Monday, September 5, 2011

Boombustology: Chapter 12

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.

In this final chapter, the author uses the framework developed in the previous chapter and applies it to current economic conditions in China. Is China in a bubble, whose bursting will result in massive repercussions that reverberate across the global economy? The answer is yes, according to Mansharamani.

First, China's assets (especially real-estate) are experiencing reflexive dynamics. Credit for mortgages and development loans is up 6 times over the last decade, fueling high asset prices. Demand continues to be strong, with governments having to apply restrictions for buyers of third properties (!). Meanwhile, many apartments sit empty according to various sources.

The problem is exacerbated by cheap money that has made real interest rates negative, which means inflation erodes the value of cash. This provides incentives to invest in assets like real-estate, helping to fuel the boom. Real interest rates are negative because China fixes its currency to the US dollar, meaning current US policies of easy money (due to recession) spill over into China.

There is a belief in China that property prices can only go up, according to Mansharamani. Extreme levels of confidence in this idea permeate the country, leading to over-investment. Based on current plans, China will have 5 of the tallest 10 skyscrapers in the world by 2015. But with fixed investment representing 45% of GDP (thanks in part to great confidence), which is extremely high, mis-allocation of capital is likely. Examples the author notes include price bubbles in garlic, some teas, steal and cement production, and the proliferation of empty malls.

Government policies are also skewing markets. Rather than let GDP be an indicator of economic growth, economic growth is pushed in order to drive GDP. Policies are constantly changing from the top in order to encourage or discourage behaviour, leading to perceived or real government guarantees, which often leads to poor capital allocation.

Finally, it appears that the whole country is infected, meaning there are few left who can contribute to the bubble. There are 124 million brokerage accounts held by the Chinese domestically, and real-estate is commonly owned by maids and others of professions with dubious abilities to pay back loans, other than through refinancing. These indicators suggest the bubble may be nearing its final hours.

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