9月15日，《China Daily》刊登上海交通大学上海高级金融学院(SAIF)副院长、金融学教授朱宁的评论文章《Why we are forever blowing bubbles》。

 

 

The slowing of Chinese economic growth and cooling of the real estate industry have heated up the debate about whether housing and the economy as a whole have formed bubbles.

 

This is a tough question. Even after many conversations with Nobel laureates, I have no clear answer.

 

What exactly are economic bubbles anyway? Charles Kindleberg, a renowned Harvard economist who has studied them, says they are "unsound economic undertakings, often accompanied by highly speculative investment and price increases".

 

The price increases themselves cause investors to think prices will keep rising without end. A key feature is a lack of fundamental support and a self-fulfilling prophecy. Traditional valuation methods are discarded during stock bubbles such as the Internet bubble of the late 1990s. Similarly, fundamental property investment criteria were ignored during housing bubbles in Japan, Hong Kong and the United States.

 

Ignoring basic criteria leads people to believe that "this time is different". The market sometimes comes up with "ingenious innovations" such as "price to sales ratio" to support ridiculously high asset prices. Ideas that later seem preposterous may appear reasonable.

 

The South Sea bubble was embraced in Britain in the early 1700s. The South Sea Company was a British firm that won a monopoly in trade with Spain's American colonies. An influential legislator declared that the rise in South Sea Company stock prices would benefit shareholders, the government and the common people connected to the company. So even if share prices were unreasonable, they were accepted as sustainable and beneficial. When the bubble burst, many British families lost their life savings.

 

Too much attention to short term prices, and obliviousness to the fundamentals, are key characteristics. During the 17th century tulip bubble in the Netherlands, a single prized bulb sold for as much as 20 townhouses in central Amsterdam. During Japan's real estate bubble in the late 1980s, the land under Japan's Royal Palace in central Tokyo (about 2 square kilometers) was estimated by some as more valuable than the total land value of California. What is intriguing is that investors were not turned off, but, if anything, attracted. This is a perverse aspect of bubbles: They are self-fulfilling prophecies. It is the belief that prices will keep rising that produces the bubble.

 

While bubbles are not always easy to define, economists have reached some consensus on their cause.

 

First, there is technological and financial innovation.

 

They are associated with a new product, a new technology, a new market, or a new region. Because of the emergence of new things, people feel they cannot rely on existing benchmarks to evaluate novel opportunities, providing ample room for speculators to spin their stories.

 

Because of the "mysteries" surrounding new things, investors are motivated to make speculative bets. Early successes stimulate the market to become foolhardy. Investors are driven by wishful thinking that the new things will change their lives forever. Innovations in business models and financial products can sometimes be even more convincing. New financial products that promised to help everyone realize the dream of home ownership proved to be too good to be true. Because such innovations take a longer time to be shown for what they really are, bubbles may last even longer and cause even greater damage.

 

Second, there is excessive liquidity.

 

Economic historians point out that there is always unprecedented excessive liquidity behind every major economic bubble. The Netherlands, the United Kingdom, the US and Japan, each the world's strongest economies in their time, have all experienced bubbles and busts. That is partly because with fast expansion, policymakers engage in accommodative, if not lax, monetary policy. Also, with fast growth, international capital is pulled in, exacerbating the excessive liquidity.

 

So, too much money chases limited investment opportunities, which drives down the investment return of safe assets (such as the US Treasury rate during the 2007-09 US housing bubble), motivating investors to chase risky investments that promise higher returns. Many investors gradually lose their sense of risk aversion and greed takes over.

 

Short-term price increases further solidify investors' beliefs. They also give policymakers a false sense of confidence for further policy easing, which is easier than popping the bubble. That further strengthens the market's belief that government would not let the market crash, inducing even greater speculation.

 

Nobel laureate economist Vernon Smith showed that the more liquidity available given the same number of securities, the bigger the bubble and the longer it would last. Such experimental findings are strongly supported by historical anecdotes.

 

The third ingredient is inexperienced investors.

 

Smith also shows that the more experience investors have, the less likely a bubble. If subjects in an experiment have never participated in the simulated market, a bubble is likely. However, if they have, then the scale and length of the bubble would be greatly reduced. In cases where all participants have participated in the experiment three times, there was no bubble at all.

 

Experience helps investors better perceive risks. Some US researchers found that those who lived through the Great Depression were less likely to participate in market mania such as the Internet or housing bubbles.

 

Why does that matter? If some investors foresee that the bubble might burst soon, they are likely to sell early. That may prompt others to worry about the sustainability of the bubble, inducing greater and earlier selling. So bubbles would burst earlier. Unfortunately, humans have short memories. Only a few years after the 2007-08 global financial crisis, people have already started to forget and are talking about a new round of stimulus and easing.

 

The fourth element is government support. Another astonishing fact is that the government's hands have been behind almost all bubbles. The government allowed excessive liquidity, providing a foundation for bubble development. Governments explicitly or implicitly supported or even encouraged bubbling asset prices. Government encouraged the taking of irresponsibly large risks by providing implicit guarantees.

 

In the middle of the tulip bubble, the Dutch government announced that for a small fee, tulip contracts could be invalidated. With such insurance-like policies, it provided peace of mind to speculative investors. The essence of such policies is very similar to the credit default swap contracts that directly contributed to the US housing bubble and subsequent market crash.

 

Finally, there is the role of finance.

 

Finance undoubtedly is a scapegoat after almost every financial crisis. Society blames the financial sector for creating excessive risks then abandoning basic moral standards in coercing the rest of society to bail it out after the bubble bursts.

 

Granted, capital markets have become far more powerful. However, the financial industry can be only as powerful as the degree to which their clients choose to ignore risks and accept the fantastic pitches of those who sell financial products.

Why we are forever blowing bubbles