“High prices are a sign of vulnerability and we have a heightened risk of a collapse,” said Robert Shiller, the Yale economist. “But I am just not in the mood to say it’s coming soon.”
Shiller was awarded the Nobel Prize in economics in 2013 for his work on the analysis of asset prices. He predicted the financial crises of 2008 by correctly identifying the fragility of the housing boom in the United States, so his comments are regarded with particular interest. He spoke to Prospect when global stock, bond and house prices were all close to historic highs.
He was deeply concerned at the high valuations, especially of Government bonds. These are contracts sold by governments, which promise buyers a series of interest payments, and eventually the repayment of the cost of the bond. Governments use bond markets for borrowing. Analysts believe that bond prices are due for a fall. In May, financial markets began selling government bonds, especially those of Germany, prompting fears that the collapse had begun. That global sell-off continued into June and the possibility of a collapse in bond prices is now seen by specialists as a grave threat, even if, like Shiller, they do not know when it might occur.
When it does, the consequences could inflict severe damage on the global economy, already weakened by factors including Greece’s inability to pay its debts and the slowing Chinese economy. Governments would find it much harder to borrow and interest rates could rise sharply.
“The bond bubble, if it’s a bubble, has proceeded further, beyond what it was in either 2000 or 2005,” said Shiller, drawing a comparison with cases where financial asset prices have risen to unsustainable heights. In both cases, inflated asset prices prefigured a sharp economic reversal. “So there is this worry about another massive collapse,” says Shiller. What has caused such high asset prices? The creation of new money—quantitative easing (QE)—by central banks, including the Federal Reserve in the US, has had an upward effect on the value of assets, including bonds. But high prices cannot be ascribed to QE alone.
“There’s a figure showing how interest rates—and real interest rates—have declined gradually over 20 years,” said Shiller. Lower interest rates tend to coincide with higher bond prices, meaning that current high…