Where will the next crash emerge from? I don't know, but I do know the past few years have challenged the efficient markets nostrum that you can never know a bubble until it bursts. Actually you can. So here are my Easter tips for bubble trouble, any combination of them will make the "recovery" we have had so far look like the best party anyone's had since Oliver Reed died.
1 Chinese real estate
Take a number, double it and add 42 per cent and you get the rough annual rise in Chinese property prices. It's chaotic and exhilarating and frightening. This one easily passes the duck test; it walks like a crash waiting to happen; it talks like a crash waiting to happen, and it quacks like a crash waiting to happen. Investors, or more accurately speculators, can still make plenty of money out of it because no one knows when it will go pop. But for policymakers, the important point is that it will in due course go pop, and the consequences will be grim. Unlike the West, which suffered its own failures of transparency, the state-sponsored Chinese banks have even less incentive or obligation to put their bad debts into the public domain, but they will feel pressure. True, many Chinese homes are bought for cash, but someone somewhere in the financial system or the household sector will suffer from the usual consequences – collapses in confidence, the construction sector and confidence in financial institutions. It will stall one of the few storing engines of economic growth and, perversely, make China more dependent on her exports – the last thing we all need.
2 Commodities
If Goldman Sachs says it's all over, that's good enough for me. This is not all bad news; it will mean that the Bank of England will see its inflation forecasts come right next year as the "baseline" effects feed through powerfully, as they did in 2009. Four months after telling clients to invest in their "CCCP basket" – crude oil, copper, cotton and platinum – GS now says that the 25 per cent gain since January is the last puff of steam, and "in the near term risk-reward no longer favours the basket". A collapse in commodity prices would do the "real economy" no harm, but again risks destabilising the financial sector. At any rate we might then find out just how important speculation has been in driving prices skywards. As Warren Buffett said, when the tide goes out you can see who's been swimming without their trunks.
3 Exchange traded funds
As I was saying about speculation... For quite a long time I, rather dozily, thought these were just a harmless diversion for naive domestic punters to attempt to make and usually lose money on markets they usually found it difficult to gain exposure to, including, predictably enough, commodities. As a proxy for the real index, and thus the real materials behind the index, they are a derivative, at which point the alarm bells ought to start ringing. Yes indeed, they are more than a little like the asset-backed securities that grew on the back of the U S mortgage market and caused all that trouble a couple of years ago. Yet again we have poorly understood "synthetic" financial instruments growing far beyond their underlying assets, only this time, one hopes, not perched perilously on the back of easy money by highly leveraged outfits hoping the taxpayer will bail them out if things get rough. Then again, can we be sure?
4 Emerging market bonds
This oddly enough, is because of inflation in the emerging markets , often forgotten as we fret about our own inexorable rise to a 5 per cent annual rise in prices. In India, China and Brazil, inflation is running rather higher than that, and they have been hiking rates and ordering the banks to restrict credit to get a grip on it. Sky-high interest rates imply plunging bond prices, sooner or later. Not that any of these nations apparently have much trouble funding themselves; but they might conceivably find economic life generally trickier if they don't get a grip on consumer price inflation (leaving aside the asset price inflation in other areas of their economies).
5 Emerging market equities
We in the West have to put our money somewhere, and the "search for yield", or at least capital gains, have pulled huge flows of capital into the trendy emerging markets. OK their economies and their companies are growing fast, but the general rule in such environments is that they have a lot of ups and downs on the way to world domination. Will western investors have the balls of steel not to run?
6 American sovereign debt
You heard the Standard and Poor's warning, and it meant it. With some $14trn of national debt, about $5trn of it owed to foreigners, a debt devaluation would destroy wealth globally on an epic scale. Far worse than a euro meltdown, bad as that will be.
7 American property
It isn't over, basically. Even now, US real estate values in the darkest corners of the property market where the worst sub-prime selling practices were perpetrated are still mounting, which means the still-large stock of "toxic assets" based on them held by banks, insurers, pension funds and governments are not going to come good soon. The worst may be over, but it isn't helping the US recover its mojo. Put it this way: if this is what happens after a couple of trillion dollars have been pumped into the economy via fiscal and monetary easing, what happens when the US starts to fix the deficit and raise interest rates on those unaffordable mortgages?
8 European banks
The IMF stated it quite bluntly: fully one-third of European banks, representing 25 per cent of the total assets of the system, are operating with inadequate capital. Any deviation for European sovereign bonds, either through the usual crisis-type dumping on to reluctant markets or through formal defaults, would trigger what economists euphemistically refer to as "negative feedback loops", with further losses and banks drawing further on national treasuries and pushing public debt still higher, as Ireland recently found. Even if the euro survives, it will be ugly.
9 Japanese sovereign debt
How do you fund a national debt running at 200 per cent of GDP? Answer: get yourself a crazily pessimistic hard saving workforce that uses domestic financial institutions like the Post Office Bank and who patriotically subscribe to government bonds with virtually nil return. Common sense and demographics tell us this cannot persist. The worldwide trend to higher rates might eventually push up the cost of debt servicing in Japan, or make foreign securities more enticing. No less destructive, though much slower, will be the ageing of the baby boomer generation that will become pensioners instead of savers. In a nation notoriously resistant to immigration, it is a poor prospect. Long before the US, Japanese debt was being disparaged by the debt rating agencies; further downgrades this year, uncharitable as it may seem at such a traumatic time, could trigger a panic.
10 Deflation
That is to say, not inflation, which is the usual worry for the West. You'll have noted by now that most of the risks I mention are to asset values. Or, to put things another way, the inflationary risk that was supposed to have shown up in consumer prices has not done so because it has all been channelled into new asset price bubbles of one sort or another – see the chart. It is tempting, and not entirely wrong, to attribute this to the massive programmes of monetary easing that have been undertaken by every major central bank in the world. You don't have to be a hard-line disciple of Milton Friedman to see that such an increase in the quantity of money chasing a finite or highly inelastic quantity of asset classes is bound to ramp their values. Indeed, this was freely admitted by the Bank of England among others at the time – it wanted to deflate gilts and to inflate the value of equities and corporate bonds, thus making them more attractive to investors and helping companies to raise cash and rebuild balance sheets. If and when it goes into reverse, it will mean a certain amount of asset price deflation; if this is not managed skilfully it might well trigger the debt-deflation nightmare we postponed with the globally co-ordinated fiscal and monetary boosts in 2009-10. We didn't escape the pain; we just delayed it.
Maybe you think some of this far fetched, but surely I get 10 out of 10 for pessimism, anyway.
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