Irrational Exuberance 3.0 Is Oozing Into Markets: William Pesek

May 11 (Bloomberg) -- If the bubble that just burst didn’t work out for you, build a better one.

That looks like the rationale of Asia investors. Their optimism has driven the MSCI Asia Pacific Index up 38 percent from a five-year low on March 9. In recession-plagued Hong Kong alone, shares have gained 52 percent. Even Japanese stocks are rallying as deflation seeps backs into Asia’s biggest economy.

Few doubt that in a world of recession and toxic debt, Asia is the least ghastly region. But 38 percent? Or 52 percent? Bullish on Japan? All that’s driving the rally are signs that the U.S. may not be heading into a new Great Depression. It’s not underpinned by indications that solid growth is afoot, just a sense that fewer of us will soon be homeless. Bubble, anyone?

Welcome to Irrational Exuberance 3.0. Alan Greenspan’s 1996 utterance about buoyant asset values has become a cliché. In 2009, though, the sentiments behind the former Federal Reserve chairman’s signature phrase are fusing together with chatter about Web 3.0. And that’s where the trouble begins.

Web 2.0 is a catchall for the second generation of Internet development and design and the explosion of online social- networking sites, blogs and other media. Web 3.0, at least as one can ascertain, would be like having a massive and personalized database that can answer complex questions. Web 2.0 was about making connections with people. Web 3.0 would be connecting information with information.

Web 3.0

What Web 3.0 has in common with the financial crisis is that its future is in the eye of the beholder. Just as some look at U.S. bank stress tests and rejoice, others are losing sleep over balance sheets. Just as some see Web 3.0 as a vast wilderness of untapped business opportunities, others are concerned that cyberspace’s next generation will erase all privacy and copyrights.

It’s understandable to grasp at the slightest hint of good news. Concerns that swine flu will infect as many as 2 billion people, as the World Health Organization has said, hardly help. News of anything from financial contagion to a terrorist attack to a pandemic could drop at any second and spook investors. So, yes, a little sunshine sounds great.

There are signs that Fed Chairman Ben Bernanke’s “green shoots” are sprouting in the Asia-Pacific region. In Australia, employers and consumers are defying the predictions of central bank Governor Glenn Stevens and Prime Minister Kevin Rudd. Last month, both said the country was in its first recession since 1991. Retail sales jumped by the most in four months in March, while exports to China have soared 80 percent this year.

China Hopes

There’s much riding on China’s 4 trillion-yuan ($586 billion) spending package. Many are betting that loose monetary and fiscal policies will safeguard growth. Yet none of this seems reason enough for Asian shares to surge.

The U.S. is a key reason why. Even if the biggest economy has bottomed, and it’s far from clear it has, that doesn’t mean business as usual for Asian exporters. U.S. consumers still need to increase their savings and reduce debt, lots of it in high- interest-rate credit cards. That means less spending.

The Fed’s desire to return some normalcy to borrowing costs also may cap economic-growth rates. The last thing Bernanke wants is for a Japan-like dependency on ultra-loose credit to become ingrained in a $14 trillion economy. That could devastate the dollar and damage hard-won gains in controlling inflation.

Serious Task

Bernanke’s challenge is to find the exit strategy that continues to elude the Bank of Japan. The process certainly won’t help the U.S. win any global growth contests.

The risk that we are seeing bear-market rallies around the globe is real. Just ask long-time businessman Ronald Arculli, 70, who says he “wouldn’t be a buyer” of Hong Kong stocks, which are at their most expensive valuations since January 2008. Arculli, by the way, is the chairman of Hong Kong Exchanges & Clearing Ltd.

“The basis for growth hasn’t established itself yet,” Arculli says. “We’re hanging on to every piece of good news. In Hong Kong’s domestic economy, you still have a lot of tales of woe.”

It’s a disorienting world and markets might not know where we are. Ten years ago, central-bank rate cuts and government spending restored growth, plain and simple. That was before the emergence of a shadow banking system. The financial regime of old was replaced by massive non-bank lending, structured investment vehicles and products allowing leverage to be built upon leverage.

In a sense, markets went from a 1.0 environment to 2.0 briefly before believing they had already hit 3.0. The delusion that risks had been repealed was fed by a system that merely hid them. Now, the exercise is about getting back to a 2.0 market mindset and making it work.

Once policy makers get serious about that task, greater transparency and accountability need to be the focus. At the moment, fresh irrational exuberance is obscuring that reality.