Myth of asset-driven growth

January 28th, 2007

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One of the dangerous myths that we often hear about is the mainstream idea of ?asset-driven? growth. As we mentioned before in The Bubble Economy, ?economists trained in the Austrian School of economic thought, such kind of growth is unsustainable. Furthermore, they believe that the severity of the following eventual bursting of the bubble is related to the preceding inflation of the bubble.?

How does asset price bubble cause economic ?growth??

The rationale behind the mainstream thinking of such growth goes like this: When asset prices are artificially inflated by loose monetary policies (inflation of money supply and credit), asset owners feel wealthier. When they feel wealthier, they increase their consumer spending, which result in businesses expanding their production due to their perception of increased demand by the consumers. This will lead to expanding production, which in turn lead to increase in hiring and business investments, which in turn increase employment and productive capacity of the economy respectively.

But we have grave reservations on this kind of economic growth?there are serious flaws that will doom it to the eventual detriment of the economy.

As asset price growth outpaces income growth by an ever-increasing margin, increasing issue of credit (i.e. the flip side of taking up of debt) is required to bridge the gap between the asset price and income. What is most often overlooked is that the uptake of debt, which is required for asset-driven growth, has to be serviced. There are two kinds of debt?investment debt and consumption debt. Investment debts are being used for investments that will generally add value to the economy by increasing its productive capacity. Thus investment debts are self-servicing loans?they will generate the necessary economic returns to make repayments possible. The problem with asset-driven growth is that much of the debts are consumption debts. Since such debts are acquired for consumption, they do not add value to the economy because they do not increase its productive capacity. As such, asset-driven growth magnifies the consumption debts of the economy, which will have to be serviced in the future. By deferring the burden of debt servicing to the indefinite future, it can only mean that the nation?s wealth will shrink in the future. Hence, asset prices cannot rise in perpetuality. Eventually, the weight of future debt servicing burdens dooms the bubble to collapse under its own weight. In Japan, when the asset prices bubble burst in the late 1980s, the financial health of banks, corporations and households were seriously damaged. What followed was a deflationary spiral that plunged Japan into recession for the next two decades.

Mark our words: nations who plunge recklessly into heavy debts are postponing their economic rot to their future generations!

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