It looks increasingly likely that the latest Chinese stock boom (now abating) was fuelled by a rush of margin financing rather than anything like fundamentals, turning the whole thing into a bit of a house of cards (you don’t say), but just in case you have doubts, here’s UBS’s Lu Wenjie presenting some supporting evidence.
First, a chart and some factoids:
Attempting to identify a bubble is considered a fool’s errand because, as the saying goes, they’re only obvious once they’ve popped.
None of that, however, has stopped Citi’s equity strategist team from attempting to identify the current bubble risk stalking the economy.
According to Robert Buckland and team bubbles are usually formed by four key forces: 1) A new paradigm story supported by convincing fundamentals, 2) surplus liquidity, 3) a demand/supply imbalance, 4) business/benchmark risk amongst asset managers. Read more
Compare and contrast:
Some observers have been arguing that our patience should be wearing thin sooner rather than later. One argument is that policy is very accommodative by historical standards and that many of the reasons for adopting such an accommodative policy no longer pertain. Demand has strengthened substantially, and the threat of pernicious deflation has receded. A second concern is that policy accommodation—and the expectation that it will persist—is distorting asset prices. Most of this distortion is deliberate and a desirable effect of the stance of policy. We have attempted to lower interest rates below long-term equilibrium rates and to boost asset prices in order to stimulate demand… Read more
Housing booms are wasteful — and the subsequent busts are deeply destructive. Worse, they have become bigger and more frequent since the 1970s. An important new paper from Oscar Jorda, Moritz Schularick, and Alan Taylor places the blame on structural changes in the financial sector that exacerbate the impact of excessively loose monetary policy.
This is a continuation of earlier research on the drivers of credit booms and their impact on GDP using data from more than a dozen rich countries going back to 1870, which we covered in detail here. For those who don’t want to reread that post, the two important takeaways are, first, that the growth rate in private borrowing during an economic expansion predicts the severity of the subsequent downturn even when there is no financial crisis: Read more
… are doomed to repeat it.
Or you could say, “have we learned nothing from the crisis?!”
That at least is the assessment of HSBC’s Stephen King regarding the current nuttiness of the market. He joins the growing ranks of concerned types who worry that it’s only a matter of time before the house of cards we are building collapses, especially given that we’re now at beyond 2008 levels on almost all fronts (apart from, you know, things like jobs).
Which brings King in his latest note to question the soundness of inflation targeting in and of itself. He claims instead that it’s the stability of inflation targeting which may be causing the instability:
In a similar fashion, the pursuit of price stability more recently appears to have given way to financial instability. Propagandists for the Great Moderation were inadvertently sowing the seeds for its eventual downfall.
James Montier of GMO is the subject of the latest Welling on Wall Street newsletter, a weekly long-form interview conducted by Kate Welling.
Montier, ever the bear, doesn’t like the negative expected return environment we’re in. He thinks we’ve learnt little from the crisis and that one the biggest risks is that the market isn’t being adequately compensated for the risk it’s being forced to take.
We can’t duplicate too much of the interview here, but consider the following something of a teaser. The questions (in bold) are being posed by Welling: Read more
If Larry Summers is correct about secular stagnation, the natural interest rate is negative and interest rates at current levels are too high to ensure that planned savings match planned investment in a way that generates full employment.
So what does one do about it?
In an op-ed for the Washington Post earlier this month Larry Summers identified three possible responses. Read more
Justin Fox at the Harvard Business Review has collated some interesting extracts from a conversation he had with Alan Greenspan late last year.
What’s striking, as Fox himself notes, is that Greenspan (generally pigeon-holed as a free-market loving Ayn Randian type) is getting pretty Keynesian nowadays. Indeed, having understood that the 2008 crisis revealed a “flaw” in his world view, rather than getting bitter about it, Greenspan appears to have spent the last few years trying to understand where he went wrong.
A period of honest self-reflection has led to some major reversals in his thinking. Read more
One of the most talked about things in economic circles this weekend?
Larry Summers’ speech to the IMF Research Conference on November 8, the video of which started circulating at old fashioned money multiplier rates this Sunday. Read more
Paul Krugman had an insightful post this week on secular stagnation. It alluded to the fact that bubbles may increasingly be coming to our rescue by inadvertently propping up our economy in a way that usually boosts employment.
We might try to figure out why we seem to need leverage and bubbles to have full employment, and try to fix it. More thoughts on that on another day. But what if that isn’t an option?
Here’s an interesting thought for a relatively quiet Tuesday: Does the investment industry’s tendency towards cap-weighted indices cause bubbles?
We arrive at it slightly tangentially via Steve Johnson’s FTfm story on investors considering a move towards fundamentally-weighted indices. These are weighted according to ‘fundamental’ factors (so for instance, GDP for sovereign bond indices) rather than capitalisation (or debt outstanding for sovereign bonds). Read more
John picked up the phone. It was the bank’s legal counsel, Peter Thompson, calling. He had dramatic news. Garland Brothers, one of the world’s oldest banks, would declare bankruptcy tomorrow. As he lay there in his spacious air-conditioned bedroom, unable to return to sleep, John tried to reconstruct the events of the last four years…
So starts a 28-age report by consulting firm Oliver Wyman, ominously titled: “The Financial Crisis of 2015: An Avoidable History.” It’s grabbing some headlines this week, thanks to a Davos-related set-piece by Bloomberg, and is worth a read. Read more
When it comes to asking what the China risk is, there’s a distinct air of ‘whose line is it anyway?’ regarding the cause of the country’s property bubble.
Is it more the fault of households buying second (third, etc.) homes? Read more
Banking regulators have quietly taken a major step towards harmonised global regulation by agreeing to raise worldwide capital requirements whenever an individual country declares a credit bubble as part of last month’s Basel III banking reform package, the FT says. The agreement says that if a country decides its economy is overheated – based on the ratio of credit to gross domestic product – it can require banks within its borders to hold extra capital against potential losses. Regulators in every other country would have to follow suit and impose a proportional surcharge on their own banks, based on the size of those institutions’ exposure to the bubble country.
At least not yet.
Although perhaps best to look away if you’re loaded up on US junk bonds, or Chilean and Indonesian equities in your portfolio. Read more
Matt King — the god of credit strategy at Citigroup — has a block-buster note out on debt — tackling everything from balance sheet recessions to bubbles and busts.
Let’s start with the basics; what does Matt King reckon debt has to do with current market uncertainty? As it turns out — a lot. King thinks leverage in the system is still running high — which means markets are more sensitive to asset price changes. Read more
Still fresh after his performance as the lone dissenting dove on the UK’s Monetary Policy Committee, Adam Posen has now used the expertise for which he is perhaps best known — Japan’s lost decade(s) — to argue in a speech that easy monetary policy doesn’t lead to asset bubbles. Not inevitably, anyway.
Posen’s targets in the speech are the world’s surplus countries, which he believes should embrace more accomodative monetary policy to stimulate domestic demand. Read more
Fears about Chinese supplies of vital rare earth elements have sent the shares of small mining companies soaring, a surge that executives and analysts warn is turning into a bubble, the FT says. China, which is responsible for around 97 per cent of current global production, recently moved to cut export quotas. An index of rare earth company shares has accordingly jumped 35 per cent in the last month alone, expanding on a post-2008 bull run. Analysts have compared the surge to the dotcom boom and the uranium bubble of 2006 to 2008, which also grew on fears over limited supply. The Macro Man blog recently covered the rise of a bubble in the sector, noting that the Chinese move will encourage end users to develop their own deposits via vertical integration, rather than buying at currently high spot metal prices.
Société Générale strategist Dylan Grice is back on the Rudolf von Havenstein trail.
Grice first brought up von Havenstein back in March, noting the Prussian central banker’s penchant for monetising Germany’s debt during the First World War — leading to massive bouts of hyperinflation. Also of note, according to Grice, was von Havenstein’s striking resemblance to one Fed chairman, Ben Bernanke. Read more
Here’s one for a spirited debate.
A new paper from the National Bureau of Economic Research by Jeffrey Wurgler, Nomura professor of finance at New York University, discusses the potentially overlooked perils of indexing. Read more
The IMF suggested on Tuesday that central banks should lean against asset bubbles, Bloomberg reports. In a published paper, the Fund advocates using a range of tools to rein in bubbles, but notes that price stability must remain the core aim of central banks’ monetary policy. The FT’s Money Supply blog notes that this represents an “intellectual shift” in central banking — spurred by the recent crisis.
How’s this for some Friday irony?
The BBC reports physicists have just discovered that, under certain (liquid, ahem) conditions, bursting bubbles don’t just disappear. No, instead they create lots of smaller ‘daughter’ bubbles, which then go on to create even littler bubbles, until they get so small they rupture into tiny aerosol droplets, which are eventually absorbed into the atmosphere. Read more
Europe’s sovereign debt crisis has sparked renewed funding fears for western banks, but their Chinese peers are still in the frame for China’s property bubble.
Or perhaps not, according to Barclays Capital. Read more
The latest edition of the St Louis Fed’s Monetary Trends is literally off the chart, FT Alphaville finds — which should prompt some reflection on the relationship of monetary policy to asset prices. Read more
Lombard Street Research made a succinct case on Tuesday for boom, not bubble, in the Chinese property market. FT Alphaville has the details.
FT Alphaville mulls the debate over whether China can achieve a soft landing.
The following ars technica headline caught the eye of FT Alphaville on Monday: ‘Historian finds tech bubble that didn’t pop (180 years ago)‘.
Ars cited a fresh batch of research by Andrew Odlyzko, author of a paper with an even more intriguing headline, on a subject that is, at best, niche. Read more
Regulators need new powers to control lending practices in targeted financial sectors and products to allow them to prick asset bubbles before they build up, according to the UK’s top financial regulator. Calling for a “radical reassessment” of global banking rules, Lord Turner, chairman of the FSA, argued in a speech that politicians and regulators had to rethink the view that more lending and bigger markets are always better. They also needed to consider whether to impose transaction taxes and higher capital charges on banks.
Breaking news — Chinese property prices just got a little more inflated.
From Bloomberg (emphasis ours): Read more
Gold is rallying — but is it all because of one man’s lack of faith in the euro?
As Bloomberg reported on Monday: Read more