Marc Faber spoke with Bloomberg News recently and had some interesting things to say about China and what he sees a burgeoning bubble. His sentiments echo those from Ten ways to spot a bubble in China by Edward Chancellor, author of a well-regarded history of financial manias, Devil Take The Hindmost.
Let me say a few words about China. The clip of Faber is at the bottom (hat tip David).
I first saw a mention of this interview in Bloomberg News’ Business Week yesterday. The article says:
“There are some symptoms of a bubble building in China, with the increase in foreign exchange reserves, rapidly rising property prices,” Faber, the publisher of the Gloom, Boom & Doom report, said in a Bloomberg Television interview today. “From here on, the China economy will slow down regardless. Whether it will crash this year or later, I don’t know.”
The point being that, when asset markets rise, at some point (I use a divergence of two standard deviations from longer-term trend as a rule of thumb), psychology starts to dominate price activity. It is rational that people speculate in an asset class that has risen so far above trend. But, that’s the point at which anything could happen. Mark Buchanan has a good analogy about “fingers of instability” in his book Ubiquity. What he shows is that many different systems reach a critical state in which any minor change in dynamics can have a disproportionate impact on the entire system because of the fingers of instability that have built up. This is the critical state.
Buchanan uses a sand pile as an example where adding one grain of sand to the pile could cause one, ten, one thousand or ten thousand grains to avalanche down the sand pile. What he demonstrates is that systems reach a critical state in which standard distributions (the bell curve) wildly understate event probabilities.
The overall point – one that Jeremy Grantham seems to make in an FT interview as well - is that markets become very unstable as they become far advanced above the longer-term trendline. And while markets always revert to mean, they do so in a violent and unpredictable way once you reach that critical state. That’s what crises are all about: you don’t know when the violent reversion to the mean will happen, but you do no it will happen.
Once bubble psychology takes over, it’s difficult to dislodge it. Remember Greenspan’s interest rate conundrum last decade?
The favorable inflation performance across a broad range of countries resulting from enlarged global goods, services and financial capacity has doubtless contributed to expectations of lower inflation in the years ahead and lower inflation risk premiums. But none of this is new and hence it is difficult to attribute the long-term interest rate declines of the last nine months to glacially increasing globalization. For the moment, the broadly unanticipated behavior of world bond markets remains a conundrum. Bond price movements may be a short-term aberration, but it will be some time before we are able to better judge the forces underlying recent experience.
Greenspan was saying in effect: "I am raising short-term interest rates, but it’s having no effect on long-term rates. I have no clue why I can’t get long-term rates to go up but apparently I can’t steer this thing."
Isn’t it altogether conceivable that the Chinese will face a similar conundrum now that animal spirits are well-entrenched in the Chinese economy.
Yes, Chinese officials are aware of the bubble and are looking to forestall any negative outcomes. But, Business Week points to another comment that Faber makes that bears remembering:
“If you believe the government can steer the economy like a car, that’s not my view,” said Faber, who oversees $300 million at Hong Kong-based Marc Faber Ltd. Government measures “always lead to unintended consequences.”
This is what Chancellor calls "Blind faith in the competence of the authorities." It is a hallmark of all bubbles. Why should we trust the competence of the authorities running things in China any more than we trust those in the US. And confidence in government in the U.S. is at its lowest ebb in decades. It’s absurd that people think the communist leaders of China are better at steering their economy than the leaders of the US have been.
That’s not to say a burst bubble means that China won’t flourish over the long-term. But, there are serious medium-term challenges. In the Bloomberg interview, Faber points this out using early American boom-bust cycles as an example. He covers a lot of other good points on China as well.
Sources
China Exhibits ‘Danger Signals,’ Marc Faber Says – Business Week
Testimony of Chairman Alan Greenspan, Federal Reserve Board’s semiannual Monetary Policy Report to the Congress Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate February 16, 2005