Identifying the Next Bubble

by Kindred Winecoff

Alex Tabarrok has a very good post on "bubbles", or investment markets that get over-blown and then collapse. He discusses all the major points, namely the difficulty in identifying bubbles, the difficulty in diffusing them, and the resilience of bubbles against education (but not wisdom gained through experience!). There are repercussions for monetary policy, rational choice theory, regulatory policy, and portfolio theory.

Most of the post simply summarizes the high points in the academic literature on bubbles and investor sentiment, but these arguments are worth reiterating (and note that Daniel Gross has argued that bubbles are a net positive force, although I don't see anyone mentioning his argument these days). Please read the whole post, and if you're feeling ambitious read the cited articles as well (esp. the Vernon Smith). I have criticized Tabarrok before, but I can't see a flaw in this post.

Some smart people have argued that the Fed, or another national regulator, should be in the business of identifying and deflating bubbles in an attempt to prevent the shocks that occur when a bubble pops. Other smart people have argued that this is impossible. Still other smart people have argued that even if it is possible for investors to identify bubbles and bet against them, "the market can stay irrational longer than you can stay solvent".

So this leads me to a challenge: Predict the next investment bubble to catastrophically explode. I'm not asking for any money to be put on the line; just a wild-haired guess. There's nothing on the line, because by the time it happens this post will be long forgotten. I'd love to see some predictions from readers and other bloggers.

Here's mine: The easy bet is on Eastern Europe, but I think that's for suckers. Those markets have already inflated and deflated several times in the past two decades, and I think investors will have learned some lessons. So my bet is on China. So far, the PRC has been careful to monitor and regulate portfolio investment inflows, but if China is going to fully integrate into the global economy that will have to change. There are already signals that China has over-reported its growth rates and may be not be quite as prepared to emerge as a global economic power as commonly believed. Add to the mix a reliance on exchange-rate stability and a strongly export-biased growth model and China seems ripe for some over-reach in the coming decade. I still remember the 1990s, and as strong as China looks now, Japan looked even stronger in 1994.

I don't actually expect to be right about this, and I'm certainly not prepared to wage real money on it, but that's the fun. So let's hear it.

Comments

[Roger Knights:]

Here are three other recent SA articles that see a bubble in China:

Http://seekingalpha.co...

Http://seekingalpha.co...

Http://seekingalpha.co...

Jul 30 07:33 AM

[Tom Burger:]

Your question simply demonstrates the folly of focusing on prices. To stop the boom/bust cycle, we have to somehow prevent central banks from manipulating the interest rate -- better to eliminate the central banks. Below market interest rates can be maintained only by flooding the country with new money, and it's the new money that creates "bubbles," leveraged investments, and speculative behavior in general.

There is no method of predicting the nature of the next bubble, although once a mania begins it's easy enough to see. There were many, many people who could see the technology bubble in real time and the same for the housing bubble. Doug Noland (The Credit Bubble Bulletin) is calling this new realm the Government Finance Bubble. When the deficits and money printing slow -- that's when the activities dependent on that credit will be revealed.

Jul 30 09:37 AM

[Valley Boy:]

China could well be bubbly for many years to come. The poorer regions of inland China can mop up any excess liquidity churned out by the more prosperous coastal regions. They can trade more extensively with other Asian nations in part to make up for the shortfall of exports to the developed countries. The government will probably keep the yuan at a reasonable price for a long time to come. The last panic has probably persuaded them to tap on the monetary brakes now and then in order to regulate the ebbs and tides of inflation.

Jul 30 05:20 PM

[Tony Daltorio:]

The obvious bubble that will blow up and end in a disaster is the bubble in Treasuries.

Jul 30 06:32 PM

[Susan Weerts:]

" I still remember the 1990s, and as strong as China looks now, Japan looked even stronger in 1994. "

I jokely brought up this comparision several days ago. I got fired up. One argument was that the analysts/economists made mistakes about Japan. Can they make mistakes again?!

**

"The poorer regions of inland China can mop up any excess liquidity churned out by the more prosperous coastal regions. "
How?

"They can trade more extensively with other Asian nations in part to make up for the shortfall of exports to the developed countries. "
Granted that there are in-asian movement. Are most of the countries in that regions export-depedent, mainly to the developed countries? Do you think it is enough to fill the slack.

Jul 31 09:39 AM

[nlipner:]

1- Cina (opaque market)
2- Gold/Silver (Inflation play)
3- Base commodities (expansion play)
4- Solar/Wind (Gaia Play)
5- Oil/Nat Gas (classic underinvestment cycle)
6- Banks (if the assets move to the fed and the liabilities reach a 3% or better spread)
7- Long Bonds (Yield steepener reaches the masses)
8- BRIC
9- EEM
10- Consumer Tech
11- Healthcare services
12- Medical Tech *(my odds-on favorite, advances even more dramatic than the tech bubble are afoot)

Jul 31 01:53 PM

[Valley Boy:]

The Japan of the 1990s was pretty much developed so it did not need to grow much. The China of the 2000s is more reminiscent of the Japan of the 1950s and, as such, is figuring out ways and means to grow despite the obstacles. The Overseas Chinese in Singapore, San Francisco and elsewhere plus the Taiwanese have assisted in the capitalist changeover in the mainland. The main dangers to the Chinese growth seem to involve any future inflationary pop or military actions.
The Chinese probably realize by now that they need richer neighbors to trade with. My impression is that they are interested in setting up some sort of Asian Common Market. That idea seems more realistic than the fear that they are trying to undermine the worldwide usage of the U.S. dollar.
The exporting countries probably need to focus on increasing the quality of their manufactured products while figuring out changes in their trading channels.
It turns out the amount paid by the Chinese to Australians and others for their recent stockpiling of metals constituted only a small fraction of their U.S. Treasury bond holdings. They must figure that they have room to maneuver despite the crash in exports partly because of their new co-dependent relationship with America.


On Jul 31 09:39 AM Susan Weerts wrote:

> " I still remember the 1990s, and as strong as China looks now, Japan
> looked even stronger in 1994. "
>
> I jokely brought up this comparision several days ago. I got fired
> up. One argument was that the analysts/economists made mistakes about
> Japan. Can they make mistakes again?!
>
> **
>
> "The poorer regions of inland China can mop up any excess liquidity
> churned out by the more prosperous coastal regions. "
> How?
>
> "They can trade more extensively with other Asian nations in part
> to make up for the shortfall of exports to the developed countries.
> "
> Granted that there are in-asian movement. Are most of the countries
> in that regions export-depedent, mainly to the developed countries?
> Do you think it is enough to fill the slack.

Jul 31 02:36 PM