Bubbles bubbles everywhere…

Following the collapse of the Dot-com bubble in 2001, Alan Greenspan, chairman of the Federal Reserve at the time, dropped interest rates substantially to cushion the impact rather than let the market imbalances correct themselves. This monetary expansion resulted in excess liquidity in the markets that eventually found its way into oil and commodity speculation and, of course, property.

Many countries experienced similtaneous property bubbles over the last decade. Property prices inflation had deviated substantially from its long term corrolation with average earnings. In many cases, such as the extreme property bubble in Ireland, justifications were invented such as demographic trends (temporary and dependant on economic conditions) and the notion that  prices were catching up with European averages (this had no-longer been the case since about 2002).  The eventual bursting of the US property bubble in 2007 exposed the financial system to the fallout of subprime mortgages which had been packaged up and sold on to buyers on the global markets.

Typical risky mortages on offer were characterised by lending an amount more than 100% of the value of the property and even paying a token amount interest thereby increasing the principal over time.  Often, mortgages were granted to people with high financial risk profiles without the means to repay them. Financial institutions such as the US government sponsored enterprises, Fannie Mae and Freddie Mac, investment banks, and other financial institutions packaged up these mortgages and sold them on to buyers on international markets. These securities, referred to as mortgage-backed securities and collateralized debt obligations, were complex and poorly regulated.

The financial crisis of late 2008 had a domino effect on many other countries and markets. It was not responsible for the collapsing property prices elsewhere, as this was only matter of time,  but it was the catalyst that finally burst other bubbles. Property bubbles in the UK, Ireland, Spain and several other countries began to collapse. The substantial levels of personal debt such as car loans and credit card debt, that was typical of Anglo-Saxon countries such as the US, the UK and Ireland, is now becoming a major issue.  The financial crisis of 2008 has turned into a more general economic crisis in 2009 with no end in sight.

Consumption patterns national current accounts

Wide imbalances have manifested themselves due to relative consumption patterns of various countries. The most notable deficits are those of the US (over US$730bn), Spain (over US$140bn) and the UK (over US$100bn). The most notable surpluses are of China (over US$370bn), Germany (over US$250bn), and Japan (over US$210bn). Relative to their small size, Portugal, Greece and Romania have excessive current account deficits.

US consumers have been living beyond their means for quite some time, depending on funding from China in particular. In turn, China, Germany and Japan have weak domestic consumption and depend on the US consumer to purchase their products. The current crisis will cause a reverse of the consumption patterns of US consumers as they try to repay debt and save for uncertain times. Chinese, German and Japanese exporters will suffer from weak overseas demand.

Eurozone adjustment

Another imbalance was the adjustment (still) taking place by European countries that adoped the new single currency – the Euro. While in the long term, eurozone countries have and will continue to benefit enormously from the advantages of the single currency, the initial adjustment was not seriously planned for, especially by countries on the periphery of Europe. Countries such as Ireland and Spain experienced a substantial drop in interest rates which proved to be an enormous monetary simulus. They did not modify their fiscal policy to counter this by increasing taxes or reducing public spending. The surplus capital in those countries drove up asset prices and manifested itself in huge property bubbles. A huge percentage of their economies became dependent on construction. The inevitable bursting of the property bubbles is now causing severe economic contraction.