When is a Bubble not a Bubble?

by Stuart Burns on November 25, 2009

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So is Asia in the grip of a bubble or just enjoying a healthy reaction to excessive gloom and doom of the end of last year? That’s a good question that is taxing many both in the region and observing from afar. Frederic Neumann, Senior Asia Economist at HSBC in Hong Kong, is reported in the FT as saying, “If left unaddressed, the current monetary set-up in Asia will ultimately blow a bubble of mind-boggling size, but so far the train has not left the station. He points out that the most spectacular price rises have been limited to pockets such as luxury flats in Hong Kong and the biggest Chinese cities, with increases for more mainstream properties remaining subdued. Even in China and Hong Kong, prices are well below the levels they would need to reach to match previous bubbles.

Nevertheless the article does state that luxury apartment prices in Hong Kong are now 30% above their low point in the fourth quarter of 2008, with prices up 14% just between the second and third quarter this year in some neighborhoods. Likewise in Singapore, prices for private homes rose 15.8% in the third quarter from the second, the first such rise in more than a year. In China, prices are up 37% year-on-year. In fact property prices are rising across Asia but only Australia has taken the step of raising interest rates to cool demand.

Frederic Neumann may be right about Asia in general but in China, Zhang Xin, chief executive of Soho China, one of the country’s most successful privately owned property developers, is reported in a different FT article as saying a property bubble was forming and was leading to rampant wasteful investment in the sector, undermining the country’s long-term growth prospects. “Real estate prices should only go up because people want to actually use the space, but at the moment we can see more and more empty buildings across the whole country and in every real estate segment, Ms Zhang said. “The rising prices are a direct result of so much money coming from the banks and the Chinese banks should be very worried. My colleague Lisa wrote about this and posted a video clip about a whole city called Ordos in northern China built over five years but still uninhabited because the properties were too expensive for ordinary people to buy. As Ms. Zhang went on to say, “In Manhattan, they have vacancy rates of 10-15 percent and they feel like the sky is falling, but in Pudong (the central business district in Shanghai) vacancy rates are as high as 50% and they are still building new skyscrapers.

So is Asia in the grip of a property bubble, may be not Asia as a whole “ yet, but parts of it are looking worrying and China’s principal dozen cities are looking worrying like property bubbles driven by a government desperate to generate growth in headline GDP but without the leavers to control the allocation of funds efficiently.

–Stuart Burns

  • a

    “worrying?”

    an empty city capable of housing 1m people is a red alarm

  • http://www.spaceclimate.net Donald Rapp

    A senior economist at the Federal Reserve Bank of St Louis wrote a learned paper in 1987 disputing the attribution of stock market crashes to bursting of bubbles. G. J. Santoni emphasized that “Many people attribute the bull markets of 1924-29 and 1982-87 and the subsequent collapses to speculative bubbles in which a crash was inevitable until the bubble burst” and he showed the similarity of these two bull markets with a graph similar to Figure 3.
    Santoni quoted many experts who blamed these bull markets and collapses on “gambling, widespread intense optimism, overpriced due to speculation, absurdly high stock prices, unjustifiably high prices of common stocks, greed and fear, and that the collapse of 1929 was implicit in the speculation that went before.”
    However, Santoni went on to say that “if stock price bubbles exist, economic policy makers face a difficult problem because bubbles suggest that plans to save and invest may be based on irrational criteria and subject to erratic change.” This seems to imply that if the behavior of the investing public is beyond rational prediction, then the Fed is in a quandary as to how to react. But the pejorative tone of the sentence suggests significant doubt that bubbles really do occur, despite the evidence of Figure 3 of Rapp: “Bubbles, Booms and Busts” , for example. Santoni went on to say:
    “If stock price bubbles exist, the periods 1924-29 and 1982-87 are likely places to look for them.”
    This is a very reasonable conclusion. On the other hand, he investigated the possibilities that these increases in stock prices may have been in line with economic fundamentals – whatever that means. Santoni’s complaint seems to have been that there is no economic mathematical formula that can be used decisively to determine whether a bubble is occurring or has occurred. He demanded specific mathematical criteria by which to judge whether in fact a bubble has formed and claimed that attributions of bubbles are made subjectively and that “attributing crashes in stock prices to bursting bubbles adds nothing to our understanding of why crashes occur or how to prevent similar occurrences in the future.” Finally, Santoni concluded:
    “This paper provides evidence contrary to the notion that the crashes were the result of bursting bubbles. Rather, the data suggest that stock prices followed a random walk.”
    Mr. Santoni did not seem to be bothered at all by sequentially repeated ~30% increases per year in stock prices over a several-year period. Such stock price increases seemed to be neither incredible, nor unusual, nor unreasonable to him. And if such increases are indeed in line with economic fundamentals, that would seem to imply that either (1) at the beginning of such a multi-year sequence stocks were grossly underpriced, or (2) that economic growth at 30% per year is commonplace. In fact, no price rise in paper assets seems to have outraged Mr. Santoni’s sense of proportion. The only thing that bothered him was that “crashes occur” and they need to be prevented. In other words, the end product of repeated 30% yearly gains needs to be preserved. If Mr. Santoni could figure out a way of doing that, he would make a vital contribution, and maybe we would all be rich. Finally, it would seem most strange that a random walk would produce a repetitive pattern of the sort shown in Figure 3.
    Economists, and particularly those who are employed by the Federal Reserve have difficulty identifying and characterizing bubbles. Part of their problem seems to be that they are so encased in economic theory that they don’t necessarily observe what is happening around them.

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