Too Much of a Good Thing

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President Dmitry Medvedev has talked about using the economic crisis to wean Russia off its oil dependency and to create a more balanced economy by investing into new technologies. Even Prime Minister Vladimir Putin, whose eight years in power Medvedev is implicitly criticizing, agrees that the crisis could be an opportunity for the economy to become more competitive.

If a crisis is a good thing, Russia may have had too much of it. It felt the economic downturn sooner and deeper than the rest of the world. Now, a new financial bubble is developing, and Russia once again risks becoming a laboratory for excessive upswings and slumps.

After rightly criticizing the administration of President George W. Bush for presiding over the worst financial bubble in modern economic history, President Barack Obama inflated a financial bubble of his own. The banking system has been literally flooded with dollars. The U.S. Treasury's Troubled Asset Relief Program infused more than $700 billion into banks, insurers and finance companies. The Federal Reserve increased bank reserves by more than $1 trillion in recent months. And U.S. households, which were saving less than $50 billion a year from 2005 to 2007, have put aside more than $200 billion between October and March.

The United States is by far the biggest provider of liquidity to the financial sector, but banks all over the world are choking with free money. The authorities have hoped that banks will start lending this money, but the problem is that there are relatively few creditworthy borrowers. Businesses are not investing since they already have too much capacity.

U.S. consumers, the engine of global economic growth until last year, are strapped. Some 12 percent of mortgage holders have trouble paying their mortgages, and with unemployment at 9.4 percent, even those who still have jobs don't want to borrow and spend.

All that the banks can do with their money is speculate. Speculation is now risk-free since governments around the world have told large financial institutions that they are too big to fail.

Cheap, plentiful liquidity has flooded world financial markets on a massive scale. The Dow Jones Global Index is up 50 percent since early March. Dollar-denominated eurobonds issued by risky emerging countries are trading at the lowest yield premium over U.S. Treasuries since last October. Commodity futures have spiked, oil has doubled from its December lows and copper is up by some 60 percent.

The biggest problem is that none of this is justified by economic fundamentals. In fact, even OPEC is concerned that oil prices are rocketing in an environment of soft global demand for oil.

While all financial markets around the world have heated up, Russia's have been among the most overheated. Investors have been piling into the ruble and Russian stocks with wild enthusiasm. The currency has appreciated from a low of 36 rubles per dollar to nearly 30 rubles, and the dollar-denominated RTS Index has gone from 500 to 1,150 in just three months. With oil at nearly $70 per barrel, the crisis no longer looks frightening, and the impetus for economic reform is likely to be weakened. Moreover, the longer the bubble keeps inflating, the more spectacular its inevitable deflation is likely to be.

Meanwhile, rising financial markets and runaway commodity prices will instill a false sense of security and leave both the Russian government and the people poorly prepared for the possible second wave of the global economic crisis, which could come some time in the fall.

Alexei Bayer, a native Muscovite, is a New York-based economist.