Saturday, March 27, 2010


In the aftermath of the credit crunch, the outlook for most developed economies appears pretty
bleak. Households need to de leverage. Western governments will have to tighten their purse strings. Faced with such grim prospects at home, many investors are turning their attention toward China. It’s easy to see why they are excited. China combines size – 1.3 billion inhabitants – with tremendous growth prospects. Current income per capita is roughly one-tenth of U.S. levels. The People’s Republic also has a great track record. Over the past thirty years, China’s Gross Domestic Product has increased sixteen-fold.

So what’s the catch? The trouble is that China today exhibits many of the characteristics of great speculative manias. The aim of this paper is to describe the common features of some of the great historical bubbles and outline China’s current vulnerability.

Section One: Identifying Speculative Manias and Financial Crises
Can we confidently identify a speculative mania before the bubble bursts? Is it possible to spot an incipient financial crisis before it explodes in our faces? Based on the performance over the last decade of most leading economists, central bankers, and Wall Street pundits, the answer to these questions is surely a resounding NO!

In fact, bubbles can be identified ex ante, as the economists like to say. There also exists an interesting, if rather neglected, body of research on leading indicators of financial distress. A few years ago, many of these indicators were pointing to rising economic vulnerability in the United States and other parts of the globe. Today, those red fl ags are fl ying around Wall Street’s current darling, The People’s Republic of China.

To read the full report: RED FLAGS