2011-03-18

Chinese Bubble, the Skyscraper Curse, Gold and Bubblogy

I have been talking numerous times about the Skyscraper Curse for the past couple of years, and it's interesting to see that this idea is gaining momentum and credibility. Today, Yahoo published a post that deals with China's bubble and the Skyscraper Curve:
In China, five of the world’s ten largest buildings are now under construction. Look out below!, says Vikram Mansharamani, a financial services veteran and part-time academic who has developed a multidisciplinary framework for sniffing out bubbles.v

Mansharamani is author of a new book, BoomBustology: Spotting Financial Bubbles Before they Burst. The book is based in part on a course that Mansharamani, who has two master’s degrees and a Ph.D. from the Massachusetts Institute of Technology, has taught at Yale, his alma mater. [...] Mansharamani has developed a series of lenses through which to examine market behavior. Systematically examining outbursts of mania, from Dutch investors’ infatuation with Tulips in the 1630s to Florida real estate in the 1920, can help sniff out bubbles.

If you look through Mansharamani’s lenses, it’s clear to see there’s a bubble going on in China. Tall buildings aren’t just symbolic of reckless ambition. “Skyscrapers are manifestation of easy money, overconfidence, and hubris,” he says. And they are excellent indicators of a top. “In New York in 1929 there were three buildings competing to be the world’s tallest skyscraper,” he notes. In 1997, the massive Petronas Towers in Malaysia were completed just in time for the Asian financial crisis. The Burj Dubai rose in 2007 to snatch the title of world’s tallest building – just in time for the financial crisis to his the Persian Gulf.

Beyond skyscrapers, Mansharamani notes, “China today exhibits many of the signs that have characterized many of the speculative manias throughout history.” Those include: easy money, overconfidence, and high amounts of leverage. The rise of moral hazard is another indicator. “In China, you have state-owned banks lending to state-owned enterprises to buy land from the state,” he notes. (What could go wrong?) In addition, it’s always a danger sign when economic systems begin to regard what should be outputs as inputs.

Throughout China, provincial officials are obsessed with hitting targets for GDP. Focusing on what should be an end result as an initial goal “leads people to do things that may not make economic sense.” Mansharamani cites as an example a regional leader in China who, desperate to meet a GDP target, blew up a recently constructed bridge. “He got credit for the explosives he bought, and then for the steel and cement he bought and the constructions workers he hired.”

The question for investors during bubbles is how to know when to get out. And that’s one area Mansharamani hasn’t tackled. “I do think timing is a very difficult problem in terms of identifying popping of it,” he said. “I’m not sure it’s worth shorting China at this point in time, but it is definitely prudent to avoid it.” What’s more, he notes, countries and industries throughout the world that depend in large measure on China’s rampant growth are also potentially in danger.

Using Mansharamani’s lenses, one would conclude that the current gold market exhibits plenty of bubblicious signs. He agrees, to a point. A key development in any investment mania is when it crosses over from the province of professionals to a mass phenomenon. That’s happened with gold. “Walking around the city, you see a lot of people advertising that they want to buy gold,” Mansharamani said. “Everyone is talking about gold, and that is a late stage sign.”

Another worrisome sign is the way that an investment boom tends to feed on itself through leverage and financial innovation. Example: housing prices rise because banks lend against housing collateral, and the rising value of the collateral spurs people to borrow more against their homes. A similar dynamic is happening in gold. “The gold market has had tremendous innovation, in the form of exchange traded funds (ETFs), leveraged ETFs, and everything in between,” Mansharamani notes. This innovation has, in turn, affected the price of gold. The advent of gold ETFs, he notes, “has increased the demand for physical gold.”

But there’s one important caveat. Before talking about gold, we should note that “it is an unusual asset at so many levels.” As a sort of “anti-money,” Mansharamani argues, “it is a proxy for lack of trust in responsible monetary policy.” And in recent years, there’s been something of a bubble in that as well.

No comments: