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Bubble trouble ahead?

AP
FILE -In this Friday, March 22, 2013, file photo, a girl plays near a screen showing the stock prices at the Korea Exchange in Seoul, South Korea. The Federal Reserve’s super-low interest-rate policy has inflated a slew of dangerous asset bubbles, just this year, the S&P 500 has jumped 26 percent. That increase corresponds with the Fed announcement last December that it would buy $85 billion of bonds each month. This has been the third attempt at bond purchasing by the Fed. Since the first round of buying at the end of 2008, stocks have climbed 124 percent. The strong increase raises suspicions of a bubble, given that stocks are performing so well in an otherwise sluggish recovery. (AP Photo/Lee Jin-man, File)

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By The Associated Press
Tuesday, Dec. 17, 2013, 12:01 a.m.
 

WASHINGTON — The 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 still-modest 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 policy meeting, here's why — or why not — these assets might be in a bubble:

Stocks

The Standard & Poor's 500 stock index has jumped about 26 percent 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 percent. Stocks outside the United States have surged as other central banks have followed the Fed with their own low-rate policies. Germany's DAX is up 20 percent, Japan's Nikkei index 46 percent.

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. “I am most worried about the boom in the U.S. stock market” because of its disconnect from a “weak and vulnerable” economy, Robert Shiller, the Nobel Prize-winning Yale economist, told the German magazine Der Spiegel.

Why it isn't:

One key measure assesses stock prices relative to corporate profits. A healthy price-earnings ratio is about 15 — or $15 a share for each dollar of profit. The P/E ratio is about 18.4, slightly above average but probably no cause to panic.

Scotch

Rare decades-old Scotch could give investors a terrible hangover. During the past five years, prices have shot up 170 percent, according to an index of auctions and sales by the Scotland-based firm Whisky Highland. It's among the investments that have grown more alluring as interest rates have fallen. 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 favor 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 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 such as New York City and Washington. Fitch Ratings estimated in November that a worrisome 17 percent of the U.S. home market is overvalued, a risk because much of the buying is tied to investments and house-flipping.

Why it isn't:

Some safety valves are in place that didn't exist during the previous housing bubble, New York University economist Nouriel Roubini wrote this month. Lending standards are tighter. Banks are cushioned from possible losses from greater capital in reserve. And homeowners have more home equity this time.

Farmland

During the past five years, the cost of Iowa farmland has rocketed 118 percent to $8,400 an acre, according to the Agriculture Department. Prices have more than doubled, too, in Kansas, Nebraska and North Dakota .

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 during 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. One ominous sign: The Environmental Protection Agency has proposed cutting ethanol blending requirements.

Why it isn't:

Unlike during the 1970s bubble, farmers haven't become “overleveraged” 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 percent in 1985 to less than 11 percent.

Bitcoin

Critics fear 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. The value of a Bitcoin relative to the dollar has surged at an average pace of 292 percent a year, according to a Bank of America analysis.

Why it's a bubble:

Prices are insanely volatile. They jumped 50 percent on Nov. 18 when regulators signaled that digital currencies could be acceptable. They plunged 30 percent on Dec. 5 when China's central bank banned Bitcoins as currency, according to the online exchange Mt.Gox.

Why it isn't:

Bitcoin may become a useful commodity in the 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.

 

 
 


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