No more bubbles?

It is widely understood that "speculative bubbles" can bring about economic collapse. This happens when the banking system invests (lends) to fuel a booming industry/ market, such as the housing market in 2008. When the line of credit runs dry, demand plummets, and prices fall. Investors struggle to repay back debts which they used to purchase the house / stock because they could never sustainably afford to pay in the first place, and relied to some extent on simply rolling over debt instead of actually paying it down. The greater the "rollover ratio", the more unstable the market, and the greater the eventual collapse. The damage to the economy in the event of a bubble bursting is largely determined by the ability of the banking system to find a new bubble to offset the losses of the old one. Ultimately, the banking system must be supported, otherwise the entire economy collapses.

In 2008, government's became fearful that losses in the housing market that had started in 2007 were not under control, and decided that enormous bailouts would be necessary. Worryingly, we have failed to make a full "recovery" because of lackluster growth. In a letter on the 6th January, Timothy Geithner, US treasury secretary, warned that the Treasury had no further financial capacity to resort to emergency measures to avert a default on its debts if Congress did not raise the "debt limit". He also warned that even austerity could not avert a sovereign debt default at this late stage. The only way the treasury can pay their debts is to borrow more money. This is exactly the stage that both the Northern Rock bank got to in 2007, and as Gordon Brown's new book "Beyond The Crash" reveals; Lehman Brothers in 2008- as they were relying on overnight finance to remain above their reserve requirements. Obviously, this shows the stupid side of reserve requirements, because even if a bank can't use the money it has on deposits, it can simply "borrow" more!

In 2011, we look set to continue to see the upwards spiral in commodity prices, driven by profligate emerging markets in the east. Of particular concern is oil, expenditure on which already accounts for 7% of GDP. Whenever the futures price has ever gone above 5.5%, the economy slows down or enters recession. Some see the oil price spike in 2008 as a catalyst for the banking crisis. The banking system has received about as much monetary stimulus as possible, so when it faces the next bubble, there will be much less government's can do to rescue it. If the oil price does surge to high, the economy will be damaged anyway, so the banking system will find it even harder to find that elusive new "bubble" to invest in. Some are beginning to suggest that there are no more bubbles to be had.