| Every boom is inevitably followed by a bust. But no one can predict when the bust will come and why. The really clever people, therefore, take precautionary steps well in advance so as not to be caught napping. |
| As the question gets to be asked with greater frequency about where the world is on the boom-bust cycle now, an article* by Mohamed A El-Erian, President and Chief Executive Officer of Harvard Management Company, Deputy Treasurer of Harvard University and a faculty member of the Harvard Business School, is worth reading with great care. A decade ago, he used to work for the IMF. |
| El-Erian has a simple point to make. This is that "in recent months, many market segments appear to be sending competing, if not confusing, signals". |
| Thus, while equity markets have been booming, the bond market has worn a worried frown. Also, those whose business it is to keep an eye on interests rates in the US can't seem to be able to decide which way it's going "" up, down or steady. |
| El-Erian says that it is "tempting to dismiss these competing signals as 'noise' but that would be inadvisable". In other words, it helps to be careful. The reason why no one can figure out what is going on, he says, is that three major changes have occurred in the last few years. |
| The first is the huge increases in global productivity as a result of integrating the world's labour market in global production. The second is the upward shift in the demand curve for commodities so that more is being demanded at every price and prices are rising. Third, thanks to derivatives, money is no longer recognisable for what it used to be. It has mutated into, if I may put it that way, a whim. |
| When we take the combined effect of all this, we get what we have now: confusion. The result, to quote the author in full is that "traditional models have become less effective in both explaining developments and predicting the future... policy reaction functions have become more tentative... markets have adopted a hesitant and bumpy path to pricing the new global realities, some of which are still developing robust anchors". |
| So what needs to be done? El-Erian says a useful approach is to first make a list of things that should not be done. The first of these is not to discourage debate and let a hundred flowers bloom. "In the process, there will be an identification of the costs and benefits associated with possible changes to operating models, business strategies and risk management approaches." |
| But mere debate will not do. The governments of developed countries have to figure out how to respond to new things, such as when the yield curve no longer is what it used to be and when risk premia are also saying something different. Most importantly, "they need to incorporate explicitly in their modelling the impact of the more rapid internationalisation of national labour forces, as well as the notable change in cross-border capital flows (particularly the growing importance of emerging economies as holders of industrial country government and corporate bonds)". |
| Meanwhile, the rest of the countries need to get to understand how to cope with the excess of, say, reserves. "In some cases, they will need to adapt their institutions to improve operational transparency and accountability, as well as change the guidelines governing investments and liability management." |
| For the international betting community, known otherwise as institutional investors, they need to figure out where to put their money because the old odds are completely wonky now and the bookies are going bust. That involves devising better methods of risk management. |
| All in all, it looks as if the old Chinese blessing "" may you live in interesting times "" has come true. |
| Dealing with Global Fluidity, Finance and Development, March 2007, IMF http://www.imf.org/external/pubs/ft/fandd/2007/03/elerian.htm |
Top Section
Explore Business Standard