Opinion Bubbles are back

There is a marked nervousness among Indian policy-makers about the prospect of fresh financial bubbles building in commodities globally,especially food and energy. Food and energy prices are once again moving up sharply,like they had done in the run up to the 2008 global financial crises. Many analysts believe global oil prices could head closer to $100 a barrel in near future. This may not be good for India as it is a net importer of energy and other commodities. Though India is poised to record a GDP growth of close to 8.7 per cent,there still seems to be a sense of foreboding among policy-makers,largely arising out of uncertainties resulting from excess liquidity and fresh financial bubbles around the world.There are many portents in global markets which look similar to what had existed in the months preceding the 2008 financial meltdown. There is no housing bubble in the United States this time round,but most analysts agree that China’s real-estate market is quite overheated. The Chinese central bankers have given clear indication of their intention to use monetary and other instruments to cool the real-estate market. Any sharp policy correction by the Chinese will certainly impact the rest of the world as China’s contribution to the incremental world GDP is the largest at present. The fear is China,which was seen as one of the saviours of the world economy after the 2008 episode,could suffer a real-estate and housing shock this time. Global analysts will watch China and its real-estate market more closely in 2011. The other condition that closely resembles what existed before the 2008 crises is the growing speculation in commodities. With more money available at near-zero interest rates,especially after the US Fed Reserve pumped another $600 billion into the system recently,Wall Street funds have been speculating ever more in commodities like oil,metals and food items. Many of these commodities are near their peak prices seen in early 2008. There were reports in early 2008 that excess liquidity available with Wall Street speculators had resulted in a near fourfold increase in funds deployed for speculation in commodities. Between 2003 and 2007,hedge funds speculating purely in commodities went up from $50 billion to a little over $200 billion. Today,the total funds deployed in commodity speculation is probably in excess of $350 billion,say some Wall Street observers. Sometime ago,one of the most celebrated commodity speculators from Wall Street,Jim Rodgers,was seen waving sugar packets before his host in a TV interview,declaring loudly that there was money to be made in commodities. However,the problem is,as commodity speculation results in excessive energy and food prices,it is bound to cause political disruptions in the developing world. For instance,India faces multiple risks from the rising energy and food prices. While the global investors recognise that robust growth is largely occurring in emerging economies like India,they are also seeing some serious medium-term risks posed by lack of policy coordination between the developed and developing economies at forums such as G-20.Recently,well-known economist Michael Spence articulated this issue quite well when he said there was an urgent need to guide the global economic system in a manner that the negative distributional effects are minimised in terms of overall growth outcomes. Put simply,it means those economies which have genuine growth potential over the next decade or so must be encouraged to act as engines of global growth in an orderly manner. Global policy-coordination mechanisms such as the G-20 should then create adequate incentive and accountability structures to make this happen.For instance,it is quite apparent that emerging economies like India and China cannot lead global growth if oil and other commodity prices move up beyond a point purely on a speculative basis. For oil and food dominate the consumption basket of over 40 per cent of the population in the developing societies. So ever rising energy and food prices are a political time bomb which would disrupt the economies of the South. This will be self-defeating for the global economic system. The responsibility then falls on the US to ensure that these commodity bubbles are checked in time.After the 2008 financial crises,there was a clear understanding that G-20 will create systems to watch asset bubbles and take timely corrective measures. But actions taken on the ground by developed economies are resulting in the opposite effect. The US is pumping more easy money into the system,fuelling speculative commodity price bubbles further. It also sees more dollar liquidity as a means to make its currency cheaper to somewhat thwart China’s exports into America. Spence has rightly argued that the US thinks it can hurt developing economies like China,India and Brazil by excessively devaluing its currency. Actually,it ends up hurting the eurozone economies much more because growth in the emerging part of the world is relatively more domestically driven. However,emerging economies like India become vulnerable in terms of volatility capital flows. For instance,if the US’s unilateral monetary actions end up hurting Europe badly and this results in some eurozone economies going into a deeper crises,then capital flows across the Atlantic can get seriously disrupted.India,for instance,is a net importer of energy and at a projected GDP growth of 8.5 to 9 per cent it will necessarily require net capital flows of at least $45 billion on a consistent basis to meet its higher current account deficit of 3.5-4 per cent-plus. So there is little doubt that India needs a steady flow of Western capital in the years to come.Unilateral monetary and currency actions by the US are not good for an orderly redistribution of global capital and output. There is too much fear of the unknown as we go into 2011. A lot more globally coordinated and mutually beneficial policy action is needed for economic imbalances to correct in a smooth and orderly manner.

The writer is Managing Editor,‘The Financial Express’

mk.venu@expressindia.com