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Financial bubbles

Updated on May 16, 2011

Book review The Fearful Rise of Markets: Short View of Global Bubbles and Synchronised Meltdowns.

The book The Fearful Rise of Markets: Short View of Global Bubbles and Synchronised Meltdowns by John Authers is a great read. It explains the causes of financial crises and how to prevent these in the future. Authers explains how investment became an industry including mutual fund managers who had as a published objective to beat the market. However their real objective was to maximize funds under management. Thus there was a conflict of interest. Every time the market crashed the Federal Reserve stepped in to support the market by lowering interest rates or bailing out various entities. Thus stock market investors were given a false belief that they could always buy stocks on the dips as the market mostly was rising in the eighties and nineties. Authers explains how the US abandoned the gold standard to inflate away its debt. Gold gained in value due to the devaluation of the dollar and investors started to use oil as an inflation hedge. Likewise investors piled into emerging markets and were exposed to their boom and bust nature. Investors borrowed money in countries with low interest rate and invested in higher interest rate countries, causing exchange rates to fall or rise sharply in market corrections. Quant funds were utilizing similar strategies, causing certain assets to correlate strongly. If one big fund had to unwind its position it caused losses for other funds, leading to further liquidation of positions. Authers demonstrates that there is little decoupling between markets and most asset classes are strongly correlated. He points to the danger of further bubbles if the Federal Reserve does not start to unwind its easy money policy.


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