Sunday, August 28, 2011

Boombustology: Chapter 9

Asset bubbles are frequently popping up, and back down. They are easy to spot in hindsight, but we appear to lack the tools to recognize them ahead of time. Vikram Mansharamani aims to rectify that with his book, Boombustology. He applies a multi-lens approach to understanding bubbles with the aim of giving the reader the ability to identify bubbles, and thereby avoid being caught unaware.

The causes of the Asian financial crisis of 1997-1998 are complex and impossible to fully summarize in a few paragraphs. However, here are some items of note based on the five lenses described in this book.

1) Microeconomics: Demand for Asian assets was reflexive, with asset prices being driven by foreign inflows which in turn served to increase credit and asset prices in turn.

2) Macroeconomics: These inflows provided cheap liquidity. A lack of property rights (compared to "first world" countries) led to crony capitalism whereby lending took place for non-economic purposes.

3) Psychology: There was a belief that a new era had emerged, as the Asian Tigers had seen economic growth for many years. Investors appeared to be anchored on recent currency prices, as many loans in foreign currencies (which are risky, since earnings are in local currencies) were made.

4) Political: Governments were pushing export-driven industries, at the expense of other businesses. Currencies were pushed down (to increase exports), resulting in expensive imports. The economies became overly reliant on exports.

5) Biology: Herding took place both during the boom and subsequent busts. For example, foreign funds herded in to pay high prices for assets, and when trouble hit, they all exited (i.e. withdrew their investments) at the same time, resulting in recessions in Asian countries that resulted in even more foreign outflows, in a feedback loop.

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