Markets: When the bubbles burst, the games will stop
The bubbles in crypto and small-caps look obvious, but most markets are over-inflated and it is a fantasy that banks are immune to the risks.
The tussle playing out between hedge fund short-sellers and day-traders mobilizing on Reddit to drive up stocks such as GameStop may be entertaining, comparable to watching a bitter argument play out on Twitter between two people you don’t like.
However, the spectacle once again raises the question whether or not broader markets are in bubble territory and, assuming they are, what the impact of the burst will be.
As Paul Donovan, chief economist at UBS Global Wealth Management, points out, the most damaging bubbles are ones that banks get caught up in because their losses impede the flow of credit to the real economy.
Losses taken by latecomers to rallies in obscure single stocks and in crypto may impact consumption patterns and induce some risk aversion, but they should not hurt the banks.
Can the rest of us sit back and enjoy the spectacle, then?
Perhaps it would be better to ponder some lessons from the disaster narrowly avoided in the first and second quarters of 2020.
Since March, all markets have been supported by trillions of dollars’ worth of liquidity injected at negative real rates by central banks.