Butter Boom! or Bakery Bust?

1 Comment

Butter consumption recently hit a 40-year high, driven by a rise in domestic demand coupled with a surging export market.  Not surprisingly, butter prices recently hit a 16-year high driven by these two dynamics.

Robust domestic demand for butter?  Have American’s forgotten about cholesterol, the heart-disease inducing villain absent in margarine and other processed oils?   Or has the transfat fascination created a preference for saturated animal fat?   How is one to know how such crosscurrents might play out?  Were there any indicators that might have helped us foresee this butter demand surge?

Anuja Miner, Executive Director of the American Butter Institute, has suggested that the Food Network and celebrity chefs may be driving this trend.  Many top culinary experts consistently praise butter highlighting its richer taste and better cooking characteristics, and this may be at least partially responsible for the shift away from margarine toward butter.  Imagine that…paying attention to TV shows to get ahead of market-moving trends!

The global demand story is one based on the global consumption boom I see coming as the emerging market middle class population balloons.  Dairy is just another component of that same story, with US shipments to Saudi Arabia, Morocco, Egypt, and Iran surging.  In the early 2000s, US exports of butter were effectively non-existent.  According to NPR, roughly 10% of butter produced in the United States today is exported.

So what?  The seemingly irrelevant dots that we've connected suggest that butter prices, TV shows, celebrity chefs, and emerging market growth can help us glean a bit of the future.

1)   Butter may merely be reflective of an underlying dynamic that affect dairy prices in general.  As such, seemingly irrelevant information on the dairy trade may give us insight into economic developments before they transpire.  The world’s largest dairy exporter is New Zealand and the largest importer is China.  Just as Australia was a country tied to China’s investment boom, could New Zealand be a leveraged play on China’s consumption boom?

2)   Although dairy prices will surely rise and fall over any one or two-year period, we are likely on a long-term trajectory of higher and higher prices.  This has big implications baked goods retailers like Panera Bread (PNRA), coffee sellers like Starbucks (SBUX), pizza companies like Papa Johns (PZZA), ice cream companies like Ben & Jerry’s, cheese users like Kraft (KFT), etc.

Perhaps it’s time for global strategists and analysts to reconsider the 1980s commercials featuring the tub of Parkay that regularly whispered “butter.”  There is insight in butter!

PBS Newshour Segment on Bubble-Spotting and China


Is China's Fast-Growing Economy Headed for a Crash?.

See more from PBS NewsHour.

Is the Chinese Bubble Ready to Burst?


Is The Chinese Bubble Ready To Burst?

29 Jun 2011 - Andrew Barber

The discussion of whether or not the Chinese economy is a bubble destined to collapse, or if the recent rash of media over empty cities and spiraling food costs are merely sensationalistic hype masking an unstoppable growth story, has become a favorite Wall Street parlor game over the past year.

May trade data from China released earlier this month registered stronger growth in imports than consensus forecasts, suggesting that demand in the Middle Kingdom is remaining resilient despite the steady rounds of tightening that the People’s Bank of China policy makers began in the fourth quarter of last year. With interest rate and reserve ratio increases still failing to tame rising prices completely, some economists anticipate that currency appreciation against the dollar peg is remains a possibility. Simply put, the longer view of the situation facing Beijing is still very much a matter of debate.

One strong voice in this debate is Vikram Mansharamani, a Managing Director at Boston-based SDK Capital and a lecturer at Yale where he teaches a seminar on economic boom and bust cycles that served as the basis for his book 'BOOMBUSTOLOGY: Spotting Financial Bubbles Before They Burst' that was published earlier this year.

Mansharamani, who holds a PhD and two master’s degrees from MIT, helps oversee a long/short global equity portfolio. "I skin the cat thematically – what I look for structural long term trends on which I can bank for longs, and on the short side I look for things that fit my framework of bubbly conditions."

One example Mansharamani gives as a potential developing bubble is base metals. "The steel industry in China boomed from 5 percent of global steel production in the late 70s to almost 50 percent today; on the back of that surge was a voracious appetite for iron ore" he says. "Anticipating that Chinese growth will continue and extrapolating on past trends, the iron ore industry is now planning expansions equating to over 100 percent capacity growth in the next ten years. Well, hold on a moment: if China continues to grow at past rates, China becomes more than 90 percent of the entire global steel market – which is unlikely, and so it seems likely that the iron ore capacity may be rising just as slowing capital investments in China cools demand."

A native of western New Jersey, Mansharamani had an unlikely path to high finance. The son of an auto service technician and a dietician, he won a scholarship funded by Jack Bogle to attend Blair Academy, a private, co-ed boarding school in north-western New Jersey. Starting at the age of sixteen, Mansharamani began an unusual (for high school students) series of summers interning on the institutional equity sales and trading desk at Bear Stearns, where he reported to Mitch Jennings, a Blair alumnus, and Ricky Greenfield. After high school (and three summers at Bear), he entered Yale where he spent his summers very differently – working at the American Enterprise institute where he assisted the legendary Sinologist and diplomat James Lilley. The experience at AEI led to fieldwork in Asia (including a summer at the US Embassy in Beijing) that ultimately sealed his fate as a China focused investor.

Mansharamani recently spoke to InstitionalInvestor.com contributing editor Andrew Barber about the factors he considers when evaluating boom and bust cycles and how these stack up for China.

Institutional Investor: Your book is based on a course that you teach at Yale. Can you tell us a bit about the course and your approach?

Vikram Mansharamani: The book is based on a seminar called 'Financial Booms and Busts' which I have taught to undergraduates for the past two years. Because the course has been so oversubscribed, I have the opportunity to select students from differing majors. In the past, I have had students from history, psychology, biology, molecular biochemistry and biophysics, physics, American Studies, art history, East Asian studies, as well as the more expected economics and political science students. One of the reasons I proactively compose the class with students from different backgrounds is that I believe firmly that a multidisciplinary approach is essential for understanding booms and busts. I also sprinkle in students from all over the world to add a cultural dimension to the discussions.

I believe that problems can generally be classified along a continuum with two extremes: one extreme is a puzzle, which is a clearly defined problem for which there is an answer. When grappling with puzzles, we need to find more data. An answer exists. We need to find the needle, but because it’s buried in the haystack, we need to go through a lot of hay to find it. For puzzles, more data is helpful.

The other extreme is a mystery, which is a poorly-defined, ambiguous, uncertain and probabilistic problem. It is one for which there is no answer, so we can just gauge various scenarios. You can’t 'solve' mysteries, but you can 'understand' them.

I think of financial booms and busts as mysteries rather than puzzles. If you think of things as a mystery, the best approach to understanding various scenarios and their respective probabilities is through the use of multiple lenses.

That’s a long-winded background about the book, but the primary contribution I think I’m making is the presentation of a framework that moves beyond the use of a single lens. While reliance on one lens may work at times, it’s surely going to not work at some point.  It’s not sufficient to use just microeconomics or macroeconomics, you have to think about psychology, about politics, about biology.

II: OK, so can you briefly describe each lens?

VM: Sure, as I’ve mentioned, there are five lenses that I suggest in the book. There’s no good reason why I limited it to five, other than space constraints. Frankly, in my eyes, the more the better. The five lenses presented in the book are microeconomics, macroeconomics, psychology, politics, and biology.

Lens 1 is a microeconomic lens and focuses on the concept of equilibrium. Traditional economic theory tells us that supply and demand adjust to create a stable price. But what happens if higher prices create more demand, rather than the expected supply?  Bubble potential driven by self-fulfilling reflexive dynamics.

Lens 2 uses a credit framework to think about the foundation upon which asset prices have risen. The macro lens really builds on Hyman Minsky’s work related to capital structure evolution over time and the Austrian School’s beliefs in mal-investment and overconsumption as a logical consequence of inappropriately priced money.

Lens 3 is a psychological lens and takes the behavioral decision-making literature and applies selected lessons to asset markets. The insights I focus on are overconfidence and hubris and how that has the ability to really generate unwarranted convictions and whether people sufficiently adjust their expectations in light of new data.

Lens 4 is politics, and I focus upon very simple things – about price distortions via ceilings, floors and subsidies as well as tax policies that may change incentives and then the morals hazards that come from bailouts and supports and the political process of preventing failure.

Lens 5 is a biological lens, and there are two sub-topics upon which I focus. If you analogize a speculative mania to a fever transmitting itself through a population, one of the key metrics to understand is how many people are left to be infected. The lesson for investors is clear: when your taxi driver is talking to you about internet stocks, it's probably not a good time to be buying. The other topic of the biological lens is an emergence concept where I look at behaviors of ants, locusts and bees to illustrate how groups of seemingly uninformed individuals can develop conviction towards a particular path or outcome.

II: Can you apply your five-lens framework to China for us?

VM: Sure. Lens 1 finds that we have residential mortgages and loans to developers growing at the same time that property prices are rising. This is a tell-tale indicator of a reflexive, self-fulfilling dynamic at work. Bankers are lending money to buyers (and therefore creating demand) who are driving prices up (and making the bankers therefore more secure). The bankers fail to realize that they are the ultimate source of the rising prices.

Through Lens 2, are we seeing mal-investment, overinvestment, or overcapacity? This topic in China is very disturbing. There are entire 'ghost cities' today in China. My personal favorite is Kangbashi, which is a district of Ordos in Inner Mongolia. Kangbashi is a city built for 1.5 million people and, as of last year, it was housing around 20,000 people. This is a city that has museums, government offices, libraries, suburban areas, urban towers apartments, four-lane highways ... but is virtually empty. That’s a great manifestation of capital deployed towards non-economic purposes. Another example is the recently built South China Mall in Dongguan. Here, a mall was built to accommodate fifteen hundred tenants. As of last year they had around 15 or 20 tenants. That’s a 99 (ish) percent vacancy rate.

Disturbing as that may be, the mall was taken over by Beijing University who installed a new CEO and, when that new CEO was interviewed on Bloomberg earlier this year, his solution to the problem was perhaps as bad as the problem ... He is going to expand!  He is going to add two hundred thousand more square meters, close to two million square feet, to help get critical mass. This is easy money at work – this is what it looks like.

When using Lens 3, we need to ask ourselves what we are seeing in terms of overconfidence. One of the most natural ways to find overconfidence in market is to look for world record prices, or any type of world record set from an asset perspective. That is usually a sign of national hubris and overconfidence being manifested in the form of buying behavior. The art market and wine market in China are spectacular cases to study – today Chinese bidders are continually setting world records at art auctions, not only ancient Chinese art finding its way home from the west but global artists as well. A Picasso was purchased last may for $110 million by a Chinese buyer. Wealthy wine enthusiasts are buying Chateau Laffite like it is going out of style. So wine and art markets are telegraphing signals of overconfidence but it doesn't stop there. ‘Mutton fat jade’ is a marbled jade variant that was historically used to fill bags to hold back flood rivers a few decades ago, but today it is selling for more than twice the US dollar price for gold. The world's most expensive dog was just purchased by a wealthy Chinese national – a Tibetan mastiff that sold at GBP1 million. The world's most expensive racing pigeon was just the subject of a bidding war between two Chinese nationals in Belgium as they were each intent on bringing pigeon racing to China. The list goes on, and on, and on.

One of my favorite indicators that combines the credit and psychological filters is the world's tallest skyscraper. Here is an indicator that, if you go back in time, you will see clearly predicts economic slowdown quite dramatically. In New York in 1929 three towers competed for the world's tallest status – 40 Wall Street, the Chrysler Building and the Empire State Building. In the early 1970s we had the World Trade Center and the Sears Tower followed by a decade of stagflation. In 1997, the completion of the Petronas towers in Malaysia came just before the currency crisis swept south-east Asia. In 1999, construction begin on Taipei 101 at the height of the tech boom. And at the height of the credit and commodity bubble of 2007/2008, Dubai took the crown with the Burj Dubai (now renamed to reflect the Abu Dhabi bailout). Today, five of the largest ten towers under construction globally are in China.

Why does this indicator work? Because the world's tallest skyscraper under construction is usually a sign of, first, speculative excesses – remember they are built by developers not the people who plan to occupy them. Second, there is no economic reason to pursue world's tallest status – that’s a simple manifestation of hubris and national overconfidence. And third, easy money – these things are never built with full equity financing – they’re they're usually built relying heavily on other people's money.

II: OK – but let's play devil's advocate. Does it matter that we are talking about a society which has suppressed built-up demand as opposed to seeing this reflected in a society that is relatively opulent to begin with? Do you think the fact that normal consumption, let alone conspicuous consumption, was not possible for Chinese citizens in years past might mark this as a more "normal" cycle of excess than a Dubai or Japan in the 80s? In other words is this celebration of new money psychologically less representative of a bubble than old money embracing excess on top of pre-existing wealth?

VM: I totally understand where you are going with that. Look, at the end of the day, private residential and commercial real estate didn't exist in china 15 years ago – this is a totally new phenomenon. But at the end the day I still stick with the conviction that this indicator is relevant because what is the purpose of having to be the world's tallest building? Why not just 100 stories? There are architects who have done analysis of structure height and economic viability and you reach a point somewhere in the process where you are realizing ever-diminishing returns on height. The optimal height is far lower than the world’s tallest towers. Consider the enormous magnitude of building going on in China and the facts presented by serious investors like Jim Chanos who said that he calculated roughly 30 billion square feet of commercial office space under construction last year in China. That equates roughly to a five by five cubicle for everyone in the country.

II: OK, now there is an overlapping observation that one could make here about what this type of consumption means for social stratification. Normally one could argue that a widening gulf between the ‘haves’ and ‘have-nots’ in any society carries negative ramifications, normally meaning in the context of a democratic or autocratic society of some sort.

In a communist society this type of disparity would appear to be toxic, potentially the most poisonous thing possible since it would appear to undermine the basic principals the Chinese government is founded on. Putin may be able to appropriate the role of Tsar in Russia, but the majority of Chinese people still seem to exhibit faith in the communist system and there is no better example than interviews of people in desperate poverty on television who still express hope that the government will fix these imbalances. Is social volatility the bigger long-term threat represented by these factors from a political standpoint?

VM: Yes. I absolutely agree. Social instability is what the communist leaders in Beijing fear the most. If there is anything that keeps them up night after night, I suspect it is the risk of revolution and popular uprisings. Social instability is the thing they will seek to avoid at all cost. Further, measuring the progress of the ‘average’ Chinese person is silly.  The inequality is so large – China has one of the largest Gini co-efficients [a measurement of inequality and wealth] in the world – that averages are meaningless. It’s like placing your left foot in a bucket of ice water, your right foot in a bucket of boiling water, and saying that you are on average comfortable.

II: So the China bulls – the very committed bullish investors who are out there and advocating buying, would likely argue that all of what we have discussed is simply froth. That the excesses we have discussed are merely symptoms of pent-up demand and poor management on a micro level and that the underlying economic catalysts are so strong that the near term impact of recent cooling measures represents a buying opportunity. How do you answer this line of thinking?

VM: I have data in my book somewhere that there were 500 malls built in China over the past five years. Five hundred. There are many 'ghost cities.' Unfortunately, these aren't one offs. So the better question is are there measures that indicate the likely breadth of misallocated capital. And the answer is yes. The Capex to GDP ratio – which is running at extremely heightened levels and has for a decade, show that China is addicted to investment-led growth. We have had greater than 30 percent Capex to GDP for more than a decade. The last few times that I know of where this ratio has been that heightened for this long was Japan in the 80s and Thailand during the mid 1980s to mid 1990s. Both of those cases did not end well. There are very few examples where you have had Capex to GDP that high for sustained periods. What they are doing, and this gets to the political lens, the national priority of sustainable growth is in direct conflict with the local objectives of rapid and plentiful job creation.

The idea of sustainable growth is not part of the vocabulary at the provincial level. The way you rise in the communist party is by putting up good GDP numbers and creating lots of jobs. And so you have all sorts of irrational behavior that comes about when GDP is the target rather than the outcome measuring normal economic activity.

II: So in some ways China today is harking back to the five-year plans that were used in Russia and China during the last century. They demonstrated that a poorly chosen goal can open up a nightmare of unintended consequences.

VM: Absolutely right. Goodhart's law states that anytime you take an economic variable that has historically been used to measure a process and make that the objective of the process itself then it loses its value as a measure.

This makes a lot of sense: GDP is the target now, and it doesn't matter what you are doing, driving GDP is the sole goal – as opposed to "well we need to get higher return projects and lets add them all up and see what they generated."

Some things that have happened there make sense in light of this dynamic. You have a bridge that is seven years old – with a useful life of fifty (with proper maintenance) – [and it is] blown up and recreated. Why? Well the explosives and the clearing generate GDP, and of course the construction of the new bridge generates GDP so you get to double dip on that project while accomplishing nothing!

II: Ok so let's discuss how the Chinese consumer factors into this. If you look at the consumption patterns of rural and less affluent consumers in China it rings true with historical developing economy precedents. People are diversifying their diet, they may replace the farm automobile with tax incentives but the first thing they buy with disposable income are healthcare and education for the kids. So how you calculate GDP even suddenly becomes important – how you measure GDP can actually distort the picture, if you see what I mean?

VM: I do, I absolutely do. I think there are a whole bunch of problems that you encounter when GDP becomes the target rather than the outcome. Ultimately we are talking about a communist central planning organization. That's never been the most efficient way to deploy resources. They are very cognizant of the need to drive consumption and they are very aware of the need to establish a social safety net or else people will continue to save for that rainy day or healthcare cost.

It is a race between the inevitable falloff in investment led growth and the pickup in consumption led growth. The clock is ticking. They need to get that consumption engine really going before the investment engine peters out. Unfortunately, I think the investment engine is much closer to petering out than the consumption engine is to getting up and running.

As a side note, we spoke about social instability in the context of conspicuous consumption earlier, but I think that education in China is one of the ticking time bombs of potential social instability. They have made massive strides in the past decades and built up the university system to the point where they went from producing 800 thousand graduates in 1998 to producing roughly 7 million a year today. At the same time we have not seen comparable growth in white-collar jobs for Chinese graduates. The most disgruntled group is the most educated group, adding more fuel to the potential social instability fire.

II: So growth is the target and it’s only measured in one way, and as such provincial leaders only care about making tractors and bridges.

VM: Yes. Consider the Chinese situation through a growth accounting lens. You don't need a PhD in economics, or need to have read Solow’s work – Paul Krugman’s 1994 piece in Foreign Affairs called ‘The Myth of Asia's Miracle’ provides a very accessible and easy to understand description of growth accounting. Basically there are three effective sources of growth: you can put in capital, you can put in labor, or you can get productivity out of the existing stock of capital and labor. Those are the sources of growth. That's it. So if we look at Capex to GDP at very elevated levels we're getting lower and lower return for each dollar of investment and there is now a huge base effect that has kicked in because now we have so many dollars used for investments. A lot of these are one-off infrastructure projects – how are you going to get growth from investment next year? You are going to have to do exactly what you did this year – but that’s already a huge number. So it becomes incrementally a smaller and smaller source of growth.

What about labor? The broad population of China is going through an ageing process making the working age population smaller over time. The one-child policy created a blip, a slowdown in population growth rates. So that's not supportive of labor being a major support for growth in China going forward.

Finally, if you think of total factor productivity or the sort of combination of these – is there a way to get more out of the existing capital and labor stock? One good proxy for that factor in China is migration and/or urbanization: when we take the farmer out of the rice paddy and put him into a factory, he tends to be more productive.

Unfortunately, even here the data doesn't look good. The demographic most likely to migrate from rural to urban areas is 18 to 24 years of age. Of that population, because of the residency permit system (hukou), roughly a third has already moved to cities but they are not labeled as such. So right off the bat a big percentage of the people that we think of as rural are not rural. Roughly 230 million people between the ages of 18 and 24 were living in China in 2010, and that number is falling by roughly 25 percent over the next five years. So, many of these people have already migrated, the overall size of the age cohort is falling, and those that haven't migrated may be necessary to agricultural production. And finally, Chinese definitions of an urban area differ from ours. They define an urban area as one having population density of at least 1,500 people per square kilometer. By that definition, Houston would not be a city. So, what this means is that even if we adjust for the hukou distortions and the demographic data, we are still left with some percentage of the population that is living in areas that resemble cities, but are not classified as such. I am therefore not very optimistic that migration and urbanization will continue to be a source of meaningful growth.

Add this stuff up and it's hard to see how China's growth can be higher than around 5 percent a year for the next decade. The world is not expecting this outcome. If this scenario plays out, there will be big ramifications across many regions and sectors.

II: So we have one more lens to discuss, the biological factor driving the group dynamic.

VM: I will leave you with one thought that I think captures the essence of my concern. Today the largest buyers of land in auctions taking place on the municipal level are state-owned enterprises. So what does that mean? If we just pause for one second to think about this we realize that we have state owned banks lending money to state owned enterprises, to buy land from the state. And somehow we think there is a price mechanism at work. This is a spectacular self-dealing situation, very prone to accounting irregularities so common in transfer pricing or revenue recognition. That's not a dynamic that gives me great comfort; it indicates to me that private developers have been squeezed out, the private amateurs have been squeezed out and now we are left with professional amateurs being financed by the seller of the land. This is a 7th, 8th, or 9th inning phenomenon. We’re not at the start of the ballgame.

The ramifications are enormous, but the impact will be much more extreme in the ‘China industrial complex’ – ie, the countries and industries that have been supporting the Chinese development story, both within and outside of China. The commodity economies, the shipping industry, the suppliers of the capital goods china consumes – that’s where the pain will be felt most dramatically. In an ironic twist of fate, China may be relatively insulated against a Chinese slowdown.

II: So taken to its logical extreme, ultimately this leads us to a possible devaluation scenario.

VM: It's conceivable that there is a political game of sorts going on where the US effectively says "look, we need the jobs over here and we are going to take our currency and debase it through QE and, if you stay pegged to the dollar at the current rate we are going to create the inflation that you so desperately want to avoid because it is instability inducing – so you will be forced to appreciate your currency." If that were to happen, it would take the razor thin manufacturing margins that have existed for a long time and push them from the black into the red. In that scenario China will find itself between a rock and a hard place –between potential social instability and potential economic instability and they are not going to want either. They will eventually find that raising interest rates causes economic slowdown and hurts the growth story and possibly undermines the economic opportunity that has been the foundation of Beijing’s legitimacy in recent years. Following a material Chinese slowdown, it is not inconceivable that they will choose to devalue the Chinese currency. They’ve done it before, and my suspicion is that they may do it again. The current path of least resistance is likely for the currency to appreciate, but if the Chinese bust scenario transpires, a major devaluation may be the cards.

Andrew Barber is the director of strategic investments for Waverly Advisors, a Corning, NY based asset management firm.

China: The Urgent Need for Speed…


China: The Urgent Need for Speed…

by Vikram Mansharamani, PhD

Recent social unrest in the Middle East has spurred speculation that similar uprisings may take place in China. Is there any reason to believe that social instability (or revolution) is possible in China? While the immediate threat of an uprising in China appears limited due to the government’s iron grip on media and communications, China faces very different dynamics than those that have recently struck Middle Eastern countries. In particular, the source of legitimacy for the Chinese authorities over the past 20+ years has been economic opportunity. At least historically, such an implicit social contract was not the basis of the regimes in the Middle East. By creating jobs and the potential for a better life, Beijing has dampened desires for political reform or representative government.

Unfortunately for Beijing, signs of increasingly difficult and less-hospitable economic conditions are increasingly apparent to the ordinary citizen. Increasingly unaffordable housing. Rampant food price inflation. Inadequate employment opportunities. Rising inequality. Forced relocations. Environmental pollution. Widespread corruption. While each of these is by itself enough to generate resentment among a populace, the combination of these factors creates explosive potential for social unrest and possibly even (gasp!) revolution. It should come as no surprise that Chinese leaders – facing this potentially lethal cocktail of issues – are concerned.

The stakes are high, and not just for Beijing. China continues to be one of the world’s fastest growing economies and has had a tremendous impact the global economy. Its voracious appetite for commodities has generated growth throughout the global commodity complex, and many industrial markets continue to be driven by Chinese demand. Any disruption to the Chinese development story will surely have global ramifications.

Author and money manager Vitaliy Katsenelson has analogized the Chinese economy to the movie Speed, in which the bus must maintain a certain speed or an onboard bomb will detonate. There seems to be good reason for such an analogy. Consider the recent boom in education. In 1998, China had less than 1 million students graduating from college each year. Estimates today suggest that number may be close to 7 million, and rising. Despite healthy economic growth, the pace at which new white-collar, professional jobs are created has not kept pace with the surge in college graduates. Between 2002 and 2009, wages for college graduates remained essentially flat (negative if you consider inflation). During the same time, unskilled laborer had their wages rise by more than 80%. In a cruel twist of fate, it seems Beijing’s spectacular accomplishment in education may threaten the regime’s very foundation.

Aside from a mismatch between the supply and demand of college-educated workers, the problem is exacerbated by the inflexibility of the typical Chinese curriculum. In most cases, students tend to spend their college years developing expertise in a particular subject (engineering, computer science, accounting, etc.) by focusing almost exclusively on the topic for four years. As a result, students lack the flexibility to adapt to China’s changing labor markets. The mismatch is likely to get worse as China migrates from an agricultural economy to a manufacturing economy and eventually on to a services economy.

Deng Xiaoping’s declaration “to be rich is glorious” unleashed significant entrepreneurial energy; what China needs today is a similar battle cry for a more flexible education policy. Labor markets for skilled and educated workers need to become more dynamic, and one way to do so is to encourage the Western model of liberal arts education. Yale University President Richard Levin has noted that the most important characteristic of a well-educated person “is not subject-specific knowledge, but rather the ability to assimilate new information and solve problems.” Education reform is needed…and soon.

The clock is ticking. China today exhibits many of the tell-tale signs of a great speculative mania. Higher prices in many of its asset markets are generating demand more rapidly than supply. The cost of money is inappropriately cheap, driving mal-investment and creating overcapacity. Confidence is bubbly, with skyscrapers rising, art markets booming, and conspicuous consumption galloping forward. Moral hazard runs rampant, and national-provincial dynamics are generating GDP growth through unnecessary and low ROI activity. Finally, amateur investors seem ubiquitous, and the largest developers today are state-owned enterprises using money from state-owned banks to buy land from the state.

All of these indicators point to the fact that the Chinese economic bus is running low on fuel. A financial bust or even economic slowdown may just detonate the onboard bomb, resulting not only in an elevated risk of social unrest or possible revolution within China, but also a meaningful slowdown in global economic growth.

Vikram Mansharamani is the author of Boombustology: Spotting Financial Bubble Before They Burst, published by John Wiley & Sons. The book presents a multi-disciplinary method for identifying unsustainable booms in financial markets.

China’s Scary Housing Bubble: Global Ripples Ahead



Global Ripples Ahead

Vikram Mansharamani

Vikram Mansharamani is the author of “Boombustology: Spotting Financial Bubbles Before They Burst.” He is a lecturer on financial markets at Yale University.

Updated April 15, 2011, 7:05 PM

China today exhibits many of the tell-tale signs of a great speculative mania. Higher prices in many of its asset markets are generating demand more rapidly than supply. The cost of money is inappropriately cheap, driving mal-investment and creating overcapacity.

The ripple effects of a real estate slowdown in China will be felt in commodity markets around the world.

Confidence is bubbly, with skyscrapers rising, art markets booming, and conspicuous consumption galloping forward. Moral hazard runs rampant, and national-provincial dynamics are generating growth in gross domestic product through unnecessary and low return-on-investment activity. Amateur investors seem ubiquitous, and the largest developers today are state-owned enterprises using money from state-owned banks to buy land from the state. All of these indicators point to the fact that the Chinese economic story is unsustainable.

The most visible manifestation of the bubbly conditions in China can be found in the property markets of major coastal cities. A deflation of the property bubble plaguing these cities will be accompanied by a material slowdown in demand for commodities.

Consider the impact on steel, a product for which Chinese consumption accounts for almost 50 percent of global production. Approximately half of Chinese steel consumption is in construction, most of which is for property development. Any slowdown in construction would reduce global demand for steel and also for iron ore, which is used in steel production.

Likewise, given that 40 percent of the dry-bulk shipping industry is connected to moving iron ore to China, the property slowdown will be felt in Norway, Hong Kong, Singapore, Greece and other shipping centers. Because the shipyards in Korea, Singapore and China have themselves expanded to meet increased demand for ships, they too will face significant overcapacity. And on it goes. For better or worse, the Chinese property markets have a global value chain. The ripple effects of a real estate slowdown will be felt around the world.

China has been a story of investment led growth; capital expenditure as a percentage of G.D.P. remains elevated in comparison to China’s own history as well as that of other rapidly developing countries.

Many commodity markets currently reflect substantial continued investment. If property markets deflate, and overinvestment and excess capacity are revealed, Chinese growth may be 5 percent 6 percent for the next decade, an outcome for which the world and commodity markets are not prepared.

The “Art” of Spotting Bubbles



The Next Art Bubble

Last week the prices for Chinese art skyrocketed to their highest levels yet, but comparisons to the Japanese art bubble prove that a crash is near, says Vikram Mansharamani.

by Vikram Mansharamani  | April 13, 2011 1:42 PM EDT

New York’s Asian Art Week was spectacular. A delicate pear-shaped Chinese vase was the star of the week, skyrocketing past its pre-sale estimate of $800 to $1,200 to sell for more than $18 million. A carved celadon-glazed ceramic Qianlong vase sold for $7.9 million, double its high presale estimate. Combined, Sotheby’s and Christie’s International took in a record $202 million during the week, 56 percent above the prior 2007 peak.

The electricity transferred over to Europe, where a Beijing collector paid a record $31 million for a Chinese scroll on March 26 at an auction in Toulouse, France. And this week has been equally exciting. Global art collectors descended upon the Hong Kong Convention and Exhibition Centre for Sotheby’s 3,600 lot series of auctions. A painting by Zhang Xiaogang set a new record, selling for more than double pre-auction estimates. The most anticipated auction was Thursday evening’s sale of the Meiyintang collection of imperial Chinese porcelain.

Thursday evening’s auction disappointed. Despite telegraphing an expected auction sales range of between HK$700 million and HK$1 billion ($90 million and $128 million) (with rumors suggesting a significantly higher sales price was probable), Sotheby’s posted auction sales of less than HK$400 million for the collection. Might this be an early warning sign of an art bubble about to burst? What are the implications of an art market slowdown?

From most accounts, China appears to be the most important driver of the art market today…and not just as a source of desired art. Wealthy Chinese buyers are the largest source of incremental demand, with Chinese billionaire buyers as the most confident. Art dealer Andrew Kahane, who specializes in Chinese art, summarized the buying desires: “Chinese buyers want to be seen spending a lot of money. They want to be seen setting world records.”

These developments certainly point to a rising sense of confidence, perhaps even overconfidence, among the Chinese. Might the ups and downs of the art business be a reflection of surging and waning confidence? Is it possible that recent world record art prices are an indication of unsustainable economic conditions? Could China be in the midst of an unsustainable asset bubble?

The recent auction records are not as anomalous as they may appear. Chinese influence on art markets has risen steadily over the past year. In May 2010, the art world was energized by a Chinese buyer paying a world record $106.4 million for a work by Pablo Picasso. Last November, an 18th-century vase from the Qianlong period, which had been found in a dusty old attic, was purchased at auction for $86 million (presale estimates had ranged from $1.3 million to $2 million) by a buyer from mainland China. It was the highest price ever paid at auction for a Chinese antiquity.

Overconfidence and hubris, manifested in world record art prices, should be as disturbing to policymakers and investors as it is exciting to Sotheby’s and Christie’s.

Traditional buyers have noted this newfound buying pressure, finding it frustrating when seeking to purchase art. Morgan Long, head of art services at The Fine Art Fund, noted that funds “have come across frantic bidding from people from the Chinese mainland. We haven’t been able to buy anything we wanted at the prices we were looking for.”

One of the largest asset bubbles ever formed was in Japan during the late 1980s. The bursting of the “Bubble Economy,” as it has since been known, might have seemed, even at the time, almost inevitable when examined through the lens of art markets. Consider the parallels.

In the then-highest price ever paid for a painting, van Gogh’s Still Life: Vase with Fifteen Sunflowers sold in 1987 to a Japanese buyer for almost $40 million, approximately four times the previous record for a painting.

The Japanese art craze possibly peaked (along with its asset markets) when Ryoei Saito, chairman of Daishowa Paper Manufacturing, paid $82.5 million for van Gogh’s Portrait of Dr. Gachet and over $78 million for Renoir’s Le Moulin de la Galette in May 1990. He then proceeded to shock the art world and the sensibilities of collectors worldwide by stating he would cremate the paintings with his body upon his death.

The similarities with Japan suggest that the enormous Chinese influence on the art market is an indicator of a forthcoming bust in China. It reflects a national overconfidence that has been a consistent ingredient in financial bubbles. Prudent investors would take great pride in selling at world record prices. Wanting to buy at world record prices is a spectacular reflection of hubris in action.

The disappointing results from Thursday’s Meiyintang auction might indicate that expectations of continually rising prices are now ahead of themselves, and that overconfidence and hubris are running out of steam. Was this auction revealing the first cracks in what has otherwise been a very positive story? Is this a sign of an imminent bust?

Seductive rationalizations about China’s enormous population, its tremendous wealth generation, or its industrious labor force are hard to transcend. Policymakers, investors, and corporate boardrooms, however, must attempt to do so because the ramifications of a China bust are so large. For example, China’s influence on the commodity markets has been domineering. If China’s appetite for materials were to slow materially, then many commodities would be over-supplied and prices would fall. Commodity markets have at least partially been supporting the emerging markets growth story, and without that story, the world will likely grow at a significantly slower rate.

Despite the allure of seductive rationalizations, healthy skepticism combined with a careful monitoring of the art market can help one realize that it’s unlikely to be different this time. Overconfidence and hubris, manifested in world record art prices, should be as disturbing to policymakers and investors as it is exciting to Sotheby’s and Christie’s, for in today’s increasingly interconnected world, even the slightest disturbance can ripple from China to Iowa.

Vikram Mansharamani is a lecturer at Yale University where he teaches a popular seminar called “Financial Booms and Busts.” His new book is Boombustology: Spotting Financial Bubbles Before They Burst.

©2011 The Newsweek/Daily Beast Company LLC

MegaMalls and Empty Purses


(originally published in April 2011 by YaleGlobal Online, picked up by the Khaleej Times, The South China Morning Post, The Korea Times, and numerous others)


Mega malls and empty purses

Vikram Mansharamani   13 April 2011

China is not only a booming country, for years it has been one of the world’s fastest growing economies. Industrialisation, urbanisation, modernisation and entrepreneurship all appear to be on steroids in the world’s most populous nation. There’s relative consensus among global investors that China will continue growing at eight per cent for the foreseeable future, providing much needed support to the global economy.

By almost any metric, economic progress in China over the past several decades has been phenomenal: GDP per capita, literacy rates, health care, infant mortality, life expectancy and national wealth have all improved remarkably.

However, as the famous disclaimer reads on most mutual fund advertisements, “past performance is no guarantee of future performance,” and this appears to be the case with respect to China’s progress. In fact, China today exhibits many of the signs that characterise the great speculative manias throughout history.

Might China slow to a more sustainable GDP growth rate, say five per cent, in the coming years? Significant evidence suggests that such an outcome is not as outlandish as the global investment community currently believes. A Chinese slowdown of this magnitude would have material impacts upon commodity markets, emerging markets and even the S&P 500’s business and earnings mix. In short, how China goes, so goes the world economy. Given this global economic interdependence, it’s highly imprudent for policymakers and investors not to consider the possibility of such a slowdown.

Given the highly uncertain and probabilistic nature of booms, busts and the sustainability of growth, the application of a multidisciplinary framework seems particularly apt in determining various scenarios and their relative probabilities. Consider the approach one takes to identifying animals: You stumble upon an animal and seek to determine what type it is. You might first look at it, followed by listening, and observing its behaviour. So if the animal has feathers and webbed-feet, and “quacks” while waddling, the probability of it being a duck is high.

Likewise, the same method can be used to assess the Chinese economic boom, using multiple lenses to determine the relative likelihood of a forthcoming bust.

From a microeconomic perspective, one method of identifying an asset-price bubble is to spot self-fulfilling or reflexive dynamics underway. In China today, higher prices in many of its asset markets are generating demand more rapidly than supply. Such dynamics are rarely stable and create situations prone to rapid corrections.

Consider property markets in which willingness to lend and prices rise together in a self-fulfilling manner. Chinese bankers have been lending money against collateral, the value of which is in part rising because of the banker’s willingness to lend. As property prices rise, banks’ collateral is worth more; the bankers feel more secure and smart, so they lend more. The cycle repeats. Unfortunately for the bankers, they’ll eventually discover that they themselves created the sense of safety and intelligence that they enjoyed. As happened with the subprime collapse in the West, reality eventually sets in, bankers step back and collateral values fall.

From a macroeconomic perspective, most asset bubbles are associated with “easy” or cheap money that drives overinvestment and overconsumption. Evidence of such easy money can be found in Chinese commercial real estate, where both entire cities – like Kangbashi, in Inner Mongolia – as well as gigantic malls remain virtually empty. ‘Time’ magazine profiled Kangbashi as a modern “ghost town,” and foreign newspapers have referred to the South China Mall in Dongguan as the “mall of misfortune.”

Chinese buyers have also set recent world records in the prices paid for a dog and a pigeon!

From a political perspective, we need to acknowledge the fact that the Chinese government remains communist in spirit, albeit increasingly less so. The party’s structure drives uneconomic activity as provincial leaders aspire to get noticed by producing more jobs and generating more GDP than the other provinces. Anecdotal reports are alarming: Perfectly usable infrastructure is destroyed and rebuilt to generate GDP. Likewise, job creation and economic activity are prioritised over sustainability and profitability.

The ramifications of a meaningful slowdown in Chinese economic activity are profound, ranging from the risk of domestic social instability to a collapse of several commodity markets.

On the global economic front, China’s voracious appetite for commodities has motivated significant expansions throughout the global commodity complex, and many industrial markets, including shipping, capital goods and more, continue to be driven by Chinese demand.

Unfortunately, the forthcoming slowdown may arrive at a particularly inopportune time. Many Australian and Brazilian mines have undertaken massive capacity expansions. Likewise, many Norwegian and Greek dry bulk-shipping companies have expanded their fleets in anticipation of rising demand. To accommodate this need for more ships, many Singaporean and Korean shipyards expanded their capacities. And so the story goes… What happens if the very foundation upon which these expansion stories are built is faulty? Might the emerging-markets tale that’s been the darling of global investors be less compelling than widely believed?

And what happens to multinational companies in a slowing world? Might the demand for US treasuries drop, resulting in higher costs for capital in the United States? Is it conceivable that the consensus belief that the renminbi will appreciate is instead met by depreciation as Beijing grasps at hopes of export-led growth? How might 25 per cent depreciation affect global imbalances?

The stakes are high. Policymakers, investors and corporate boardrooms must consider the risk of a material Chinese slowdown. Despite the allure of “China is different” explanations, there is a reason well-read and seasoned investors claim the four most expensive words in the English language are “it’s different this time.”

Vikram Mansharamani, PhD, is the author of Boombustology: Spotting Financial Bubbles Before They Burst (Wiley, 2011). For the past two years, he has taught the popular undergraduate seminar “Financial Booms and Busts” at Yale University
© 2011 Yale Center for the Study of 

CNBC: Bullish on Books


(originally posted to CNBC.com March 2011; http://www.cnbc.com/id/42343583)

Spotting Bubbles Before They Burst

Published: Thursday, 31 Mar 2011 | 9:34 AM ET
By: Vikram Mansharamani, author of BOOMBUSTOLOGY: Spotting Financial Bubbles Before They Burst”

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.

Guest Author Blog

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.

Skyscrapers and Bubbles





Skyscrapers Are A Great Bubble Indicator

Vikram Mansharamani 03.10.11, 3:41 PM ET

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.

World’s Tallest Skyscrapers and Related Busts

BuildingLocation (Completed)Spire HeightFinancial Crisis
SingerNew York (1908)187 metersPanic of 1907
Metropolitan LifeNew York (1909)247 metersPanic of 1907
40 Wall StreetNew York (1929)283 metersGreat Depression
ChryslerNew York (1929)319 metersGreat Depression
Empire StateNew York (1931)443 metersGreat Depression
World Trade CenterNew York (1973)526 meters’70s Stagflation
Sears TowerChicago (1974)527 meters’70s Stagflation
Petronas TowersKuala Lumpur (1997)452 metersAsian Financial Crisis
Taipei 101Taipei (2004)*509 metersTech Bubble
Burj DubaiDubai (2008/9)**828 metersGlobal 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).

Subscribe To My Newsletter