investors would like to see governments unveil clear plans for reducing those deficits over themedium term, with the emphasis on spending cuts rather than tax increases.
Markets have already tested the ability of the weakest governments to bear the burden of their debt. Dubai had to turn to its wealthy neighbour, Abu Dhabi, for help. In the euro zone, doubts have been raised about the willingness of Greece to push through the required austerity measures. Electorates are likely to chafe atthe cost of bringing down government deficits, especially if the main result is to repay foreign creditors. That will lead to currency crises and cross-border disputes like the current spat between Iceland, Britain and the Netherlands over the bill for compensating depositors in Icelandic banks (see article). Such disputes will lead to further outbreaks of market volatility.
Investors tempted totake comfort from the fact that asset prices are still below their peaks would do well to remember that they may yet fall back a very long way.
Today the prices of many assets are being held up by unsustainable fiscal and monetary stimulus. Something has to give.
 
Pulling apart

The world’s big economies were all hit by the recession. Now the field is spreading
In rich countries outputplunged; in China and some other emerging economies growth slowed sharply.
China’s rebound began earliest and has been the most spectacular. America’s economy began growing in the middle of 2009 and seems to have accelerated sharply in the final months of the year.
Shifting growth patterns could have big consequences for asset prices. Sustained strength in emerging economies could push upcommodity prices further, while a rapid rebound in America’s economy relative to Europe’s could strengthen the dollar more against the euro.
Optimists argue that every deep post-war recession has been followed by a vigorous recovery. But much household-debt reduction still lies ahead. And there is the risk of a correction in stockmarkets.
The euro zone faces two different problems. Former bubble...