U.S. stocks and Taiwan stocks have repeatedly challenged historical highs, and real estate prices have continued to rise. Is this a rare investment opportunity, or calm before the storm? According to December 25 Central Bank report on the “Impact of the COVID-19 Pandemic and Countermeasures,” “ultra-loose monetary policy in response to the pandemic has caused severe volatility in financial markets. Notably, the real economy remains sluggish, but some financial markets have rebounded strongly; the real economy and financial markets seem to have been decoupled, which may exacerbate concerns about financial instability or even asset bubbles.”

Finance Minister Su Jian-Rong and FSC Chairman Huang Tien-Mu also said they “worried” about an asset bubble when questioned on January 12, 2021 by Legislator Lai Shyh-bao in the Finance Committee of the Legislative Yuan.

In December 2020, the government adopted several measures to control the bubble, including further central bank credit control of corporate purchases of residential mortgages, third residential mortgages for natural persons, land purchase mortgage loans, and surplus housing loans. The Financial Supervisory Commission (FSC) will control the concentration of bank construction financing and require banks to complete a stress test around May 2021 as reference for follow-up supervision. The Legislative Yuan also rushed to pass Real Price Registration 2.0, further refining price disclosure. It has also prohibited “red slip flipping,” a practice in which scalpers sell off “red slips” reserving spaces in newly built apartment buildings, requiring no money down.

Global credit inflation from QE4

The government has not been just worrying about asset bubbles, but also taking action. But have these actions been warranted? The COVID-19 pandemic quickly swept the world, reshaped global trade, and severely damaged the economy. Countries used fiscal and monetary policies to stabilize their rapidly falling economic momentum. The US Fed, for example, cut rates again by 1.5% in March 2020, lowered the federal funds rate to 0%-0.25%, and launched a US$700 billion quantitative easing (QE) program, which later expanded to become almost unlimited. Europe also expanded the scale of its debt purchases, added an emergency pandemic debt purchase plan, and provided a third round of long-term refinancing to reduce the interbank lending rate to -0.25%. Central banks such as Japan and China have also taken similar measures to stabilize the economy and rescue businesses hit by the epidemic.

The pandemic has shrunk the volume of global trade, prevented people from moving freely, and severely damaged the shipping and tourism industries and large-scale cross-border capital movement. Furthermore, the ongoing mutations hamper efforts to make further predictions. Will the situation only affect the real economy, or will the impact also extend to the financial sector?

This global monetary infusion could be regarded as QE4, as a continuation of the 2008 financial crisis, but it is also by far the largest QE. Under the combined influence of the previous three stimulus efforts, governments have once again injected capital, resulting in a substantial expansion of global debt.

The Central Bank noted that the Fed, European Central Bank (ECB), and Bank of Japan (BoJ) continued to purchase bonds on a large scale, causing assets to rise to a record high. The rate of expansion surpassed that from 2008-2009. The Fed's balance sheet expanded from US$ 4.17 trillion at the beginning of 2020 to US$ 7.22 trillion by November 2020, an increase of 73.14%. The ECB grew 46.7%, from 4.69 trillion euros to 6.88 trillion euros, and the BoJ grew 23.25% from 572 trillion yen to 705 trillion yen. Measured by GDP, the assets of the three major central banks have also risen significantly, about 3-6 times their ratios in 2007, prior to the global financial crisis. A massive inflow of capital into emerging markets has also given these economies severe challenges such as exchange rate appreciation and asset bubbles.

Bubble alerts issued

While US and Taiwanese stocks have continued to hit new highs, many institutions have also been warning about possible asset bubbles. During an interview in early January 2021, Jeremy Grantham, a well-known investor and co-founder of the asset management firm GMO, sounded a warning: “the long, long bull market since 2009 has finally matured into a fully-fledged epic bubble.” AlphaOmega Advisors LLC founder Peter Cecchini said in an interview with Bloomberg that the market is clearly in bubble territory, and many stock prices are the result of speculation. Mohamed El-Erian, the chief economic adviser of Allianz, however called this a “rational bubble” which will not burst so quickly. The latest issue of The Economist anticipates that the pandemic will end, fiscal stimulus measures will continue, and interest rates will remain at an unprecedentedly low level, making it difficult for the stock market not to continue its surge.

The Nasdaq 100 Index has doubled in two years, and US stock issuances and IPOs have both reached new highs. First-day IPO returns have risen to their highest level in 20 years. According to 2019 research by Harvard University, increases in stock issuance and volatility, and doubling in the market index, are warning signs of a bubble.

The stock market and asset prices have continued their rise. For example, Bitcoin has been on a rampage, and Tesla shares have risen by over 750%, which has encouraged investors and funds to enter the market. Marshall Front, Chief Investment Officer of Front Barnett Associates, also said, "I don’t know how long the party will last, but it never ends well."

Everyone is warning of a bubble, but no one has predicted when it may burst. Huang Yin-Ji, chief economist at Yongfeng Financial Holdings, said that people have been predicting an impending burst almost every year since the launch of QE in 2008. Nevertheless, the US stock market has doubled from 14,198 points prior to the financial crisis.

Economists and financial analysts haven’t seen anything like this. Huang emphasized that current stock market and housing prices reflect capital injections rather than economic fundamentals. The funds don’t enter the real economy, but rather flow into financial markets and push up prices. Instead of the price-to-book ratio, investors are looking at the price-to-dream ratio, so it seems that the price-to-earnings level of 20 used in the past as an indicator for overheating is no longer applicable. Huang said, “as long as we keep dreaming, the price won’t fall.”

Will the world face a Minsky moment?

While countries continue to print money and use QE to maintain their economic strength, Huang also said that as long as the inflation rate and unemployment rate do not rise, and the epidemic remains uncertain, major central banks such as the Fed will continue their QE policies. They won’t announce plans to recover the funds too soon either, so the money will continue to flow into the financial asset and housing markets, pushing up prices.

Japan’s “lost decade,” Thailand’s crash which set off the Asian financial crisis of 1997, and the subprime crash in the US are examples of “Minsky moments,” in which excessive private debt and speculative credit cause cash flow problems, resulting in price collapses. Assets may collapse overnight, destroying economic growth.

Huang noted that in the past, private debt worth over 200% of GDP was a warning line, and was accompanied by real estate price bubbles. This has been confirmed in Japan, Thailand, the US, and Spain. Canada and China are fast approaching this threshold, but as long as governments continue to print and spend money, and there’s no major increase in inflation and unemployment, no one can predict when the bubble might burst.

Financial institutions are also trying to find effective indicators and early warning systems for bubbles. If they can defend themselves early by selling their stocks and bonds at high points, and avoiding high-risk credit industries, they can avoid danger. But if they’re wrong, they’ll dispose of assets too early, or avoid profitable investments altogether. If this capital market boom continues, they’ll be unable to compete with their peers. That’s why no company has dared to say that it has found an effective early warning indicator.

The central bank said frankly, “Taiwan is a small pond. When a big whale jumps in, the water splashes.” Taiwan cannot isolate the spillover effects from enormous cross-border capital movements brought by ultra-loose monetary policies of major economies. Exchange rate fluctuations in the New Taiwan dollar have increased, and Taiwan can only hope for the pandemic to ease as soon as possible. Only in this way can central banks exit their loose monetary policies in an orderly manner, alleviating concerns of financial instability and spillover impact on small open economies; and will government debt not rise sharply to an unsustainable level, so that the fiscal policy can be sustained.