Bubble trouble is the next danger

• Last Updated: November 12. 2009 8:11PM UAE / November 12. 2009 4:11PM GMT

Has the global economy’s dirty laundry been scrubbed clean? Fears about toxic debt have subsided. Equity markets have advanced more than 50 per cent since their lows last winter. Prices for credit default swaps – a barometer for the cost of debt and appetites for risk – are down. Markets are awash with capital. But as any mother knows, a bubble bath never gets you completely washed. Today, this lesson is just as important for economists and investors.

New asset bubbles and old ones that were reflated to spur a global recovery must be contended with, and soon. The US Federal Reserve and most other major central banks have kept interest rates at historically low levels to encourage borrowing, investment and economic activity that had all but stalled in the last quarter of last year. But investors can borrow so cheaply that leveraged finance – one of the main drivers of the financial crisis – is becoming just as attractive today as it was to bankers at Bear Stearns and Lehman Brothers when they were Wall Street giants.

Bubbles can be particularly dangerous to global growth when they emerge in commodity markets. As Nouriel Roubini, one of the few economists who cautioned that a property bubble would cause a global economic crisis, said this week: “If oil goes to $100 today, it would have the same effect on the global economy as what $147 oil had last year.” Oil, of course, is priced in dollars; another dip in the dollar and the price of oil will flirt with $100. The astonishing rise in gold prices, also driven in part by the greenback’s weakness, cannot be ignored either. That investors are more comfortable putting their money into precious metals, instead of putting it to work through investment in industries that create jobs, suggests enduring unease with economic conditions. There may be reason for anxiety. China’s currency is still undervalued, its economy too export driven. America’s debt load is still massive and its unemployment rate is at a 24-year high.

Still, the employees of Goldman Sachs who will share in a $3 billion dollar bonus pool this autumn have reason to celebrate. So do the millions of workers who saved for retirement in mutual funds that have recovered some 40 per cent of their value since last year. But rather than breaking out the bubbly, policy-makers must start reckoning with the bubbles that they have helped to create.