China: The Urgent Need for Speed…

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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.

BUBBLY BOOKS: Is Education Overvalued?

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BUBBLY BOOKS: Is Education Overvalued?

by Vikram Mansharamani, PhD

College graduation is a time of great joy, of optimism, of forward-looking enthusiasm.  Indeed, the very term “commencement” implies a positive new beginning.  Unfortunately, this is not universally the case in America.  Many students this year will graduate with questionable educations and mountains of debt; as more students go off to college and borrow money to do so, student loan debt in the United States is likely to top $1 trillion this year, exceeding credit card debt for the first time in history.

Might our strong belief in the value of an education be misguided?  Is higher education in America a bubble about to burst?  As a student of booms and busts, I have developed a framework for identifying unsustainable price dynamics, which are as applicable to higher education as they are to tulips, Japanese real estate, and Internet stocks.

Two primary dynamics seem to telegraph bubbly price action regularly through history’s great speculative eras.  First, an unquestioning faith in the asset’s value leads to an ever-increasing universe of buyers, despite price increases.  Second, the availability of “easy money” or “loose credit” is often driven by policies that generate significant moral hazard.   Higher education in America today exhibits both of these warning signs.

The argument in favor of education is based on average salaries for differing education levels, and on the surface, the numbers are compelling.   According to data from the U.S. Census Bureau, average earnings in 2008 for those with an advanced degree were ~$83,000, compared to ~$58,500 for those with a bachelor’s degree.  This compares to high school graduates’ average salaries of ~$31,250.

Recent research from the Pew Research Center provides confirmatory data in the unquestioning faith in the value of an education: 94% of parents with children under the age of 17 indicate they expect their children to go to college.  There is a broad universality of this view, with 93% of parents who did not graduate from college and 97% of those who did subscribing to this aspiration.

Despite these responses, only 5% of those surveyed by Pew indicated higher education provided excellent value for the money (57% say it does not even provide “good” value).  Further, a college degree ranks fourth (work ethic, social skills, and technical skills all rank higher) in terms of perceived life success factors.  Enrollment data does not reflect this concern.

The number of American college students has risen from approximately 9 million in 2009 to approximately 13 million over the past ten years.  Enrollment in the for-profit education sector has been particularly brisk, rising at multiples of the overall higher education growth rate, with 2009 enrollment growth in the 20%-25% range.  Marginal students have been wooed by this sector and have sought education in droves.

TOTAL FALL FULL-TIME COLLEGE ENROLLMENT IN AMERICA
(Source: College Board, Trends in College Pricing 2010, Figure 17a)

During that same time period, the price of a college education (i.e. tuition) has risen faster than inflation.  Tuition and fees at public, four-year institutions have risen on average at 5.6% per year more than inflation over the past decade.  While private college tuition has risen at a less dramatic rate (~2.5%-3.0% more than inflation), it was significantly more expensive to begin with.

Increasing participation of price- and value-insensitive buyers, check.

In its noble quest to provide educational opportunities to all Americans, the Department of Education has administered over $500bn in federal financial aid to students seeking post-secondary education over the last five years.  For the academic year 2009-2010, the College Board estimated that total federal aid was approximately $147bn, a 136% increase over the past ten years, a growth rate faster than either enrollment or price increases might explain.

TOTAL FEDERAL FINANCIAL AID ($MM)
(Source: College Board, Trends in Student Aid 2010, Table 1)

The securitization market has fueled this development.  Just as mortgage backed securities enabled rapid growth in housing finance, so too have student-loan asset backed securities (SLABS) enabled rapid growth in education finance.  The dollar value of SLABS grew from approximately $76mm in 1990 to over $2.6 trillion by 2007.   SLABS are deemed by some investors to be government sponsored securities (Sallie Mae played a major role in enabling this market) and due to the full recourse nature of student loans (i.e., filing bankruptcy does not eliminate them), many investors believe the risk of loss to be small.  The rapid and brisk lending pace has enabled even marginal borrowers to obtain education loans without question.

Evidence from the for-profit sector is particularly concerning.   Despite low completion rates (less than half of students who start finish their program), many for-profits receive close to 90% of their revenues from government financial aid sources. From 1987 through 2000, the industry received federal financial aid (Title IV funding) of between $2 and $4 billion per annum.  In 2009, the industry received over $21 billion.

Easy money supported by moral hazard, check

One of the philosophical underpinnings behind the US housing bubble was the belief that all Americans should own their homes, even if they borrowed to do so.  A similar philosophical belief has taken hold in higher education.

An increasing percentage of graduates are finding themselves burdened with student loans upon graduation; less than half of the graduates in 1993 received loan repayment coupons with their degrees.  In 2008, more than two-thirds graduated with loans, having borrowed double what their 1996 counterparts did.   Almost 50% of those with student loans indicate repayment makes it hard to make ends meet, and around 25% indicate student loans impact career choices and delay the purchasing of a home.

Parents, students, bankers, investors, and policymakers alike should reconsider the value of education and ask the uncomfortable but critical question: Is higher education an overvalued asset?  Much of America has come to question the value of $1,000 per square foot homes.  The time has come to reconsider the value of $1,000 per week education.

Vikram Mansharamani, Lecturer at Yale University, is the author of the recently released Boombustology: Spotting Financial Bubbles Before They Burst (Wiley, 2011).  He has been an active participant in the education bubble, having acquired a bachelors degree from Yale University, two masters degrees from MIT, and a PhD from the Sloan School of Management.

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