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Against the tide: High price of the risk rally

The financial markets rally cannot be maintained because there is no way we can go back to the bubble economy of the past that was gorged by excess leverage. Far from being unwound, this has been sustained by governments.

The jumbo rally in risk assets continues. New post-crisis highs in equity and commodity prices are reached every week. It’s blue skies ahead. But I remain in the camp of the worried. This rally is not sustainable. It is driven by expectations of a quick and durable recovery in economic growth and fuelled by government support for asset prices and leverage.

The rally in risk assets is unsustainable because the markets’ view of a V-shaped economic recovery will be disappointed. All the economic growth we are seeing is a supply-side adjustment to boost production to meet low levels of final demand, which is no longer falling off a cliff.

The markets are working on the assumption of a rapid return to business as usual. However, the causes of the credit crisis should tell us that we cannot return to the old ways. The pre-crisis bubble economy was so pervasive that it affected almost every part of the economy. Leverage boosted asset prices to unsustainable levels. This created illusory wealth through asset price inflation. That, in turn, boosted demand and growth as well as reported productivity. A similar growth of credit cannot be sustained post-crisis, so growth and productivity will be correspondingly lower.

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