Is China's Fast-Growing Economy Headed for a Crash?.
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(originally posted to CNBC.com March 2011; http://www.cnbc.com/id/42343583)
Financial booms and busts are, particularly from an a priori perspective, probabilistic events for which multidisciplinary analysis is essential. Addressing financial booms and busts through a single lens may in fact have negative impacts and lead to gross misunderstandings.
Adopting a singular perspective will lead to an emphasis on depth of data versus breadth of information. It leads to deeper and more thorough understanding of particular information, but it misses the point that information is not the essential element.
There are plenty of “dots” but the connections between them are lacking.
Conceiving of financial booms and busts as uncertain ambiguities necessitates the application of different lenses to develop a probabilistic interpretation of scenarios to better understand how they may evolve. Economists, political scientists, psychologists, and even hard scientists have much to learn from each other. What we need today are analysts who employ a multidisciplinary perspective to connect the dots.
With this in mind, I designed a course to teach such a methodology about three years ago. Since 2009, I have taught this course at Yale University to undergraduates studying economics, psychology, political science, art history, American studies, history, East Asian studies, English, physics, and even molecular biochemistry and biophysics. Last fall, my class comprised students from Singapore, Greece, China, India, and several other countries.
The class is structured in three parts.
The first presents several theoretical lenses that have proven useful over time in the study of booms and busts.
These lenses include microeconomics, macroeconomics, psychology, politics, and biology. The second part then applies these lenses to historical booms and busts ranging from Tulipomania to the current crisis, and the final section asks students to develop a framework for identifying bubbles before they burst. The final class is focused on student presentations of current bubbles, with an emphasis on the believability of their story.
To help students focus on moving beyond the ivory tower, I invite a market commentator or working professional to serve as the “bubble judge” and to help me grade their presentations. Past judges have included David Swensen from the Yale Investments Office and Jim Grant from Grant’s Interest Rate Observer.
These presentations are a highlight of the course, and serve as wonderful insight into what those with fresh eyes and free of Wall Street propaganda think are likely bubbles. So, what looks bubbly to those trained to use multiple lenses?
1) China, or more specifically, Chinese property. A handful of students suggested that the real estate boom in China appeared unsustainable. The rise of organized “speculator groups” was noted alongside rapidly rising credit levels, lofty property valuations (relative to income), and a forthcoming explosion in inventory levels.
2) Gold. Described by several students as the “ultimate greater fool” asset, the bubbly nature was also evident in student analysis of financial innovation (ETFs, leveraged ETFs, etc.) that has helped increase amateur investor participation. Ubiquitous commercials about buying and selling gold provided further support for their case.
3) Credit. Highlighting that US Treasuries were trading at historically low yields, or that municipal bonds seemed to be trading on a “too big to fail” assumption, students noted that the universal belief that moral hazard and extrapolation of past trends were likely to create “return-free risk.”
4) Social Networking. A group of my students in 2009 highlighted that the lack of appropriate valuation anchors enabled an Internet-era like approach to pricing these assets. Parallels were drawn with other historical innovations (canals, railways, telegraph, radio, automobiles, etc.) and the fancy valuations received by “new era” companies.
5) Emerging Markets. The universal belief that emerging markets were the sole source of growth in the world today led various students to suggest that the scarcity of believable growth stories would drive emerging markets to unsustainable levels. Within this theme, negative real rates were considered a culprit and one that would eventually be addressed through restrictive policies. India was highlighted as particularly expensive and vulnerable to this inflation-driven tightening.
Numerous other ideas have arisen, many of which appear to have well-analyzed, believable logics to them, ranging from the rare earth mining industry (multi-billion dollar valuations with little financial support), alternative energies (change the world, new era beliefs), and even garlic (medicinal purposes rising, Chinese demand, etc.).
To date, the multi-disciplinary framework developed in the class has proven useful on numerous fronts. It has helped those adopting it to take a step back and acknowledge that the bark they have studied is a part of a tree, and that the tree is in a forest…and most importantly, it creates a healthy skepticism of the alluring and seductive “it’s different this time” rationalizations which can be so hazardous to one’s wealth.
One of the first skyscrapers was designed and built by Bradford Lee Gilbert in 1887. It was designed to solve a problem of extremely limited space resulting from the ownership of an awkwardly shaped plot of land on Broadway in New York City. Gilbert chose to maximize the value (and potential occupancy) of the small plot by building vertically. His 160-foot structure was ridiculed in the press, with journalists hypothesizing that it might fall over in a strong wind. Friends, lawyers and even structural engineers firmly discouraged the idea, warning that if the building did fall over, the legal bills alone would ruin him. To overcome the skepticism of both the press and his advisors, Gilbert took the top two floors for his personal offices. From then on, the skyscraper has been a symbol of economic and financial success, the mark of one’s ascent.
It has also been one of the most robust bubble indicators over long time periods–specifically, the world’s tallest skyscraper has been. You may be aware of the Burj Dubai’s ascent as the world’s tallest structure, and the corresponding global credit crunch that soon followed, but few are as familiar with the consistency of the pattern. Consider the following table, which lists the world’s tallest skyscrapers (at the time) and the accompanying financial crisis that struck the market in which it was built.
|Building||Location (Completed)||Spire Height||Financial Crisis|
|Singer||New York (1908)||187 meters||Panic of 1907|
|Metropolitan Life||New York (1909)||247 meters||Panic of 1907|
|40 Wall Street||New York (1929)||283 meters||Great Depression|
|Chrysler||New York (1929)||319 meters||Great Depression|
|Empire State||New York (1931)||443 meters||Great Depression|
|World Trade Center||New York (1973)||526 meters||’70s Stagflation|
|Sears Tower||Chicago (1974)||527 meters||’70s Stagflation|
|Petronas Towers||Kuala Lumpur (1997)||452 meters||Asian Financial Crisis|
|Taipei 101||Taipei (2004)*||509 meters||Tech Bubble|
|Burj Dubai||Dubai (2008/9)**||828 meters||Global Credit Crunch|
*Taipei 101 was financed and construction began in 1999, quite near the peak of the technology boom. **It is interesting to note that the uncompleted Burj Dubai tower was classified as the world’s tallest structure on July 21, 2007, right around the peak of the U.S. market before the financial meltdown.
Why might this indicator be so consistently useful? While there are many likely reasons, two seem particularly striking. Skyscrapers are inherently speculative ventures, in that they are rarely, if ever, built by their intended occupant or with committed tenants. “Build it and they will come” captures the prevailing spirit. Thus you can think of the world’s tallest skyscrapers as indicators of lofty overconfidence. Second, because speculators rarely build such structures with their own money, skyscrapers are powerful evidence of “easy money.” Accepting the importance of these two variables in creating a fertile context for bubble formation, skyscrapers are actually a spectacular indicator of bubbly conditions. The economist Mark Thorton eloquently summarized the context surrounding the construction of the world’s tallest skyscrapers: “First, a period of easy money leads to a rapid expansion of the economy and a boom in the stock market . . . credit fuels a substantial increase in capital expenditures … [and] this is when the world’s tallest buildings are begun.”
While it seems particularly unlikely that the Burj Dubai will be surpassed in height anytime soon, we can look at the tallest skyscrapers under construction to see where money is easiest, speculative juices are flowing and confidence is high. According to Skyscraperpage.com, five of the 10 tallest buildings now under construction are in China. By 2015 the website estimates that Chinese skyscrapers will occupy spots Nos. 2, 3, 5, 9 and 10 of the tallest buildings in the world. Might the booming Chinese economy be susceptible to a bust? Is the skyscraper indicator describing a state of overconfidence and/or easy money?
Manifestations of overconfidence can be found in other speculative endeavors, too, particularly in situations where higher prices drive demand, not supply. This is exactly the case in several Chinese markets, including real estate, garlic and even “mutton fat” jade. In each of them, speculator confidence appears to be running very high.
Likewise, monetary conditions are extremely easy, and negative real interest rates are encouraging many investments that might not be economic at a normalized cost of capital. Consider the virtually empty South China Mall, in Dongguan, China, which has recently decided to expand despite enormous vacancy rates. Or Kangbashi, in northern China, which has been labeled by Time a “modern ghost town.” Misallocated capital? Overinvestment? Sure seems so.
Despite the allure of “it’s different this time” explanations of why China is unique, most of the indicators associated with an imminent bust are present. The Boombustology seismograph is generating lots of activity, indicating that a forthcoming quake may in fact be imminent. Investors and policymakers alike should exercise extreme caution, because chances are high that it’s probably not different this time.
Vikram Mansharamani is the author of Boombustology: Spotting Financial Bubbles Before They Burst, just published by John Wiley & Sons (March 2011).