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Steven Jon Kaplan began in August 1996 as a weekly blog and later expanded this to a daily newsletter with intraday updates in February 2006. He has been trading his own account, and those of family and close friends, since 1981, and handles separately managed accounts for... More
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  • Japan, Ireland, and China.
    • Today's main topic is Japan, Ireland, and China.

      Here's your quiz for the day: what do the above three countries have in common? Great food? Good try, but not quite. Distinctive cultures? Of course, although that's not what I had in mind. Wonderful music? Certainly; I thought about this update while listening to one of my favorite songs, "Dublin in the Rare Old Times", written by Pete St. John in the 1970s and beautifully performed here by Rick Fannin:

    • Dublin in the Rare Old Times

      Is that a clue? Consider this: what did everyone think about Japan in the 1980s, especially near the end of the decade? Almost any positive adjective will do. What did everyone think of Japan eight years later? As negative as it had been positive. What happened to the Japanese miracle? Real-estate prices at three times fair value plummeted, causing a major recession.

      Now let's progress to the Celtic tiger, also known as Ireland, which had the world's highest growth rate from the middle of the 1990s to the middle of the past decade. Any description of Ireland's economy was one superlative after another. What has happened since then? Only the world's most dramatic economic collapse. What happened to cause the Celtic tiger to go back into its cage? Real-estate prices at three times fair value plummeted, causing a major recession.

      Okay, now it's China's turn. Anyone who hasn't figured out the answer must head for the back of the class. China has been the envy of the world with its double-digit GDP growth rate for several consecutive years. China is going to allegedly take over the world. China's currency is supposedly wildly undervalued. What could happen to cause a shift in this situation? Well, just the minor point, hardly worth mentioning in polite company, that real-estate valuations in China are at three times fair value in many cities--and at four, five, six, seven, eight, nine, or ten times fair value in some urban areas. Is this going to be a problem? Don't see why it should be, right? After all, it's different this time--NOT.

      The collapse of the Japanese real-estate bubble happened so long ago that those in recent years can perhaps be forgiven, if indeed forgiveness is the appropriate word, for thinking that it was a unique case since the Japanese drink sake and eat sushi and wear those odd clothes on special occasions. That, plus the language, it's so hard to read that no wonder the economic miracle didn't last. One sharp fellow in Dublin noticed the similarities, but everyone thought he was a nut. Below is one of the best-written economic essays I have read in several months, perhaps even in several years, which makes my own writing style appear positively amateurish in comparison. It will take you some time, but I highly recommend this fabulous essay about Dublin and how its real-estate collapse led to an even worse situation than in that well-known poster child, Iceland:

    • When Irish Eyes Are Crying

      The real tragedy of the present situation is that it's not only China which has a severe real-estate bubble today, although it is by far the most blatant and dangerous case. I went through a list and came up with about seventy countries in which real estate is roughly twice fair value or higher, with numerous individual cities including Vancouver, Melbourne, and elsewhere at three times fair value or higher. The inescapable truth is that a real-estate bubble anywhere creates the illusion of prosperity, but will eventually lead to economic despair. Unlike true growth in wages or living standards or GDP, a real-estate bubble is a facade, a cruel tease which causes people to stop saving money since their houses are their retirement plans, so why not buy a few more with borrowed money so we can all get rich.

      There are always excuses in the media about why a given real-estate bubble won't burst. Each case is treated as though it were entirely separate from the others: Japan had dangerous collusion between banks and the government; the U.S. had subprime mortgages and foolish mortgage repackaging and zero down payments; Ireland had virtually unlimited liquidity and access to borrowed money; China has strong central government control; and so on. In other words, any obvious similarities between Japan, Ireland, and China are dismissed due to irrelevant minor issues. Sure, you can tell yourself that if it hadn't been for liar loans, the U.S. real-estate bubble would not have collapsed, or that without implicit government collusion, Irish real estate would have continued to move higher, but that's pure nonsense. Any asset which reaches twice fair value is at severe risk of plummeting, and any asset which reaches three times fair value is a terrible accident waiting to happen.

      Of course it's convenient for financial analysts to pooh-pooh the idea that anything bad can happen in China. After all, the government is in charge. Can't they just make real-estate prices just keep going up? Sure, and they can decree that the country is going to make a great leap forward. China has enjoyed such persistent economic success in recent years that some have concluded that lack of democracy is actually a positive feature of their economy. No doubt this would be wonderful news to even more repressive regimes around the world, but of course real life works otherwise. Those who thought six years ago that housing bubbles only collapse in countries where people eat sushi, or who believe today that a highly centralized, corrupt bureaucracy guarantees eternal prosperity, are going to have to relearn the same lessons of history all over again. Two years from now, of course, they'll say how "obvious it was" what would happen--so obvious that they're saying the exact opposite today.

      One fellow who lives in London takes personal umbrage at any negative comments that I make about China. I think he visited there for a grand total of two weeks and thereby considers himself a brilliant expert on the topic. I admit that unusual economic success has its siren call: I visited Japan in October and November 1987 in order to see up close what an economic "miracle" was all about and whether it made sense. One of the first people I encountered, at a Shakey's Pizza shop where I had all-you-can eat pizza lunch with some amazing flavors, was a missionary who had lived in Japan since the days of the American occupation in the late 1940s. He spent almost the entire conversation telling me what a genius he was for buying a house way back when, which made him richer than all his classmates who had pursued careers in medicine, law, and business. In those days, I was just beginning to refine some of my contrarian concepts, so I didn't have sufficient historic perspective or well-formed ideas with which to argue his main points. At the height of the real-estate bubble in Ireland, National Public Radio featured a woman who owned a small house in the worst years of postwar Ireland, and stubbornly refused to sell year after year. In 2006, she was offered a huge sum for it, and still insisted on holding on indefinitely. She was treated almost as a revered example of how you should stick with your plans through thick and thin. In China today, a person's status is almost entirely a function of how many houses that person owns and where those houses are located.

      It's going to be a particularly long, tough road down in a country like China, since there is no recent history of capitalism. People in China don't believe that sometimes you make money and sometimes you lose money. They know you can sometimes lose money in the stock market, but with real estate it's "guaranteed" that you'll come out ahead. Whenever there is the least concern about risk, risk is always greatest. The world has also forgotten that the real-estate collapse in relatively few countries led to the most severe recession worldwide since the Great Depression. As the far more numerous and more exaggerated real-estate bubbles today soon collapse, it's going to be at least as bad as the last bear market and probably worse. This is probably why the cracks in the facade are already growing wider: funds of Chinese equities including FXI have been in downtrends for three months, with similar behavior in many other emerging markets with the most overvalued real-estate prices.

      Japan, Ireland, and China are all countries which experienced economic miracles which were followed by spectacular economic collapses. In all three countries, real estate reached an average of more than three times fair value in most cities. Japan and Ireland have already seen their fortunes plummet; China has not. There are two kinds of people: those who believe it is indeed different this time in China, and those who know better. The players have changed but the game is the same.

    Disclosure: I am long TLT.

    Additional disclosure: In addition to my substantial new long position in TLT, I am short QQQQ, SLV, and EWY, in that order.
    Feb 07 4:43 PM | Link | 2 Comments
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