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Spectre of a stock market bubbleThe Globe and Mail - Friday, April 24, 1998 BANK of Canada Governor Gordon Thiessen sailed through a Senate banking committee meeting yesterday, helped by low inflation, job gains and optimistic growth forecasts. These days, of course, economists define "strong" growth as any breeze that gets the economy up to an annual expansion rate of 3 per cent and keeps unemployment down to about 8 per cent -- numbers that would have been viewed with alarm back in the 1950s, before 50-per-cent marginal tax rates and incentive-destroying regulations reduced the economy's potential. Mr. Thiessen glossed over the Canadian dollar, which has fallen back from the short-lived and dealer-hyped Charest rally, and is now trading at about 69 cents (U.S.). The dollar's weakness was again ascribed to tdeus ex machina of lower international commodity prices brought on, in part, by the Asian crisis. The fault, Dear Senator, is not in ourselves, it's those darn foreign developments. As a result, Canada's floating dollar, which the bank had been claiming was set to rise, now appears to be permanently glued to the bottom of its recent trading range, and nobody -- least of all Mr. Thiessen -- seems to care. A far more explosive topic came up at the committee meeting -- the possible existence of a stock market bubble. That spectre of a bubble was given new credibility this week by The Economist's cover story, "America's bubble economy," in which it argued that the U.S. Federal Reserve Board's monetary expansion has gotten out of hand, creating a classic situation of asset inflation comparable to the real estate balloon that developed in Japan during the 1980s and the U.S. stock market boom of the 1920s. "Because the Fed has again left it rather late," The Economist said, "it will be hard to prick the bubble without risking a recession." In his Senate appearance, as reported by Dow Jones Service, Mr. Thiessen put as neutral a spin on the bubble scare as he possibly could: "Deciding when you have got a serious speculative bubble, which is somehow separate from what's going on in the real economy, is a very difficult judgment to make. And I would have to admit to you that there is not a consensus in the central banking community on exactly what you should do . . . I think there is no question that everybody worries a bit that, if those markets become too speculative and then crash, they are going to have some implications for the rest of the economy. We are all monitoring them very closely. There could be a moment when, quite evidently, things have gotten out of hand, and you have to respond to them." This giant hedging statement -- no consensus, don't know when, everybody worries, monitoring closely -- is far from comforting. Mr. Thiessen essentially seemed to be saying that central banks are keeping an eye out for something they wouldn't recognize if they saw it, and wouldn't know what to do about when it arrived. His comments were similar to those made by U.S. Fed officials in 1928, as recalled by The Economist: "There is no means of knowing beyond question how far this recent rise in stock prices represents excessive speculation, and how far a readjustment of values to increased industrial efficiency . . . and larger profits." Finding parallels with the 1920s is ultimately not very helpful. Central bankers have, in fact, been saying much the same thing about the current bull market in stocks for several years. From Fed chairman Alan Greenspan's famous "irrational exuberance" comment to other observations by central bankers in conferences, the theme is consistent. They worry about an overblown stock market, but they have trouble deciding whether it's a problem or not. The bubble theory, however, has many believers. The most notable in Canada is Albert Friedberg, head of Friedberg Commodity Management Inc., whose monthly newsletters have consistently warned that central banks all over the world have been pumping money into their economies at unsustainable rates. The usual product of excess money supply growth, and the one watched by central bankers, is price inflation. If there's no price inflation, central bankers argue, it means their monetary policies must be working. The flow of excess money into the world economy can also end up in other places, including the stock market. In the United States and Canada, where individual investors are pouring billions of dollars into the markets every month through mutual funds, the risk of a massive speculative binge is substantial. At last report, Canadians are investing in funds at the rate of $8-billion a month. The latest Friedberg newsletter claims that "millions of poorly informed investors have joined the fray. Speculative fires have not burned themselves out." If this assessment proves accurate, central bankers are going to have a lot to answer for. We welcome your comments. |
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