MONEY OBEDIENCE

Bubbles, bubbles everywhere

We recently wrote about the Black Friday mania and the similarity between shoppers’ herd behavior and the gold bubble. Then we commented on a blog that talked about investing bubbles, one of which was the gold bubble. We added one investing bubble that had not been listed in this blog post: emerging markets, foremost of which is China’s economy. The author of the post responded that it was just plain old silly to add China. So, I’m gonna be really silly and write an entire post about the emerging markets and China bubble.

Why are emerging markets bubbles? Let’s look at two major ingredients for a bubble and see whether we can apply them to the emerging markets scenario.

First major contributor to a bubble: excess liquidity. The Chinese are sitting on around two trillions in Dollar assets, mostly held in Treasury bonds. The Chinese just have too much money in their economic system. (Other so called emerging markets like Taiwan, Korea, and Brazil are also flooded with Dollars.)

What do they do with all that money? You might not be surprised that they buy things like gold and real estate. No wonder prices of these assets are rising. As prices rise, these assets become more attractive to others, who then buy and push up prices even further. This is exactly how a liquidity-induced bubble forms.

All this money sloshing around in these emerging markets has an affect on other prices too, like consumer prices. For example, The Economist looked at the Big Mac index – it is calculated to compare the prices charged in different countries for a Big Mac. Guess what? You can find one of the most expensive Big Macs in Brazil where it costs $5.26 compared to $3.71 on average in the US. It does not make sense to me that the Big Mac should be that much more expensive in a country that was practically bankrupt only some 25 years ago and that is known for its slums (favelas) around the big cities.

Second major contributor to a bubble: the belief that “this time it’s different.” Most people have the same reaction the blogger did who responded to our statement that China was in a bubble. This-time-it’s-different becomes the standard explanation why things like China are not a bubble. This-time-it’s-different is required for the motivation to pay exorbitantly higher than normal prices for an asset in the first place. So, the response to our blog comment actually gives us further evidence for our belief that China is a bubble market.

If you want a good analysis of the real estate bubble in China and why things are really not different this time around, read the article “Empty Flats” by the renowned China analyst and China bear, Andy Xie. His analysis sounds all too familiar to what happened in places like Florida until about three years ago.

Please keep in mind that we are only relaying our opinion about potential current bubbles. Do not use our opinion as a basis for your investment decisions. Please also keep in mind that by reading this blog you agree to the site’s User Agreement.

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Posted in Investing