What Does The Future Hold?

So what is the future for markets and are they still vulnerable to suffer from asset price bubbles? It would normally be safe to assume that after suffering so much pain and coming close to the collapse of the entire banking system investors would exercise more caution in the future. However history does not prove this to be the case. The DOTCOM bubble burst in the early 2000’s and investors lost much of their savings and pensions however the lure of quick, large and easy profits soon eradicated any thoughts of caution or rationality and once again we ended with another, even bigger bubble.

Looking toward the future many commentators and investors are already pointing towards the Gold price as being too high and remarking that this will soon burst. The widely known investor George Soros has stated many times that he believes the Gold price will correct soon and has even referred to it as the ‘ultimate bubble’. He has also reduced his holdings by 99 per cent! (See video below) Others have pointed to the entire Chinese economy as being a bubble. They claim that it is obviously not sustainable for the Chinese economy to continue with double digit levels of GDP growth and for their Government to keep the Renminbi, pegged at an artificially low level against the dollar. What will be the wider global consequences if the Chinese economy was to retract?

My concluding thoughts are that The Fed ultimately has responsibility for the wider economic stability of the system and it therefore has a duty to act if it feels any market could potentially damage the economy. The idea presented by the Efficient Market Hypothesis that investors make rational decisions based on all the information available is no longer valid. We all know from our daily lives that human beings don’t always make rational decisions and can be influenced by their background or others around them. However the argument that The Fed cannot prevent every increase in prices without damaging the economy is still valid and therefore presents the question ‘When should The Fed step in and when should they let the market run its course?’

I believe that the answer lies in whether or not the bubble is presenting a real threat to the wider economy. The housing bubble in the US was so dangerous because of the high levels of debt financing involved and the fact that in many cases either the underlying asset or the borrower was of low quality. However in the case of other bubbles such as the DOTCOM bubble in early 00’s or the potential bubble growing in the Gold market The Fed should let the market run its course as these do not present the same high level of risk to the economy. In these markets investors are mostly self-funded or use funds from their pensions and therefore run the risks and will ultimately face the consequences alone.