Asset prices could push central bankers off course long before any bubbles burst

THE post-crisis challenge for central bankers has long seemed easy to describe. They must steer between the shoals of short-term deflation and the longer-term risk of accelerating consumer prices. But recently a new concern has cropped up: that loose monetary conditions are creating dangerous bubbles in all manner of assets, from oil prices to Asian apartments, that could capsize the global recovery.

Asset prices have certainly risen impressively. The S&P 500 index is up by 62% from its low on March 9th; the MSCI index of emerging-economy shares has climbed by 114% from its nadir of a year ago; the price of oil is 155% higher than it was in December 2008. Gold prices set a new record of over $1,120 an ounce on November 12th . Chinese house prices rose at their fastest pace in 14 months in October.

However, these rebounds have followed even more dramatic slumps, so asset-price levels are less eye-popping. Gold apart, commodities are still well below the peaks of mid-2008. The earnings multiple for Shanghai’s A-share index is less than half the level it reached during the 2007 bubble. American shares may be richly valued relative to earnings, but they are less unhinged than in earlier booms. According to Smithers & Co, a research firm, the price-earnings ratio for America’s S&P 500 on a cyclically adjusted basis is about 40% above its long-term average, compared with over 100% in the late 1990s.

There are other reasons for calm. Earlier this year investors were in panic mode. Much of the rebound since then reflects a return to more normal risk appetites. Nor is today’s asset boom fuelling the kind of leverage that made the bust so awful. Bank lending is contracting in America and weak elsewhere in the rich world. In Asia, property-related borrowing is heavily curtailed compared with America’s pre-crisis boom. And from Singapore to Seoul, the authorities are demanding higher down-payments from borrowers and restricting lending to developers.

Nonetheless, it would be a mistake to be too sanguine. Another violent drop in share prices could have disproportionate effects on confidence and hence demand. Equally important, frothy asset prices could cause damage long before any bubbles burst, by increasing the risk that central bankers make mistakes.