Just hours before US president Barack Obama arrived in China, the country’s chief banking regulator said the US was fuelling “speculative investments” and endangering global recovery through loose monetary policy.
Hours after the president landed, Ben Bernanke, US Federal Reserve chairman, said he did not think new asset price bubbles were forming in the US. Who is right? Near-zero interest rates in dollars are one reason for the rush for higher-yielding assets, from US and European stocks to emerging market equities to corporate bonds and commodities. Indeed, creating demand for risky assets is part of the point.
What is not clear is how dangerous it is. A so-called “carry trade” of borrowing in dollars in low rates to invest in higher-yielding assets could be reversed as soon as US interest rates rise or the currency shifts. If there is a rush for the exits, some investors fear a knock-on collapse in prices of assets.
Though some investors are likely to be borrowing in dollars, it may not be that widespread. “Money and credit have been quite weak, suggesting that asset price movements have not been fuelled by increased leverage that would leave financial intermediaries vulnerable to a reversal of recent gains,” said Donald Kohn, Fed vice-chairman, this week. In the US, as well as in Europe, bank lending continues to fall. The amount lent against securities in the repurchase, or repo, markets is also well below the peaks of 2008.
The problem with measures of leverage in the financial system is they ignore market psychology. If nothing else was reinforced by last year’s market gyrations, it is panic travels fast. Aggregate positions also may not reveal build-ups in particular trades, which present particular exit dangers. Leverage is down, but a lack of leverage in markets does not mean there will be a lack of volatility.
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