Five potential danger zones for asset-bubble bursts
From booze to bitcoin, some see rising risks
WASHINGTON — The U.S. Federal Reserve’s super-low interest-rate policies have inflated a slew of dangerous asset bubbles. Or so critics say.
They say stocks are at unsustainable prices. California homes are fetching frothy sums. Same with farmland, bitcoins and rare Scotch.
Under chairman Ben Bernanke, the Fed has aggressively bought bonds to try to cut borrowing rates and accelerate spending, investing and hiring. Its supporters say low rates have helped nourish the stillmodest economic rebound.
Yet some say the Fed-engineered rates have produced an economic sugar high that risks triggering a crash akin to the tech-stock swoon in 2000 and the housing bust in 2006.
On the eve of the Fed’s latest policy meeting, here’s why — or why not — these five assets might be in a bubble: Stocks
The Standard & Poor’s 500 stock index has jumped about 26 per cent since the Fed announced a year ago that it would buy $85 billion in bonds each month. And since the Fed’s first round of bond buying at the end of 2008, stocks have soared 124 per cent. Stocks outside the United States have also surged. Why it’s a bubble: By artificially depressing bond yields, the Fed has led more investors to shift money into stocks. Such a flood of cash can swell share prices without regard to corporate earnings. Once the Fed unwinds its support, many investors could abandon stocks and send shares tumbling. Why it isn’t: One key measure assesses stock prices relative to corporate profits. A healthy price-earnings ratio is around 15 — or $15 a share for each dollar of profit. The current P/E ratio is about 18.4. Janet Yellen, nominated to succeed Bernanke, said last month: “If you look at traditional valuation measures ... you would not see stock prices in territory that suggests bubblelike conditions.”
Scotch
Rare, decades-old Scotch could give investors a terrible hangover. Over the past five years, prices have shot up 170 per cent, according to an index of auctions and sales by the Scotland-based firm Whisky High- land. It’s among the investments that have grown more alluring as interest rates have fallen. The buyers aren’t just tycoons with tweed blazers, empty snifters and money to burn. There’s “a perception that this is a good area of investment at a time when more traditional investments are producing low rates of return,” says Martin Green, a whisky specialist for the auction house Bonhams. Why it’s a bubble: Regardless of how high someone bids, Scotch still tastes the same. It generates returns by appreciating in price, not producing income as stocks, bonds or real estate can. By definition, whisky, wine and fine art are speculative and can abruptly lose favour with investors. Why it isn’t: What inflates bubbles beyond rationality is greed. Green says most buyers acquire Scotch for other reasons: “the mystical allure of the taste,” the thrill of the chase, the pursuit of status.
Housing
The last housing bubble ignited the worst economic catastrophe since the Great Depression. Home prices became inflated in part from an influx of cash and low rates driven by the Fed and other central banks. And in recent months, prices have again soared in some hot U.S. markets. Why it’s a bubble: It depends on location, location, location. All-cash sales, low rates and tight supplies have lifted prices in areas like New York City and Washington, D.C. Fitch Ratings estimated in November that a worrisome 17 per cent of the U.S. home market is overvalued. New York University economist Nouriel Roubini worries about bubbles in Switzerland, France, India, Indonesia, Turkey, Israel and Brazil. Why it isn’t: At least in the United States, some safety valves are in place that didn’t exist during the previous housing bubble, Roubini wrote this month. Lending standards are tighter. Banks are cushioned from possible losses from greater capital in reserve.
Farmland
Over the past five years, the cost of Iowa farmland has rocketed 118 per cent to $8,400 an acre, according to the Agriculture Department. Prices have more than doubled, too, in Kansas, Nebraska and North Dakota. The prices recall a 1970s-era boom. That ended with a bust that put many family farms into foreclosure. Why it’s a bubble: The Fed’s low-rate policies have encouraged farmers to expand their holdings over the past five years. Ethanol subsidies led them to plant more corn as prices for that crop rose over the past three years. “The bubble has been climbing,” said Dan Muhlbauer, a grain farmer who’s also a Democratic representative in the Iowa House. Why it isn’t: Unlike during the 1970s bubble, farmers haven’t become “over-leveraged” with debt, Esther George, president of the Kansas City Fed, noted last summer. The percentage of farmers’ assets financed with borrowed money has dropped from 22 per cent in 1985 to less than 11 per cent.
Bitcoin
Critics fear that the Fed’s low rates are undermining the dollar’s value. For some, the hot new choice is an Internet-based currency called bitcoin. Because there’s a finite supply of 21 million bitcoins, devotees say the currency will continue to appreciate. Why it’s a bubble: Prices are insanely volatile. They jumped 50 per cent on Nov. 18 after regulators signalled that digital currencies could be acceptable. They plunged 30 per cent on Dec. 5 after China’s central bank banned bitcoins as currency, according to the online exchange Mt. Gox. And the volatility suggests that Bitcoins are highly speculative. Why it isn’t: Bitcoin may become a useful commodity in the future economy. Its digital nature could make it easier for immigrants to send money back home. It could charge lower transaction fees than credit cards, saving retailers money.