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Identifying bubbles

September 15, 2009

One of the biggest debates about China today is whether it is at the stage of asset price inflation or has entered into a bubble. Here are some useful quotes from leading bubbleologists to help you decide:

Charles P. Kindleberger, author of Manias, Panics and Crashes: A history of financial crises, uses the term bubble to mean any deviation in the price of an asset or a security or a commodity that cannot be explained in terms of the “fundamentals”. Small price variations based on fundamentals are called “noise”.

Kindleberger and co-author Robert Aliber explain further: The bubble involves the purchase of an asset, usually real estate or a security, not because of the rate of return on the investment but in anticipation that the asset or security can be sold to someone else at an even higher price; the term “the greater fool” has been used to suggest the last buyer was always counting on finding someone else to whom the stock or condo apartment or the baseball cards could be sold.

In an effort to determine how bubbles form, Robert Shiller focuses on a psychological feedback loop among investors, who become ‘attracted to an investment irrationally because rising prices encourage them to expect, at some level of consciousness at least, more price increases. A feedback develops – as people become more and more attracted, there are more and more price increases. The bubble comes to an end when people no longer expect the price to increase, and so the demand falls and the market crashes.’

All this wisdom is helpful, but it is still very difficult to distinguish between a rise in asset prices caused by irrational exuberance and one which is driven primarily by improving fundamentals.

Take Chinese property as an example. Billions of dollars of infrastructure money has improved the value of the land so property prices deserve a revaluation. The demand for property seems to have drive up prices to the point that rental yield becomes very low, indicating that prices might have gone ahead of themselves.

That’s why I will save this for the last quote. ‘The first lesson about bubbles,’ according to Allan Meltzer, ‘is that all explosive movements are not bubbles.’

(Credit goes to Andy Rothman, China strategist at CLSA who compiles the quotes)

Comments

Good one,

Does bubble therefore = stagflation or hyperinflation or neither ?

Posted by Casper | Report as abusive
 

What would this mean for holders of portable assets like Chinese art and antiquities?

 

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