The highs and lows of bubble economics

An old English music hall singalong trips cheerily: “I’m forever blowing bubbles, pretty bubbles in the air. They fly so high, nearly reach the sky.” Next, reality: “Then like my dreams, they fade and die.” Central bankers know about that now.

In January eight years ago Ben Bernanke took the chair of the Federal Reserve, the United States’ central bank, to succeed Alan Greenspan, who had (in)famously kept the “punch bowl” full during the riotous 2000s asset-bubble party.

At the time the United States economy, according to Stephen Roach of Morgan Stanley, was sucking up 80 per cent of the world’s savings. That had seriously unbalanced the United States economy and the world economy. United States consumers were on a sort of party pill.

On this oceanic turbulence then Reserve Bank governor Alan Bollard was a pingpong ball. Current governor Graeme Wheeler, picked to lift the bank’s official cash rate (OCR) on Thursday, was watching from the World Bank in Washington.

Bernanke provided intellectual underpinning to Greenspan’s belief that as long as inflation was low (even though, as I wrote at the time, rapid improvements in productivity suggested price changes should be much lower still or even falling), the Federal Reserve should not intervene: if a bubble was being blown, the Reserve could not be sure it was a bubble. A central bank’s job, Bernanke said, was to mop up afterwards.

Bernanke has got high marks for his mop-up after the bubble began to deflate in mid-2007 and collapsed in 2008. His successor, Janet Yellen, will have to continue for a good while yet.

The deeper point is that before 2007 Bernanke applied his towering intellect to backing policies which were “blowing bubbles” to “nearly reach the sky”, after which they “faded and died” — as did the dreams of a lot of middling and less-well-off folk in many countries, who got hurt, many of them badly. Some bubble-blowers in the financial sector took a hit, too, but since 2010 most have been doing very nicely, many of them kindly subsidised by taxpayers.

This has prompted a multi-faceted debate, ranging from what is the right type and tightness of regulation of the finance sector — at one end of that debate is ACT leader Jamie Whyte who told his conference on March 1 regulation caused the global financial crisis — to the appropriate role of debt in the economy. Some trace debt back over millennia to a pathway into slavery.

Go back six years: Bill English and John Key were then arguing for more debt instead of taxes. They have since changed tack and, in with masterful market expertise, have foregone more in dividends from part-state-owned electricity companies than they would have paid in debt.

Who have collected the spoils of Bernanke’s post-bubble money-printing? The richest 10 per cent and, even more, the richest 1 per cent. Stock markets are on a binge. Property prices in some places — New Zealand is one — have been climbing.

But New Zealand is now less blowing up a bubble (the property scramble seems to be slowing) than living in one: a prosperity part-delivered by high dairy prices, which, even though down a bit last week, are “nearly reaching the sky”. Business confidence is up there with them, consumer confidence not far behind and two-thirds of voters tell pollsters the country is going in the right direction.

But the trade balance is far from healthy despite this Chinese bonanza and that suggests consumer complacency is inflated, as prices soon will be.

Is consumer complacency an election factor? Mostly it works for the incumbent government but there is some poll evidence that over-confident voters sometimes feel free to vote for a generous opposition. So there is a political reason as well as an economic one for English to warn that the global economy could suddenly go wrong. China, for example, has had periodic mini-panics over debt, including one last week.

That argues for a cautious budget in May. Consumers probably understand that caution because at the middling household level the improvement is modest at best, by contrast with the top 10 per cent.

Add in two factors. Country debt to foreigners, which is mainly private, is still very high. That is a vulnerability if something goes wrong here or abroad. And interest rate rises are on the way, as Wheeler will probably underline on Thursday.

Australia’s Reserve Bank is suggesting banks confine mortgages to those who can handle a 4 per cent interest rate rise. Here Wheeler in December indicated a 2.25 per cent rise over two years. That could well be higher because the OCR often overshoots “neutral”. Wheeler has relied so far on his limit on loans to those with less than a 20 per cent deposit on a house purchase.

But most of the coming rise will be after the election both in the amount and in the number of households it affects. And Labour is practising hard at own-foot-shooting. English and Key can cruise on, not in a bubble near sky-high but not exactly earthbound.