While 2009 was the year of uncertain recovery, 2010 has seen robust consolidation around the globe as far as stock markets are concerned. The big bang aid packages thrust into the global economy by Governments indifferent continents seem to have finally worked. However, before we become overconfident about the coming year, it is important to take the risks in to account. These include those which caused the last crisis, as well as those which are waiting in the wings.

Coming out from the Crisis

What began as the Real Estate crisis in the United States in 2007 was enough to shake the global economy, affecting widespread erosion of wealth throughout the world. However, many would like to trace the roots of the economic tragedies that unfolded in 2007 to upto a decade before that year. Joseph Stiglitz refers to the Capital Gains tax regime, where liberalisations in Capital Gains taxation since the late 1990s actually created the base on which the falling Fed rates built the Housing Asset bubble with the aid of sub-prime mortgages during the five years preceding the crisis. If that is not enough, then you have that ever expanding global trade imbalance created by the two superpowers of the past and future – United States and China, where the latter consistently parked its current account surplus in the US Debt market, lowering yields to ridiculous levels giving Fed an opportunity to carry on with an even more absurd policy that pushed real interest rates close to zero, and in turn, shifted investments from stable debt markets to highly volatile equity and housing markets. The consistent pattern of this unsustainable global trade that went on without a single manifestation of a crisis was what created that false sense of security in the mind of investors and executives alike, that finally lead to sub-prime risks and the ultimate outcome – the crisis !

Are we safe now ?

As 2010 comes to an end with markets performing consistently the world over, the million dollar question that we need to ask ourselves is this – is this sense of over-confidence a repetition of what now constitutes history, or whether we have actually done away with all the building blocks of the previous crisis. Those who feel that we are living on borrowed time cannot be blamed as public memory has repeatedly been found short of what could be considered as safe to trust, and the information that floods the world around us is actually controlled and twisted by those who survive on high voltage economic volatility and not safe stable run-of-the-mill existence.

What helped us recover

Read more in Investing
« How to Make Money While in a Recession
My New Ichimoku Forex System: Leoku »

To be precise, there were two major factors that helped in global economic recovery in 2008. First was the allocative efficiency correction achieved by the crisis itself. Asset bubbles typically suck in enormous resources into themselves, where the principle of diminishing marginal returns would be expected to dictate that the returns on such investments are bound to rebound once the hot air attracting those investments is released. As inflows stop and outflows accelerate, the asset markets begin to regain their productivity, but while the productivity recovers, the sentiment doesn’t and it usually takes a few years before these markets are able to attract fresh preys. In case of stocks, this adjustments process is very fast, so they can recover in a couple of years. In case of housing, prices are sticky, and historically the next cycle is seen only after a decade and a half. As a result, while misallocation of resources in stocks often corrects itself quickly, a misallocation in housing assets often takes much longer to unwind.