04/13/10 Stockholm, Sweden – Despite their bubble-like growth, we’ve recently discussed the investment potential of emerging markets. Similarly, we’ve looked at whether certain bubbles, like housing in China, are real or not so real.
Today, in that same vein, we consider economics professor Kenneth Rogoff’s nuanced view of bubbles and how we can learn to spot them as an ongoing and pernicious phenomena.
From the Financial Times:
“In the classic bubble, an asset (say, a house) can have a price far above its ‘fundamentals’ (say, the present value of imputed rents) as long as it is expected to rise even higher in the future. But as prices soar ever higher above fundamentals, investors have to expect they will rise at ever faster rates to make sense of ever crazier prices. In theory, ‘rational’ investors should realise that no matter how many suckers are born every minute, it will be game over when house prices exceed world income. Working backwards from the inevitable collapse, investors should realise that the chain of expectations driving the bubble is illogical and therefore it can never happen. Are you reassured? Back in my days as a graduate student, I know I was…
“The answer, as Carmen Reinhart and I demonstrate drawing on centuries of financial crises, is to look particularly for situations with large rapid surges in leverage and asset prices, surges that can suddenly implode if confidence fades. When equity bubbles burst, investors who made money in the boom typically swallow their losses and the world trudges on, for example after the bursting of the technology bubble in 2001. But when debt markets collapse, there inevitably follows a long, drawn-out conversation about who should bear the losses. Unfortunately, all too often the size of debts, especially government debts, is hidden from investors until it comes jumping out of the woodwork after a crisis. In China today, the real problem is that no one seems to have very good data on how debt is distributed, much less an understanding of the web of implicit and explicit guarantees underlying it. But this is hardly a problem unique to China.”
Rogoff sees the coming bubble in sovereign debt, and the unique complexities associated with it… both as opposed to equity bubbles, and with the special additional concerns found in emerging markets like China.
He also cites how “huge off-balance-sheet guarantees and borrowings remain hidden for political expedience around the world.” Clearly, this has been a major problem in Greece… but, hopefully it’s not a problem we’ll have crop up at home in the US anytime soon.
You can read the full details in Financial Times coverage of how bubbles lurk in government debt.
Best,
Rocky Vega,
The Daily Reckoning
Rocky Vega
Rocky Vega is publisher of Agora Financial International, where he advances the growth of Agora Financial publishing enterprises outside of the US. Previously, he was publisher of The Daily Reckoning, and founding publisher of both UrbanTurf and RFID Update -- which he ran from Brazil, Chile, and Puerto Rico -- as well as associate publisher of FierceFinance. Rocky has an honors MS from the Stockholm School of Economics and an honors BA from Harvard University, where he served on the board of directors for Let’s Go Publications, Harvard Student Agencies, and The Harvard Advocate.
The Daily Reckoning is your premier source for making sense of the news Washington and Wall Street generate. Each business day, The Daily Reckoning calls on its stable of world-class writers and thinkers to show you how to get ahead.
Start your 100% FREE subscription to The Daily Reckoning today and you’ll get a free research report, “How to Survive the Fall of Social Security.” Simply enter your email address below to get your free report and join over 495,000 worldwide Daily Reckoning subscribers!
We Respect Your Privacy and We will
Never Share or Sell Your Email Address
