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A Cautionary Fable
ONCE UPON a
time, Western opinion leaders found themselves both impressed and
frightened by the extraordinary growth rates achieved by a set of
Eastern economies. Although those economies were still substantially
poorer and smaller than those of the West, the speed with which they had
transformed themselves from peasant societies into industrial
powerhouses, their continuing ability to achieve growth rates several
times higher than the advanced nations, and their increasing ability to
challenge or even surpass American and European technology in certain
areas seemed to call into question the dominance not only of Western
power but of Western ideology. The leaders of those nations did not
share our faith in free markets or unlimited civil liberties. They
asserted with increasing self confidence that their system was superior:
societies that accepted strong, even authoritarian governments and were
willing to limit individual liberties in the interest of the common
good, take charge of their economics, and sacrifice short-run consumer
interests for the sake of long-run growth would eventually outperform
the increasingly chaotic societies of the West. And a growing minority
of Western intellectuals agreed.
The gap between
Western and Eastern economic performance eventually became a political
issue. The Democrats recaptured the White House under the leadership of a
young, energetic new president who pledged to “get the country moving
again”–a pledge that, to him and his closest advisers, meant
accelerating America’s economic growth to meet the Eastern challenge.
The time, of
course, was the early 1960s. The dynamic young president was John F.
Kennedy. The technological feats that so alarmed the West were the
launch of Sputnik and the early Soviet lead in space. And the rapidly
growing Eastern economies were those of the Soviet Union and its
satellite nations.
While the growth
of communist economics was the subject of innumerable alarmist books
and polemical articles in the 1950s, Some economists who looked
seriously at the roots of that growth were putting together a picture
that differed substantially from most popular assumptions. Communist
growth rates were certainly impressive, but not magical. The rapid
growth in output could be fully explained by rapid growth in inputs:
expansion of employment, increases in education levels, and, above all,
massive investment in physical capital. Once those inputs were taken
into account, the growth in output was unsurprising–or, to put it
differently, the big surprise about Soviet growth was that when closely
examined it posed no mystery.
The source of the cautionary fable
outlined above is Paul Krugman’s 1994 essay titled The Myth of Asia’s
Miracle. While we applaud Morgan Stanley’s Stephen Roach for
his plea to take a baseball bat to Krugman for “giving
Washington very, very bad advice,” we can’t help but think that the
Nobel Laureate got this one right. A few short years following the
publication of this essay, the Asian Crisis proved that trees don’t grow
to the sky.
Consequently, it is important for
investors (and politicians) to understand that the concerns surrounding
the rise of China today are not new. In fact, they are quite similar to
past threats faced by our great nation – the Soviet Union in the 60s,
Japanese Superiority of the 80s, and the Asian Tigers in the 90s. The
lessons learned, from an investment perspective, are no different than
the countless experiences of bubbles past – if something can’t go on
forever, it won’t. If it seems too good to be true, it probably is.
More often than not, investors are rightly focused on the odds that circumstances turn
negative. But every so often, it is much more important to consider the
consequences of these
low probability events. With so many believers in today’s Chinese
growth miracle and China’s path to world dominance so obviously clear,
risks to the downside are not immaterial.
There is no such thing as a bad
investment; only a bad price. We were constructive on Chinese equity
markets early last year, as we discussed in the First Quarter 2009 Broyhill
Letter. We still believe that Blowing
Bubbles in emerging markets may well develop into the
next Financial Mania. But after triple digit percentage increases from
the panic lows reached one year ago, investor fear has been quickly
replaced with greed. And greed has an unfortunate habit of making
investors blind to risks. We’d encourage China bulls to consider the
following:
- Chinese leading economic indicators are
stalling and topping out, whereas they were recovering from depressed
levels last year.
- Chinese Fixed Asset Investment as a per
cent of GDP is massive and unprecedented in history. See Krugman’s
essay for implications.
- Chinese Real Estate is a bubble. Period. A recent NYT
article notes that apartment prices in Shanghai have reached up to
$200K where most residents earn less than $5K annually.
Can the Chinese economy and risk assets continue their relentless
march higher? Sure. Forecasting the timing of such trend changes is
always a challenging (and frustrating) exercise. But just because the
timing is questionable, doesn’t mean the risks should be ignored. GMOs
Edward Chancellor outlines many of China’s
Red Flags in a recent white paper. I’d hope we’ve learned at least
that much from our own domestic housing bubble which defied gravity for
longer than most anyone expected. We wonder how industrial commodity
prices would fair if the Chinese decided that 30 billion square feet of
office space is probably enough for now . . .
Disclosure: At the time of publication, the author was short
iShares FTSE/XINHUA China 25, although positions may change at any time.
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The latest from Martin Armstrong just published today sheds some light on the decline of the USA & the emergence of China. In the mean time, he's been forced to sleep on the floor of his prison sell. Disgusting...
http://www.scribd.com/From-the-Hole-7/d/29424807
It sounds like if you take an agrarian peoples and turn them industrial they will always explode.
The basic premise is insanely wrong.What entire industries were exported to behind the iron curtain?What western powers sent truckloads of capital behind the iron curtain?
Contrast that with today and China is in no way comparable.It is different, very different.
Getting this distinction wrong makes me question the entire article.A lot.
Not to support the article, and I do agree with your argument, but consider the following. A great deal of technology existed within Germany at the end of WWII that was absorbed into both the US and USSR more or less equally. That simultaneous injection of new technology into both societies/cultures presents an interesting case study. Accounts for the exported industries quotient. As far a truckloads of capital, when loaning money to the king how do you insure your head isn't lopped off when the note becomes due?
Emerging markets are our equivalent of a rainy day fund.
America. F*ck Yeah!
Chris, this is an excellent piece that will change my investing/trading!
"More often than not, investors are rightly focused on the odds that circumstances turn negative. But every so often, it is much more important to consider the consequences of these low probability events " -- yes! that exactly was my thinking. i thought too mucg about the odds of the "black swan", and not enough about the consequences!
Economist tend to overestimate growth and underestimate downturns. They also tend to overestimate the effects of government intervention in pull demand forward programs. They will get the demand right when intervention is done, but will act surprised when demand falls correspondingly after the program. The stimulus has a lot of demand forward programs. The problem with moving demand forward is it will return to equilibrium. The government is fighting the housing market deflation. The price was wrong in 2008 because anyone could get a loan for 8 years. You either return to those conditions or you allow the price to retrun to equilibrium. People say the banks aren't lending, they shouldn't. The collateral is going to decline in value unless there is inflation, and if there is inflation in the future, the interest rate the banks would have to charge right now would be higher than what the government is charging. This can't go on forever and with the unemployment rates where they are, the housing market is set for another revaluation.
USSR economy was so successful at the start because it was based on an emotion even stronger for humans than greed: fear.
If you were a factory manager or an official at a State Bank and you did not perform, you were not sacked, you were shot.
Powerful incentive to perform. Russian HR approach.
yes, shot or jailed, but only in the 1930s and 1940s. however, you have to keep in mind that liek everything else in the centrally planned economy, the NKVD (KGB) had their quotas for executions too. as a result, it didn't really matter if you made the numbers, didn't make the numebrs, or made the numbers up. one coudl be jailed/executed if your 2nd in command wrote anonymout letter to authorities stating that you don't like comrade statil or whatnot. most of the time it had little to do with on-the-job performance.
in general, making the numbers up out of thin air was the name of the game. reporting productions that's never took place. reporting 75% built building as compelte, and then "forgetting" about it for next 5 years becasue, well, it was reported as completed and there was no more money to finish it. in two words - central planning
After the third manager is shot for not meeting quotos. The quality of people managing things tends to go down. The intelligent realize they are less likely to shoot a quiet worker.
Another example of diminishing returns.
Agree with Ripped Chunck
command economies are like a plane with a dead stick..push pull do what you will the plane still ends up plunging to the ground ..while the people are told of wonderful success coming soon. great leap foreword, 5 year plans, what entertainment..