Chinese Bubbles

I guess you have to keep dancing until the music stops, right?

SHANGHAI — The spacious duplex comes with crocodile-skin bedposts, hand-carved bronze doors inlaid with Swarovski crystals — and a $45 million price tag.

Signs of exuberance are everywhere. An investor in Shanghai recently bought 54 apartments in a single day; a villa sold for $30 million last year; and in December a consortium of developers paid more than $3.5 billion for a huge tract of land in Guangzhou, one of the highest prices paid for any property, anywhere. In the city of Tianjin, in north China, developers have created a $3 billion “floating city,” a series of islands built on a natural reservoir, featuring villas, shopping malls, a water amusement park and what they say will be the world’s largest indoor ski resort.

Floating islands and indoor ski resorts? Sounds a lot more like irrational exuberance than the normal kind.

Those who buy an apartment here tend to be extremely wealthy, like Liu Yiqian, an eccentric Shanghai entrepreneur whom Forbes magazine says is worth about $540 million.

Mr. Liu, 47, got his start driving a taxicab in Shanghai but eventually made a fortune investing in the stock market. In an interview this week, he acknowledged owning hundreds of apartments in Shanghai (he said he could not remember exactly how many), including a 6,000-square-foot apartment in Tomson Riviera, which he bought in 2008 for about $11.5 million.

“I invest in properties,” Mr. Liu said, noting that he also collects art, antiques and jade. “I think in Shanghai in five to seven years the real estate prices will be even higher.”

Of course, everyone who invests in a bubble has to say that, even if they don't believe it.

Despite the fear of a bubble here, Mr. Tong said his prices were just right, particularly because of so much hidden wealth in China. The publicly listed company is controlled by his family.

“I have a friend,” he said. “She makes maternity clothes. Her company has 20 percent of the world’s market share, and they’re not even a listed company.”

And when the renminbi finally does appreciate, as it will, she's not going to have 20% of the world's market anymore.

But a sales agent at Tomson Riviera says this is the future financial capital of the world, not the dying one.

“Look at this bronze door,” said Wang Yaodong. “That costs $50,000! Look at these Gaggenau appliances. They were made in Germany.” The glasses were imported from Belgium, the Jacuzzi from Italy. And don’t worry about losing your key, he said, “This lock can read the palm of your hand.”

Oh, boy.

Preventing Bubbles

Baseline Scenario touches on the Fed's newfound desire to manage asset bubbles here.

I'm a little bit skeptical of the Fed's ability to do this. They didn't seem to learn much from the dotcom and real estate bubbles.

There will always be bubbles, in the sense that, in the universe of capital allocation, there will always be some segment that is less efficient.

In other words, there will either be perfect equilibrium, or a bubble(s). So the idea that we can eliminate or prevent all bubbles is illusory.

Given that, the question before us should be how to minimize bubbles, and how to isolate their impact.

As always, I think we need to start with reducing leverage and complexity. Complexity feeds bubbles by obscuring their existence through a reduction in market information. Leverage is the mechanism by which they metastasize.

Focussing on these two problems would be a good place to start.