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When money bubbles burst  

FINANCIAL bubbles are a phenomenon as old as old as capitalism itself. From tulip mania in Rembrandt's Amsterdam to the Souk Al Manakh crash in Kuwait and the Nikkei-real estate asset spiral in Japan in the 1980s, financial bubbles in disperse cultures and societies exhibit eerie parallels.

Asset prices begin to soar beyond any concept of intrinsic value. A mass hysteria for leveraged speculation overtakes the investment world. An Alice in Wonderland ethos of silly logic and nonsensical value judgements pervades the financial totems of the time, be they Dutch tulips or Tokyo office towers or Internet IPO's.

Supposedly prudent banks are happy to create a Matterhorn of debt to finance the speculative mania, as the post-dated checks which financial Kuwait's Souk Al Manakh and the tokkin trusts that were the high octane fuel for the Japanese asset price bubble prove. Then something in the whole equation changes. A sea change in investor psychology takes place. There is a mass run to the exits by investors.

The bankers panic and dump their collateral on a falling market. The next thing you know meltdown, crash, monetary disaster. Financial bubbles are the deadliest of all monetary phenomena, not least because of the painful losses they cause investors who are swept along in their madness. When money bubbles burst, they cause a financial chain reaction of economic recession, corporate bankruptcies and bank failures.

After all, the Kuwaiti and Japanese banking systems still bear the painful wounds of Souk Al Manakh and the Nikkie Dow rollercoaster more than a decade after the event. America and Europe sank into Depression for a decade after Wall Street's fateful 1929 stock market crash.

So what relevance have all these historical parallels to the investment milieu of late 2000? Quite a lot. It is difficult to argue that the parabolic rise of Nasdaq in 1999, driven by cheap money from the Fed and the mania of momentum investors, exhibited all the characteristics of a financial bubble.

From Interent IPOs that rose 500 per cent on their opening to a worldwide mania for day trading to the inexorable rise in margin debt, there is no doubt that bubble psychology overtook Wall Street. Of course, venture capitalists, investment bankers, fund managers, equity analysts and their ilk were the cheerleaders of this financial bubble in Silicon Valley and the world's financial capitals. How could they resist the temptation, given the billions at stake?

The New Economy was a mesmerizing concept, if for no other reason than the fact that a technological revolution unprecedented in both scale and pace was transforming computers, wireless, telecom networking, semi-conductor fabrication and a dozen other industries.

Yet the valuation excesses on Nasdaq contained the seeds of their own destruction. When the Fed began to tighten credit, momentum investors began to desert the market in droves. The IPO window snapped shut. The dotcom bubble exploded with a vengeance. Technology indices all over the world, from Nasdaq to Hong Kong, peaked in March 2000. Nor is it easy to make the argument that there is value in Nasdaq now even though it has halved when its price-earnings multiple is still a 100x.

When a bubble explodes, as Nasdaq did in 2000, investors can find no safe haven in even the bluest of blue chip stocks. Take Yahoo, for instance. A year ago it was 250, now it is a mere 38. But the carnage is far worse elsewhere. Even the bellwether large caps hve been humbled by the market's spectacular descent. Intel, Microsoft, Cisco, Oracle. We may now be at a point where the collapse of the technology bubble, far from being limited to investors and Wall Street, may acquire an ominous macroeconomic significance.

US Federal Reserve Chairman Alan Greenspan's reluctance to cut interest rates despite clear evidence of distress in the international capital markets makes no sense. The latest GDP growth numbers are the slowest in four years. Inflation is nonexistent. Commodities and metal prices are stagnant. Credit spreads and loan default rates are extremely high. The currencies and stock indices of the emerging markets are a prima facie indicator of deflation, not inflation, risk.

The dollars extraordinary strength in the foreign exchange market proves that monetary policy in the US is far too tight. It is time that the US central bank realises that its obsession with its own arcane inflation models have created a serious risk of recession in the financial markets.

The management of a post-bubble economy needs sophisticated monetary guidance, not a rigid adherence to doctrinal formulae. After all, Greenspan had no hesitation to cut interest rates after Black Monday in '87 and the Russian debt default in 98. The situation is as dangerous now. A new money bubble has burst. The Fed must act before it is too late !


The opinions expressed by the writer are his own and not endorsed by Press Release Network.

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