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Bailouts Create Stock Market Bubbles, Krugman Wrong

By: Peter Cooper, Arabian Money

-- Posted Sunday, 18 October 2009 | Digg This ArticleDigg It! | | Source:

Horrendous stock market bubbles have been inflated all over the world as a direct consequence of the government interventions since last September. This has been the unwelcome and to some extent unexpected consequence of this action.


Commodity prices have also surged putting further pressure on the profits of industrial concerns at a time when raising general price levels is all but impossible. This squeezing of margins obviously makes stock market valuations look even more outrageous.


Dubai stocks overbought

The stock market has even been pumped up in Dubai where government debts of more than $85 billion and dozens of abandoned construction sites surely show that a recovery is at best someway in the future.


The Dubai Financial Market is 45 per cent up from its mid-July low and 65 per cent higher than its February bottom. To be fair that is still around 60 per cent off the previous high but this is still a stellar recovery in local stock prices.


But then look at the Dow Jones at 10,000 points and you have a similar tale of an outstanding rebound in equities against a deteriorating economic background, and the worst recession since the 1930s. What is going on?


Even the most casual analysis of cause and effect reveals that the obvious must be true: government interventions since the crash of last autumn have produced some of the most monstrous valuation bubbles in history. Cheap money is the devil in the system yet again.




The Dow Jones is on a trailing price-to-earnings ratio of 140, considerably higher than in the dot-com boom. Well, we know what followed – the dot-com crash.


For Professor Paul Krugman to publicly call for additional stimulus packages is bordering on insanity. Current stock market valuations show that governments can not bend the laws of economics without consequences. They are indeed fueling up the next big bust.


The need is to reduce debt in our economic system to a level that does not produce such unsustainable asset price bubbles, or at least something containable. The system that was saved last autumn is the problem, not the solution.


Anybody in banking will tell you that the money created has gone into the banking system and is not getting to the real economy: hence trade is still stalled by a global credit squeeze and shipping rates have just plummeted again. Financial assets are being inflated in value at the expense of the real economy. This is not wise government.


Sadly it looks as though another major collapse in asset values is going to be necessary before anybody seriously questions conventional wisdom. Piling more debt on top of an indebted person or nation just does not work, the requirement is for debt relief.


Professor Krugman really ought to know that economics is a science with laws of supply and demand creating market forces. Governments can interfere for a period but the basic law of gravity remains the same and can not be changed.


Big crash coming?


Moreover, the longer markets are inflated by cheap credit the worse the final Day of Reckoning is going to become. What has gone up very quickly will come down very quickly as well.


How can investors protect themselves? A mixture of cash and gold is one way of hedging downside risk. Then if the bubble inflates further the gold will help you keep up, while when the bubble pops the rally in the US dollar will be as formidable as its recent decline.


For those who feel they have to stay in the stock market then hedging with short positions or short ETFs should be seriously considered, although short instruments are tricky to handle and if you are not competent then avoiding stocks altogether is the best option.

-- Posted Sunday, 18 October 2009 | Digg This Article | Source:

About Peter Cooper:
Oxford University educated financial journalist Peter Cooper found himself made redundant by Emap plc in London in the mid-1990s and decided to rebuild his career in Dubai as launch editor of the pioneering magazine Gulf Business. He returned briefly to London in 1999 to complete his first book, a history of the Bovis construction group.

Then in 2000 he went back to Dubai to become an Internet entrepreneur, just as the dot-com market crashed. But he stumbled across the opportunity to become a partner in, which later became the Middle East's leading English language business news website.

Over the course of the next seven years he had a ringside seat as editor-in-chief writing about the remarkable transformation of Dubai into a global business and financial hub city. At the same time prospered and was sold in 2006 to Emap plc for $27 million, completing the career circle back to where it began a decade earlier.

He remains a lively commentator and columnist as a freelance journalist based in Dubai and travels extensively each summer with his wife Svetlana. His financial blog is attracting increasing attention with its focus on investment in gold and silver as a means of prospering during a time of great consumer price inflation and asset price deflation.

Order my book online from this link


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