It looks as though the US dollar bubble has finally burst. The rapid depreciation of the dollar in recent weeks has brought exchange rates closer to their long-term equilibrium level and is therefore a good thing, though of course there are both costs and benefits. My main interest for the moment is in pointing out that the bubble representations yet another refutation of the efficient markets hypothesis, this time for bond markets (which might be expected to be immune from some of the sources of inefficiency that affect stock markets, such as the influence of amateur ‘noise traders’.
As I pointed out last October,
If you accept that the $US has to depreciate at some time, then holding bonds denominated in $US, and paying interest rates lower than those obtainable in other currencies, is a dumb idea. Unless you think either that European governments are likely to default on their debt or that euroland is poised for inflation, eurobonds are a better bet, and similarly for Australian government bonds denominated in $A. But I’ve given up even the residual belief in the efficient markets hypothesis that would lead me to try and work out a coherent explanation of perverse asset prices.
The failure of the efficient markets hypothesis is not complete. As this NYT report says, the proportion of new issues of debt denominated in euros has risen sharply in the last few years (relative to the predecessor currencies, most notably the deutschmark), and is now about equal to that in dollars. Given that most debt issues involve rolling over existing debt, it’s likely that the majority of new debt is being denominated in euros, and that, as the report indicates, some holders of debt are shifting part of their portfolio into euros. But this kind of gradual adjustment is not what the efficient markets hypothesis would predict.
Update 21/5 Dean Baker at In These Times also considers bursting bubbles. He correctly traces the problems back to the Clinton boom. In addition to the stock market and the dollar, Baker is concerned about a bubble in housing prices. My instinct is to agree. But it’s worth noting that if there’s a bubble in the US, where real prices have risen 30 per cent, the situation here in Australia, where prices have nearly doubled in a lot of markets, is far more dangerous.