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Macro abc

Asian Economics Global Research

 Little has changed: easy money still risks

The Anatomy of blowing asset bubbles across the region

 Impending monetary loosening in the US


Bubbles will only aggravate Asia’s policy dilemma
Touched up and improved
 We explore the evolution of bubbles with
insights from behavioural economics

Here we go again
Regular readers will recall our series on the anatomy of asset
bubbles last year, warning of the risk of loose monetary and
financial conditions. This call remains well on track. We thus
thought it would be worthwhile to issue an updated version of
the series, drawing renewed attention to Asia’s policy dilemma.

Asset bubbles are curious animals. They evolve in stages,


rather than in a straight line. Excessive caution usually breeds
policy inaction with ultimately fatal consequences. A better
understanding of their evolution is essential for investors and
officials alike to avoid the pitfalls strewn across their path.

Averting asset bubbles is easier said than done. No doubt. As


we noted elsewhere (see The options: what can Asia do about
bubbles?), the region faces a tough set of policy challenges.
The options include appreciation, rate hikes, capital controls,
tighter financial regulation and fiscal consolidation. No single
measure will prove sufficient. Only a mix will do. This raises
policy risks. The next few months, therefore, could be rather
volatile: the West eases and the East needs to respond. Decisive
action is needed. Whether it is coming is by no means clear.

Chapter one looks at the initial conditions required for the


21 October 2010 occurrence of asset bubbles. Uncertainty is needed to keep
Frederic Neumann policy-makers forgiving, even as investors ready the lotion
Economist and jump in the pool. Chapter two deals with what’s needed
The Hongkong and Shanghai Banking Corporation Limited to sustain the run. Leverage is essential, and rising asset values
+852 2822 4556 fredericneumann@hsbc.com.hk
render marginal tightening ineffective. Chapter three closes
in on the end, when a powerful narrative justifies dizzying
View HSBC Global Research at: http://www.research.hsbc.com
valuations, and even the most hawkish policy-makers can
*Employed by a non-US affiliate of HSBC Securities (USA) Inc,
and is not registered/qualified pursuant to FINRA regulations get carried away with the frenzy before the show unravels.
Issuer of report: The Hongkong and Shanghai Banking We pay particular attention to psychological findings and
Corporation Limited
what new behavioural insights teach us. If you think it’s still
Disclaimer & Disclosures about strict rationality, we suggest you open a newspaper
This report must be read with the every once in a while.
disclosures and the analyst certifications
in the Disclosure appendix, and with the
Disclaimer, which forms part of it
Macro
Asian Economics abc
21 October 2010

Uncertainty rules
 Asset bubbles have their origin in prolonged policy accommodation,
with officials worrying more about faltering growth than investors
 The current outlook for global growth remains precarious, leaving
policy-makers, especially in Asia, reluctant to tighten aggressively
 The recent run in asset prices, however, will require a breather for
a true asset bubble to develop, otherwise it will wither prematurely

We just don’t know Wind back the clock for a moment. In the aftermath
of the tech bust, concerns in the US centred on the
In the beginning there is uncertainty. Economic
risks of deflation. After the dreadful experience that
prospects at this stage are extremely difficult to
Japan had just suffered through, and with various
judge and risks are deemed to be extraordinary in
price gauges plunging to unaccustomed depth,
an historical context. This, then, elicits a
monetary officials worried that the United States
prolonged period of policy accommodation: rates
might slip into a similar trap where prices would
are kept low, or extra cash may even be injected
fall and turn the tech rout into a decade-long slog.
into the economy, to guard against tail-risks of
To top things off, a dramatic terrorist attack kept
economic calamity. It is difficult to appreciate in
everyone on edge, as did a subsequent war in Iraq.
hindsight the uncertainties that are involved in
At the time, it hardly seemed justified to raise
policy decisions at any one point in time. But, the
interest rates to prevent a housing bubble that
future, as our readers well know, remains
could conceivably develop years down the road.
impossible to predict. One is left, therefore, only
with the certainty of contemporary facts, which at They aren’t alike
this stage draw a dark, discouraging picture of
All pretty straight-forward. But one puzzle remains:
possible economic abyss.
if uncertainties are such that policy-makers will
Only think of the US housing bubble. It is now not tighten monetary policy, why would investors
commonplace to suggest that one of the main venture out and start to buy assets, kicking off an
contributing factors was an extended period of asset price spiral that years later ends up in a full-
low interest rates between about 2001 and 2004. blown bubble? After all, the same information is
Other factors, of course, mattered as well, such as available to all. If investors are brave enough to
the inflow of foreign savings and new financial jump into the pool in spite of lingering uncertainties,
instruments; but monetary accommodation in the officials should act as well and put an early stop
run-up to the bubble played a central role. Why to the incipient party.
were interest rates not raised earlier?

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The answer to this puzzle relates to asymmetric pay- markedly: central bank statements, and official
offs between policy-makers and investors. Officials, pronouncements, continuously underline the
by and large, fear losses more than investors, while ongoing risks to the world economy, while
investors have a greater yearning for gains. A central investors seem to shrug off those worries. As a
banker, to put it bluntly, will not see his life changed result, monetary policy has stayed accommodative
if growth rebounds swiftly and pushes towards or even as financial assets rallied impressively.
even beyond trend. But, should the economy remain
stuck in recession, or fail to meet expectations, he The question is, what happens next? Given the
will surely be saddled with most of the blame. severe dislocation in financial markets and industrial
The daring investor, on the other hand, can reap output over the past two years, the unusual nature of
very substantial rewards by buying assets early in this recession, which centres on a US financial bust
the cycle. No doubt, he fears losses, too, but the with persisting deleveraging pressures, and the
prospect of outsized gains handsomely enormous challenges of global rebalancing that this
compensates for taking risks. episode has exacted, we suspect that growth
uncertainties will linger for quite some time. Thus,
In short, under uncertainty, policy-makers are biased
monetary accommodation will not disappear any
towards leaving in place monetary accommodation,
time soon, whether in Asia or elsewhere, laying the
fearing a continued, re-renewed, plunge in activity.
ground for a secular rally in Asian asset markets.
Investors, meanwhile, facing the same degree of
uncertainty, nevertheless venture to buy assets There is, however, a nuance to this story that is well
because their potential returns help compensate worth remembering. Uncertainty is partly a function
them for any risks they are taking. of the performance of financial markets: prolonged
rallies can help dispel some of the uncertainties
Recent insights from behavioural finance add
about future growth, not least because powerful
another layer to this analysis. There is evidence
wealth effects begin to kick in. If this occurs, then
that the subjective interpretation of relative risks
depends greatly on the potential pay-offs that officials are no longer biased towards monetary
someone receives. So, if central bankers are accommodation, becoming far more confident in
relatively more exposed to losses than to gains, their assessment of economic recovery. The upshot,
they will tend to interpret available information in then, is this: if markets continue to rally as they have
a more cautious light. On the other hand, investors, over the past few months, the risk rises that policy-
who would gain relatively more from a strong makers will tighten the reins and put a stop to the
rebound in growth and financial markets, are more incipient bubble. True asset bubbles, in short, require
likely to see green-shoots sprouting. Under a periodic eruption of uncertainties over future
uncertainty, in short, the conclusions that officials growth prospects sharp enough to prompt a
and market participants draw about the prospects temporary correction in financial markets.
for growth and relative risks will tend to differ.
Needing a breather
Why we care
Note that we don’t think that the recent rally has
Currently, uncertainties about the future path of been strong enough to fully dispel lingering doubts
growth remain extraordinarily large. As a result, among policy-makers about a lasting rebound in
officials have maintained monetary accommodation growth. Still, a sustained asset bubble in Asia,
even as asset markets have started to rally. What’s fuelled by loose monetary policy, is only possible
striking is that the interpretation of officials and if asset markets take a breather every once in a
investors of economic risks is also differing while to preserve a modicum of uncertainty.

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There is another insight from behavioural finance Runaway asset prices, in short, tend to narrow the
that is worth addressing. Periods of consolidation investor base, rendering it less likely that a rally
are also needed because they help reshuffle investor will mature into a full blown bubble. Periods of
participation. True, sustained bubbles draw in a consolidation are thus required to offer others the
broad range of participants over time; but new opportunity to participate in the run-up at a
buyers only emerge if prices settle temporarily. seemingly decent price. When such a period of
The reason for this is simple psychology: the most consolidation will occur in this particular rally is
powerful reference point for any investor in deciding extremely difficult to say. But, after an impressive
whether to part with his cash is the recent price run-up over the last few months, we may be getting
history of an asset. A big jump in prices tends to closer to the point at which such a breather
discourage new investors more than it lures them. becomes necessary. Otherwise, this rally may never
What’s needed is a periodic lull in activity that mature into a true asset bubble, either because
convinces potential buyers that they haven’t missed policy-makers step in, or because potential
the boat entirely. Fundamentals, in fact, matter far investors take fright at the seemingly ineluctable
less than they should, at least according to rise in prices.
conventional models.

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Need marginal buyers


 The cash for asset purchases must come, over time, from either
profits or leverage, with the latter often associated with bubbles
 Interest rates are low across the world, but Asia has the balance
sheet strength to lever up, which is why bubbles are a risk here
 Apart from leverage, every bubble requires a narrative that justifies
the escalation of asset prices, and Asia’s story is quickly unfolding

A sustained rally, or a bubble, requires a marginal profits, then, generate the cash that can be used
buyer of assets. Funds for such purchases have for asset purchases. What’s more is that the robust
only two sources: profits and leverage. In general, returns on such investment, as long as they prove
the former is associated with sustained rallies, sustained, justify rising asset prices. The second
while the latter is more commonly found in asset source is financial leverage whereby the financial
bubbles. Over the coming years, the outlook for system generates extra cash that ends up fuelling
profits remains a little challenging as excess capacity the demand for assets. Note that financial leverage
and rising raw material costs squeeze margins. So can occur when underlying profits are not rising,
leverage remains the main source of cash for although investors certainly expect profits, whether
marginal asset purchases. Asia is among the few speculative or economic, to increase in the future.
regions in the world able to lever up. That’s why
Of interest here are only rallies sustained over the
bubbles are more likely to occur here.
course of a few years, not the short-term gyrations
The bigger picture that financial markets are prone to. Take the
stunning rebound since the lows markets reached
We are all a little too caught up in the daily grind
in March of last year. The move has surely been
of financial markets. It helps to take a step back
impressive. But, arguably, it doesn’t include the
every once in a while. What drives asset prices
ingredients of a sustained rally. For one, there has
over time is not so much the relative performance
been no jump in structural profits in the economy:
of a company or sector, or the relative preference
cyclically, of course, profits have begun to recover,
of investors for bonds and stocks. These things
but this reflects merely normalization after an
matter, of course. But in the long-run any run-up
unusually deep slump. In addition, with the notable
in asset prices can only be sustained if extra cash
exception of China, there has been no real rise in
is being generated for their marginal purchase.
leverage. Rather, the Western financial system is
Broadly speaking, there are only two sources for still de-leveraging, a process that will continue for
such funds. The first arises if past economic quite some time.
investments yield healthy returns. The resulting

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From an economic perspective, therefore, all that has remain under pressure for quite some time. Beyond
occurred is that asset prices have normalized after a rationalization, the only way profits can continue
tremendous confidence shock: marginal purchases to grow is with gains in total factor productivity,
have been driven by cash returning from the which usually requires an increase in capital
sidelines after a major sell-off. Technically, investment, preferably of the judicious kind, and
therefore, this has been merely a rotation in asset rapid improvements in technology. We are not
allocation away from money. An additional source arguing that these are impossible to achieve, but,
of funds, evidently, has been central bank purchases at the current juncture, such advances certainly do
of assets with newly created cash. On the whole, not feature in the justification of asset price gains
however, we would hardly regard this as the primary and we would suggest that advances of that nature
driver of the recent rally, though certainly a useful are still quite some time away.
confidence boost. In any event, central bank money
This leaves leverage. Here, too, it is difficult to
creation is not a sustainable source of cash for
see the global financial system leveraging up in
marginal asset purchases, even if some central banks
the coming years. The process of deleveraging, as
in the West may be gearing up again to print cash.
noted, will persist for many years in Western
Looking for a driver economies. As a result, it appears misplaced to
expect the emergence of an asset bubble in these
We’ll leave our strategists to comment on the near-
markets so soon after the last has collapsed. But,
term performance of financial markets, a call that
this doesn’t mean that local asset bubbles could
depends much on when and where residual cash
not develop elsewhere in the world. Most notably
holdings will be deployed. Suffice to say here that
in Asia, balance sheets, whether among firms,
from an economic perspective, the recent rally can
financial institutions, or households, remain in
hardly prove sustained without a rise in structural
fairly robust shape. Excess liquidity, coupled with
profits or financial leverage. On both fronts,
record low interest rates, a state that we expect to
however, the global economy is facing challenges.
persist, provides a powerful ferment for rising
Take profits first. It is true that in the United
leverage across the region.
States, for example, corporate profits have been
surprisingly resilient. This, however, is largely Need to believe
due to the relentless rationalization of the labour
But, even if the ingredients of flush liquidity, robust
force rather than fundamentally higher returns on
balance sheets, and low interest rates are in place,
capital investment or a rise in structural productivity
this in itself doesn’t necessarily entail rising
(there was, admittedly, an increase in cyclical
leverage. For this to occur, an additional factor is
productivity, which is associated generally with
required: confidence. Even with cash in hand, the
rationalization, rather than structural increase such
marginal buyer will only step forward if he truly
as the discovery of a new technology).
believes that the future is bright. It is, of course,
It remains to be seen, therefore, whether the gains difficult to judge whether sufficient optimism will
in profits can be sustained. In the US and elsewhere, take hold in Asia for leverage to build and an asset
there are reasons to remain sceptical about a lasting, bubble to ensue. But, recent insights into behavioural
structural improvement in profitability: not only are patterns of investors offer some clues and suggest
capacity utilization rates still at extremely depressed that the region may indeed be gaining the confidence
levels, but raw material prices are also rising for to step up its game.
structural reasons. Profit margins, in short, will

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The first observation relates to risk appetite among return to the old days of heady growth. Whether
investors over time. Bubbles and busts appear with this view is justified or not is not the point: rather,
a remarkable periodicity, usually some 10 to 15 confidence in Asia remains such that risk appetite
years apart. This has both institutional and may well continue to flourish.
behavioural reasons. Institutionally, many financial
There is another insight from the behavioural school
market participants of previous busts are no longer
that is useful. Rather than being strictly objective,
around and a younger, more aggressive crowd has
investors need to frame their decisions. As tempting
taken over. This matters because most investors
as it is to believe that profit projections and other
therefore no longer possess the necessary dose of
such forecasts have a scientific foundation in
risk aversion, which a bursting bubble inevitably
analysts’ models, in reality they are contingent
instils. But even among those market participants
upon a qualitative assessment of the future. What
who lived through the previous bust, the impression
matters, therefore, is an interpretative paradigm of
fades over time, with some studies suggesting that
where the economy is currently headed in order to
the rate of decay of such recollections is exponential.
anchor subjective expectations as well as the various
Asia’s bust is now 13 years in the past and the risk assumptions that ultimately feed into our models.
aversion that the financial crisis originally Such narrative is all the more important because
engendered has now disappeared. The region, in financial markets trade on expected, rather than
short, is ready to leap once more. In fact, upon realized, profits.
closer inspection, it is evident that Asia started to
Looking at past bubbles, it quickly becomes
re-lever already in late 2006 or early 2007,
apparent that an essential ingredient is a perceived
concluding a ten-year period of continuous de-
“game changer”, or the “next big thing”, which
leveraging and lingering risk aversion. Loan to
supposedly alters the way the economy operates
deposit ratios, for example, started to increase
and thus affects prospects for returns. The tech
again around that time, while asset values, most
bubble is perhaps the most notable in this respect,
notably property, started to rise rather briskly.
with investors being swept into a frenzy about how
This process was only temporarily interrupted by
the internet would change the world. But, every
the Lehman bust, and we have now quickly
such episode evolves from a particular narrative:
returned to a giant re-leveraging cycle that was
even the housing boom in the United States was
already underway before the recent crisis hit.
justified by the assumption that interest rates had
There are other indications that confidence has reached a permanent low due to superior monetary
returned in Asia more swiftly than elsewhere. policy and financial wizardry. We only remind our
Consumer confidence indices, for instance, have readers of the tale about the “Great Moderation”.
rebounded sharply after the Lehman shake-up,
In Asia today, a bubble mentality may well be
unlike similar measures in the West. This underlines
taking hold. No longer trapped by risk aversion,
a crucial point: the crisis, while devastating for
financial market participants in the region are
industrial output in Asia, had nowhere near as
displaying a remarkable appetite for assets despite
large an effect on confidence as it did in the West.
the severe slump over the last few months.
There is a prevailing sense, quite evident for
Arguably, the recent crisis itself has provided the
residents in the region, that the financial crisis was
region with the next paradigm it requires: that
fundamentally a Western affair and that, while
Asia has matured enough to shape its own destiny
representing real challenges, Asia will swiftly
irrespective of developments in the United States.

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And as with any such narrative, there is an


element of truth in it, although to what degree this
justifies run-away asset valuations remains to be
seen. The paradigm now concerns the issue of
Asia, and foremost of China, coming of age. After
all, what investor, Asian and Western alike, can
resist the lure of almost three billion consumers
finally starting to spend? And so, the story begins.

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It feels good
 Bubbles develop their own momentum, first slow, then speedy,
but, as the years wash by, progressively more difficult to stop
 Incremental tightening quickly loses its effectiveness as investors
shrug off hikes and rising asset values ease financial conditions
 Harsher policy steps are often avoided until it’s too late, with even
determined hawks blinded by the levity that asset bubbles entail

Once an asset bubble gets under way, it becomes asset price increases and interest rate hikes can
exceedingly difficult to stop. Conventional coexist for quite some time, with seemingly no
monetary policy is swiftly overwhelmed by the effect of the latter on the former.
momentum of an asset price spiral, and marginal
What is the explanation for such impotency of
rate increases lack the potency to stop the train in
monetary policy? Two answers. First, consider the
its tracks. This highlights the need for pre-emptive
notion of the financial accelerator. This essentially
rate hikes in order to prevent a bubble from
states that rising asset prices boost the value of
forming in the first place. But policy-makers fear
collateral for loans. In turn, banks become more
losses more than gains in the early stages and
willing to lend, loosening lending criteria and terms.
remain accommodative. Once the bubble matures,
An initial cut in interest rates, therefore, carries
euphoria grips officials as well, enabling them to
through over time via rising asset prices that
buy into the rationalization for the dizzying rise in
effectively prolong the impact of monetary easing.
asset prices. Until the bubble pops.
This effect may eclipse the rise in interest rates so
Hitting the accelerator that financial conditions – as opposed to monetary
conditions – become progressively looser and not
One of the curious aspects of an asset bubble is
tighter, further fuelling asset price gains. The
that it is immune to marginal interest rate increases.
financial accelerator, in short, reduces the potency of
Consider, again, the recent experience in the US:
rate hikes once an asset rally is under way.
once economic uncertainties and perceived risks
of deflation dissipated in 2004, the Federal Reserve The fact that banks loosen their lending criteria
embarked on a series of interest rate hikes. Yet, during a run-up in asset prices is partly a behavioural
monetary tightening had no influence on the phenomenon. Bankers, along with everyone else,
housing market. Rather, the hot phase of the are eventually infected by general euphoria about
property rally was between 2004 and 2006, prospects for growth and the consequent justification
precisely the time when the Fed tightened the for rising asset values. But, this is not an
screws. This is quite a common feature of bubbles: instantaneous reaction to any rally. It takes time

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for loan officers and risk managers to react to Getting used to it


developments in asset markets. In any decision,
Apart from the financial accelerator, there is a
proximate experiences feature far more prominently
second reason why the potency of rate hikes can
than more distant events. Initially, therefore, risk
be surprisingly limited. Once again, consider the
aversion prevails following a bust. The longer the
US housing bubble. The Federal Reserve, as
rally endures, however, the more prevalent becomes
mentioned, raised interest rates considerably
the impression of rising asset prices and lending
between 2004 and 2006. However, long-term
conditions are subsequently eased.
interest rates did not rise in accordance, something
These insights hold immediate relevance for us termed a “conundrum” at the time. This, in effect,
today. Despite the debate about the timing of exit allowed the housing bubble to flourish despite
strategies of central banks, it is far from certain hikes in the Fed Funds rate. One explanation
that a gradual tightening of monetary conditions frequently put forward was that inflows of foreign
over the coming quarters would have a similar savings, especially by Asian central banks with a
impact on financial conditions and therefore penchant for secure long-term investments, pushed
curtail the appreciation of asset prices. Following down benchmark rates along the yield curve.
the recent bust, lending criteria, even in Asia,
There may be something to this explanation,
remain tight and are only now showing signs of
although we wouldn’t push that argument too far
being gradually relaxed. Even the most hawkish
since it is not clear that there was indeed a global
advocates of rate increases hardly expect a big
glut of savings as many had argued at the time.
jump in policy rates by late 2011. Gradual rate
Rather, our argument concerns market psychology
hikes, therefore, may well be offset by a loosening
and the strategy for US rate hikes. The Federal
of lending criteria among commercial banks.
Reserve raised interest rates at 25bp increments
Of course, there are notable differences among over a period of more than two years. This was a
countries. In China, if anything, lending criteria fairly predictable and consistent pattern of
may be tightened after being extremely loose over monetary tightening, justified in part by the
the past two years, although even here rising asset prevalent belief among central bankers that
prices may offset some of the intended tightening monetary policy needs to be as transparent and
effect. Elsewhere in Asia, the run-up in asset unsurprising as possible to allow the market to
prices is likely to serve as a more powerful properly price risk. The trouble with this
financial accelerator: bank lending guidelines are approach, however, is that it engenders something
less controlled by policy-makers and because termed “habituation” among investors: consistent
commercial banks had tightened criteria more and predictable policy rate hikes lose their
during the crisis than in China, they still have potency because they are anticipated by the
some way to go towards normalization. In the market, pushing down the risk premium on long-
West, meanwhile, lending criteria may be relaxed term bonds even as the policy rate rises.
more gradually than in Asia, reducing any
Currently, with uncertainties over the future path
immediate risk of an asset bubble. Moreover, even
of growth extraordinarily large, and central
if bank officers are starting to ease conditions in
bankers still wedded to the concept of the need for
these countries, the disappearance of the shadow
predictability and transparency in monetary
banking system will weigh on the overall availability
policy, we fear that officials will repeat the
of credit for years to come.
mistake of the past, which was to tighten too

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gradually and predictably. This, in turn, may once months. But, whether this is enough to redress the
more lead to habituation among investors, who structural imbalance in world monetary condition
will come to shrug off any rate hikes as essentially requirements (Western easing, Eastern tightening)
inconsequential for their investment prospects. remains to be seen.
What would be needed, in fact, is for central banks
Caught in the act
to inject a degree of “deliberate uncertainty” into
financial markets in order to avoid habituation and Once bubbles are in full swing, central banks
thus raise the potency of any rate hikes. Such evidently need to tighten aggressively and
uncertainty may be generated by raising rates surprisingly in order to derail asset price momentum.
more than the market anticipates at any particular But, over the latter stages of such rallies, policy-
policy-meeting, thus preserving a certain level of makers tend to remain comparatively inactive as
policy risk premium in the pricing of securities. well. There is a behavioural reason for this. The
supporting narrative for the rally eventually acquires
How likely is it that central banks will follow these
some plausibility among everyone involved,
insights from the behavioural school? We doubt
including officials. Especially in emerging markets,
officials will adopt strategies of injecting deliberate
rising asset prices are often taken as a sign of
uncertainty into financial markets. In the West, a
economic success. Given that policy-makers in these
number of central banks have already committed
economies are usually more intimately involved with
themselves to keeping interest rates low and stable
guiding the economy than in advanced markets,
for a long time, implying rate hikes will materialize
there is a tendency to interpret a rise in asset prices
only gradually and likely in a predictable manner.
as corroborating the expediency of public policy,
In Asia, central banks have in the past acted a little rather than being a folly of the market. This is, in
less predictably. Only this week, officials in China fact, quite human: decision-makers are prone to
hiked rates to everyone’s surprise. In Korea and interpreting available information as
Taiwan, too, the authorities are prone to throwing substantiating their prior actions.
the occasional curve-ball at the market. But, in a
With economic policy thus remaining
region of general asset price appreciation over the
accommodative, asset prices continue to rise,
coming years, and given the scale of the
usually at an ever-accelerating pace, until the final
dislocation of monetary conditions, even this may
collapse arrives. While it is tempting to think that
not be sufficient to inject the necessary policy
public policy usually puts a stop to bubbles, this is
uncertainty to prevent bubbles from growing.
in fact incorrect: most such rallies tend to fizzle out
One possibility, however, is that policy-makers use on their own, mostly because the cumulative
surprise regulatory tightening to shake things up. misallocation of capital over the course of the
As we noted elsewhere (see The options), Asia is investment boom starts to generate losses that
facing a number of policy constraints currently, gnaw at the confidence of investors. With falling
making it necessary to resort to a mix of different profits and declining leverage, the marginal buyer
measures to prevent asset bubbles, including fiscal of assets, so crucial to sustain the run, eventually
consolidation, capital controls, exchange rate disappears. The collapse, then, comes hard and fast.
appreciation, and financial regulation. The variety And policy-makers are tasked to clean up the mess.
of measures, and in many cases their untested
nature, certainly raises investor risk and may lead
to surprise policy announcements over the coming

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Our world, now How likely is an asset bubble in Asia over the
coming few years? Quite. Although hardly
In the first three chapters we outlined the different
inevitable. Already, markets have rebounded
stages of asset bubbles, paying particular attention
sharply as idle cash was rapidly deployed. A
to new insights from behavioural economics. In the
breather may eventually be necessary to sustain
first stage, unusual economic uncertainty leaves
the run in asset prices, given that a consolidation
policy-makers biased for accommodation, fearing
would allow policy-makers to remain
a relapse into recession more than investors do.
accommodative and other investors to buy into the
Markets, in this phase, rally as idle cash is deployed
market. Economic uncertainties are likely to remain
from the sidelines, leading to a quick rebound from
such that officials are not in a position to tighten
the panic sell-off that gripped the market during
monetary policy aggressively any time soon.
the earlier bust. A cash rally, however, only carries
Moreover, even if profits may not materialize, the
so far and for the run-up to be sustained either
region’s financial systems remain capable of
profits need to rise or leverage has to build.
generating substantial further leverage to power a
As valuations approach bubble territory, a sustained run in asset prices.
powerful narrative emerges that justifies higher
Lastly, there is palpable optimism that the region
asset prices still. Eventually, these help to lift
will indeed be the “next big thing” on the global
growth and dispel residual uncertainties about
economic agenda. The key, therefore, is whether
economic prospects. At this stage, policy-makers
policy-makers will eventually step up to the task
begin to tighten monetary policy. But, marginal
and spoil the party. History suggests that this is
rate hikes often have little impact, being eclipsed
extremely difficult to do and the current mindset
by the rise in collateral value, which loosens
among the region’s central bankers makes
financial conditions further. As the bubble matures,
decisive action arguably less likely. Not every
a more aggressive monetary policy response is
recession, of course, sets the stage for an asset
called for but not forthcoming: officials themselves
bubble, but, as things stand currently, this looks
start to be caught up in the narrative, in part
like one of those times.
because the alleged economic gains reflect positively
on the conduct of public policy. As losses mount,
the run in assets eventually turns into a rout.

12
Macro
Asian Economics abc
21 October 2010

Disclosure appendix
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Macro
Asian Economics abc
21 October 2010

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14
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Global Economics Research Team


Global Emerging Europe, Middle East and Africa
Stephen King Alexander Morozov
Global Head of Economics +7 495 783 8855 alexander.morozov@hsbc.com
+44 20 7991 6700 stephen.king@hsbcib.com Murat Ulgen
Karen Ward +90 212 376 4619 muratulgen@hsbc.com.tr
Senior Global Economist Simon Williams
+44 20 7991 3692 karen.ward@hsbcib.com +971 4 507 7614 simon.williams@hsbc.com
Madhur Jha Liz Martins
+44 20 7991 6755 madhur.jha@hsbcib.com +971 4 423 6928 liz.martins@hsbc.com
Europe Latin America
Janet Henry Argentina
Chief European Economist Javier Finkman
+44 20 7991 6711 janet.henry@hsbcib.com Chief Economist, South America ex-Brazil
Astrid Schilo +54 11 4344 8144 javier.finkman@hsbc.com.ar
+44 20 7991 6708 astrid.schilo@hsbcib.com Ramiro D Blazquez
Germany Senior Economist
Lothar Hessler +54 11 4348 5759 ramiro.blazquez@hsbc.com.ar
+49 21 1910 2906 lothar.hessler@hsbctrinkaus.de Jorge Morgenstern
France Economist
Mathilde Lemoine +54 11 4130 9229 jorge.morgenstern@hsbc.com.ar
+33 1 4070 3266 mathilde.lemoine@hsbc.fr Brazil
United Kingdom Andre Loes
Stuart Green Chief Economist
+44 20 7991 6718 stuart1.green@hsbcib.com +55 11 3371 8184 andre.a.loes@hsbc.com.br

Andrew Grantham Constantin Jancso


+44 20 7991 2170 andrew.grantham@hsbcib.com Senior Economist
+55 11 3371 8183 constantin.c.jancso@hsbc.com.br
North America
Mexico
Kevin Logan Sergio Martin
+1 212 525 3195 kevin.r.logan@us.hsbc.com Chief Economist
+52 55 5721 2164 sergio.martinm@hsbc.com.mx
Ryan Wang
+1 212 525 3181 ryan.wang@us.hsbc.com Central America
Lorena Dominguez
Stewart Hall Economist
+1 416 868 7523 stewart_hall@hsbc.ca +52 55 5721 2172 lorena.dominguez@hsbc.com.mx
Asia Pacific
Qu Hongbin
Managing Direct, Co-head Asian Economics Research and
Chief Economist Greater China
+852 2822 2025 hongbinqu@hsbc.com.hk
Frederic Neumann
Managing Direct, Co-head Asian Economics Research
+852 2822 4556 fredericneumann@hsbc.com.hk
Paul Bloxham
Chief Economist, Australia and New Zealand
+61 2925 52635 paulbloxham@hsbc.com.au
Song Yi Kim
+852 2822 4870 songyikim@hsbc.com.hk
Donna Kwok
+852 2996 6621 donnahjkwok@hsbc.com.hk
Sherman Chan
+852 2996 6975 shermanwkchan@hsbc.com.hk
Wellian Wiranto
+65 6230 2879 wellianwiranto@hsbc.com.sg
Seiji Shiraishi
+81 3 5203 3802 seiji.shiraishi@hsbc.co.jp
Yukiko Tani
+81 3 5203 3827 yukiko.tani@hsbc.co.jp
Sun Junwei
Associate
Sophia Ma
Associate