In a recent edition, The Economist newspaper warns of the dangers of banking bubbles, fuelled by governmental stimulus around the world. Where should investors turn for advice?
The Economist [Jan 9th 2010] makes its case powerfully:
“In 2008 falling markets caused a vicious circle of debt defaults and fire sales …The Market rebound was necessary to stabilise economies [in 2009] but now there is a danger that bubbles are being created.”
The metaphor of a financial bubble describes a situation which markets show signs of growth, with ‘all signals go’ to encourage further investment and speculation. Some unexpected shock such as a radical innovation (railways, the internet) promises rewards for fast-movers. Credit becomes available for acquiring assets. But warning voices are unheeded, as investors become caught in a frenzy of activity. But the financial dynamics are inevitably followed by a very sudden implosion as the bubble bursts.
There are some principles worth keeping in mind. Almost everyone offering advice has a belief system or map. The better we study of ‘test’ the map, the more we can feel confident and draw conclusions.
The Invisible Hand and Animal Spirits
Since 2008, there has been a growing awareness of the limitations of the so-called Neo-Classical economics associated since the 1980s with Milton Friedman, and taken up in the USA and The United Kingdom under Ronald Reagan and Margaret Thatcher respectively. There has been a rediscovery of elements of John Maynard Keynes and in particular the notion that human behaviour is not simply guided by Adam Smith’s Invisible hand of the market but also by animal spirits which lead individual investors into a collective panic.
A recent book on behavioural economics suggested
The current crisis .. was caused precisely by changing confidence, temptations, envy, resentment, and illusions—and especially by changing stories about the nature of the economy. These intangibles were the reason why people paid small fortunes for houses in cornfields; why others financed those purchases; why the Dow Jones average peaked above 14,000 and a little more than a year later fell below 7,500; why Bear Stearns was only (and barely) saved by a Federal Reserve bailout, and why later in the year Lehman Brothers collapsed outright; why a large fraction of the world’s banks are underfunded; and why, as we write, some of them are still tottering on the brink.
The warning from the Economist was that “The longer the world keeps its interest rates close to zero, the greater the danger that bubbles will appear – most likely in commodities, and in emerging markets, where growth keeps investors optimistic and currency pegs import loose monetary policy”. Unsurprisingly, this is a matter of interest and debate in China at present:
BEIJING (Commodity Online): Is the Chinese economy caught on the verge of a bubble? That is the heated discussion these days among global analysts, investing pundits, hedge fund managers and economic experts.
Noted global hedge fund manager Jim Chanos says China is in a bubble that will burst soon. He says there are some serious problems with Chinese disbursement of bank lending. Chanos says that China’s economy is overheated and thus will burst badly. According to him the Chinese economy is being over-stimulated by its stimulus program of $586 billion dollars. Most of this money is going into speculation and overproduction of goods that China will not be able to sell.
But global commodities investing guru Jim Rogers has blasted Chanos for what he has said on China. Rogers, who has been passionately investing in China for the last few years, says that China is not in a bubble as Chanos has predicted. Rogers, who shifted his residence to Singapore two years back as he felt that Asian countries like China have huge investment potential, says that Chinese economy is on strong and sound foundations. Rogers points out that Chanos may not know the fundamentals of the Chinese economy and the basics of ‘bubbles. [Rogers has] lambasted Roubini’s lack of fundamentals on gold and said that the yellow metal was set to cross $2,000 per ounce in the next decade.
Faced with such conflicting advice, if a commodities investment company were evaluating its portfolio in Asian markets in the next year, what sort of research investigation should it consider commissioning?