Dangers lurking in bubbles' wake

THE test of an economics guru - an abundant species these days - is whether his or her predictions come true. Roger Bootle's controversial 1996 book The Death of Inflation, enthusiastically reviewed on these pages at the time, got the prices issue just right.

So we should pay attention to his warnings in his new work Money For Nothing.

The theme is bubbles. In the 1990s, investors thought that they could condense the productive potential of new technologies into instant capital. In other words, money for nothing. This was the stock market bubble which, he says, is not played out even now.

The share boom so inspired by new technology has an obvious parallel in the railway mania of the 19th century. The advantages of rail travel were unquestioned. But those who piled into the stocks at the outset lost their shirts.

The fall in stock markets, from which we have already suffered, saw a classic move of capital into another bubble - the housing market.

This is not, by the way, just a British phenomenon. It can be seen elsewhere in Europe and in North America. People think that they can grow rich simply by sitting still - money for nothing again.

But we can no more grow rich this way than we can by taking in each other's washing.

A difficulty for those of us watching the British market must be to identify the trigger which will set off Bootle's predicted tumble in house prices, given the 'affordability' of mortgages in today's low interest rate regime.

In the early 1990s, it was soaring interest rates which upset the apple cart.

Today, of course, rates are sensible, inflation is low and the Bank of England can keep those rates within reasonable limits.

Bootle thinks a rise to, say, 5% (from today's 3.5%) is conceivable at some point - it was the rate in August last year - and that could easily turn round the housing market.

But one suspects that the turn could come even without that rise in rates. Today we have house sellers in no hurry, but buyers who are - they fear rising prices will rob them of the property they are hoping to get.

At some point the music stops - perhaps because real wages are not rising - and the sellers become eager and the buyers hesitant.

If that starts off a downward spiral in prices, even if only a modest one, sellers could well become eager, even frantic, and buyers would hold off - and the bubble bursts.

Bootle can foresee rising interest rates in the short term, perhaps to curb consumer spending, itself boosted by high house prices.

But he fears that the eventual deflating of the housing and stock market bubbles will produce a very different reaction at central banks.

Pricked bubbles will threaten deflation for whole economies.

He says the US Federal Reserve, the European Central Bank and even the Bank of England, too, should be prepared to reduce interest rates to zero as and when this menace is in sight.

An alternative to that, which he trusts will be avoided, would be countries shutting out foreign goods to safeguard their own industries and employment levels.

This would raise the spectre of the sort of protectionism which plunged the world into slump.

He thinks it ironic that the danger of deflation should face us when the world is poised 'on the brink of the greatest increase in prosperity in our history'.

He has great faith in globalisation, not least in the prospective rises in the Chinese and Indian economies and the benefits they can bring to all.

Whether it is wise to expect such a boom (it would be a real one in this case, not a bubble) given the recent collapse of the Cancun conference on world trade - well, that is a different question.

Money For Nothing by Roger Bootle, Nicholas Brealey publishing, £20.