While President Obama declared today from the White House that his goal was to create “post-bubble” growth in the U.S. economy, a top economist at New York University published an article in the Financial Times charging that under Obama the Federal Reserve is creating one of the greatest economic bubbles in financial history.
NYU economist Nouriel Roubini argued in the newspaper that by keeping federal fund interest rates at zero, Federal Reserve Chairman Ben Bernanke is stimulating a historic stock market rise that is being fueled by money investment managers borrowing from the federal government.
Roubini warned that the dollar has become the “mother of all carry trades” and that it faces “an inevitable bust” that will cause asset prices to plummet in what will amount to a global stock market crash of historic proportions.
A currency is defined as being involved in a “carry trade” when the currency can be borrowed at relatively low cost and invested for what appears to be a certain or “locked-in” gain.
The Federal Reserve has held federal funds rates, the rate banks charge each other to borrow federal funds short-term, effectively at zero since December 2008.
Asking rhetorically what is behind the stock market rally in which the Dow Jones Industrial Average has shot above the 10,000 benchmark after reaching a low of 6,547.05 on March 9, Roubini answered that the explanation lies in the dollar replacing the Japanese yen as the world’s carry trade of choice, and that has caused U.S. stock markets to be hit by “a wave of liquidity from near-zero interest rates.”
Roubini’s analysis was reminiscent of the attack launched against President George W. Bush that Federal Reserve Chairman Alan Greenspan had caused the “mortgage bubble” by keeping interest rates artificially low at 1 percent in 2003-2004 in order to stimulate the post-9/11 U.S. economy.
The bursting of the mortgage bubble is widely blamed for being the precipitating cause of the economic recession that officially began in December 2008 following two consecutive quarters of negative growth in U.S. gross domestic product, or GDP.
“The U.S. dollar has become the major funding currency of carry trades as the Fed has kept interest rates on hold and is expected to do so for a long time,” Roubini wrote.
As long as U.S. stock markets continue to go up, investors participating in the carry trade look like geniuses, Roubini argued, capable of realizing total returns in the 50-70 percent range since March.
But the carry trade cannot last forever, Roubini warned. He said at some point the Federal Reserve no longer will be able to continue buying U.S. Treasuries and other federal agency debt securities in order to keep interest rates depressed.
WND reported that on March 25 the Federal Reserve began to buy longer-term U.S. Treasury securities and debt issued by other federal agencies to depress interest rates in an environment where the U.S. Treasury was entering the market to fund what ended up being a $1.4 trillion federal budget deficit for fiscal year 2009.
On March 24, a Federal Reserve Bank of New York press release specified that the Federal Open Market Trading Desk within the Fed would purchase $1 trillion of government and quasi-government debt, including up to $300 billion of longer-term U.S. Treasury securities, in what amounted to a government-subsidized purchase of U.S. government debt.
The announced Fed purchases also included $750 billion of Freddie Mac and Fannie Mae debt and up to $100 billion of debt issued by various other government agencies.
To many Americans, the move appeared equivalent to a retail consumer in debt using a MasterCard to pay the Visa bill.
“But one day this bubble will burst, leading to the biggest coordinate asset bust ever,” Roubini wrote. “A stampede will occur as closing long leveraged risky asset positions across all asset classes funded by dollar shorts triggers a coordinated collapse of all those risky asset – equities, commodities, emerging market asset classes and credit instruments.”
“This unraveling may not occur for a while, as easy money and excessive global liquidity can push asset prices higher for a while,” he warned. “But the longer and bigger the carry trades and the larger the asset bubble, the bigger will be the ensuing asset bubble crash.”
“The Fed and other policymakers seem unaware of the monster bubble they are creating. The longer they remain blind, the harder the markets will fall.”