Getting less certain

Harvard economist John Kenneth Galbraith in 1974 declared “The Age of Uncertainty” in a book with same title as he assessed the murky waters of a world economy rocked by the oil price turmoil of 1974. The future of the global economy is still as unfathomable as it was four decades ago.

Eight years has passed since the Wall Street-triggered financial meltdown began to take its toll on the global economy. Recovery in the advanced economies has been slow and fragile, raising concerns of a protracted stagnation.

The possibility of a hard landing for the Chinese economy is also on the horizon. The world is as uncertain and perilous as ever with military conflicts, skirmishes and tensions in many parts.

Financial market volatility adds to uncertainties in the global economy. Stocks and bonds are on upward spirals but few can definitively say how long the bull market will last and if or when a sudden reversal will take place. Financial markets are doing well not because of optimism in underlying economies but due to fluid liquidity pushing capital into asset markets.

Nobel Prize winner and Yale economist Robert Shiller warned of speculative bubbles in U.S. stocks, citing higher averages than historically when corporate earnings after inflation were adjusted for the last 10 years. He also cautioned that bond prices are overrated as the 10-year treasury yield hovers at the lowest level since 1972.

Billionaire investor Warren Buffett predicted a stock crash down the road once the U.S. Federal Reserve starts raising interest rates, making stocks look too pricey. Federal Reserve Chair Janet Yellen also pointed out that “equity market valuations at this point generally are quite high.”

“We’ve also seen the compression of spreads on high-yield debt,” Yellen said, “which certainly looks like a reach for yield type of behavior.”

Her warning of overvalued stocks and bonds sent shockwaves through financial markets across the globe. She emphasized that there were no hallmarks of bubbles and described risks to financial stability as “moderated, not elevated,” but investors interpreted her comments as an indication of a monetary policy moving closer to higher interest rates.

The bull market in equity and bond markets has largely been driven by low interest rates and liquidity easing by central banks. Stocks and bonds will be headed downwards once the central banks start raising interest rates.

Many are worried about the foam forming in financial assets, but are not sure how big it is and when it will start to dissipate. It is also uncertain how far prices will go down.

Alan Greenspan, who chaired the U.S. Federal Reserve for 18 years from 2008, famously said we will know the when the bubble bursts after it does. The former Fed chairman warned of “irrational exuberance” when people rushed to the stock market in 1996 lured by the dot-com bubble of the 1990s, but nevertheless stayed pat on low interest rates, leading to a further buildup of bubbles in financial and real estate assets.

His successor, Ben Bernanke, also said a national housing boom was not a bubble that would go bust and didn’t see the build-up of the sub-mortgage crisis on the horizon in 2007. Galbraith said economists are worse than soothsayers in predicting the economy.

Korean stocks can hardly be described as being in a bubble compared with their U.S. counterparts. U.S. stocks have gained 80 percent on average over the last five years while Korea’s gains haven’t exceeded 30 percent. It is also an overstatement to claim stock prices are too high against the future returns and potentials of Korean companies.

News reports of a bull run are tempting ordinary citizens to take out loans to invest in stocks. We cannot know whether they really know what they are getting into. The daily limits on the fall and rise of stock prices will be expanded to 30 percent from the current 15 percent from June 15.

Volatility could increase. Investors must be aware that the local market will tremble once the U.S. Federal Reserve starts raising interest rates as foreign capital will pull out of Korea and head to the U.S. market for greater returns. The Bank of Korea will inevitably have to move the local rates higher in order to keep in tune with rates elsewhere. The quantitative easing party will come to an end.

The danger of risk in an investment falls entirely on the investor. Investors must study the value of a product before they put their money in. Regulators must examine whether there are practices encouraging reckless gambling. The International Monetary Fund accuses financial institutions of fanning bubbles to seek quick returns.

Investors are often burned because financial institutions are not clear or transparent when they explain products and risks. It remains unclear how much consumer protection has been strengthened in Korea after the Tongyang Group’s corporate bond crisis in 2013. An act to strengthen financial consumer protection has been under review for three years in the legislature. Financial regulators must nevertheless keep watch over the market to prevent innocent investors from unfair losses in another age of uncertainty.

Translation by the Korea JoongAng Daily staff

JoongAng Ilbo, May 22, Page 35

*The author is an economics professor at Korea University.

by Lee Jong-wha