Chinese Dream Of Investing In The US Market: Identifying Speculative Fanaticism And Financial Crisis

Can we identify speculative fanaticism before the bubble burst? Can we see it before the outbreak of financial crisis? Looking at the views of famous economists, central bank officials and Wall Street authorities in the past ten years, the answer to these questions is: impossible!

But in fact, bubbles can be identified beforehand. Though often ignored, there are indeed some people studying the leading indicators for judging the financial crisis. A few years ago, many indicators in this set of indicators reflected that the economy of the United States and some other regions was very fragile. Today, these red warnings are hovering over the "new favorite" of Wall Street, China.

There were many common features of past speculative frenzy and financial crisis. Next, I will list the ten characteristics of the famous bubble in the past three centuries.

　　 1. huge investment disasters often start with a convincing growth story.

It can be revolutionary new technologies, such as railways in nineteenth Century, radio in 1920s, or recent Internet. Even if these technologies are true, their expected growth rate may be overestimated. The rapid growth of early years often leads people to predict that this growth will continue in the distant future.

Similarly, such growth myth may also target a particular economy. An economy will have the potential to become a hegemon. In many cases, it is often a dream of investors. The French Mississippi bubble in 1719 was inspired by the Compagnie des Indes (John Law) of India, believing that it could make France a European hegemony. In the late 1980s, investors in Tokyo came to believe that Japan could take the place of the United States as the world's leading economic power.

　　 2. blind trust in the ability of the authorities is another characteristic of fanaticism.

In 1920s, because of the establishment of the Federal Reserve, people believe that the cycle of economic prosperity and recession has ended. A "new era" has begun. People believe that stocks are no longer risky and stock valuations have risen sharply. In the mid 90s of last century, a similar reason was also popular. It was believed that Federal Reserve Chairman Greenspan had tamed the business cycle. The "new paradigm" disappeared in the bear market in the new millennium. Soon, it was replaced by Bernanke's theory of "great moderation", and Bernanke believed that a high level of mortgage debt is feasible because the level of monetary policymakers has been greatly improved. Well, it turns out that "great moderation" is just another ridiculous self comforting: when people are being deceive, they often comfort themselves: "this time it is really different."

　 Three Investment The general increase.

This is another leading indicator of financial disaster. In blind optimism, capital is often squandered. Only after the bubble burst did the consequences of this mismatch come to light. As John Stuart Muller, an economist in nineteenth Century, said, "panic does not destroy capital." John Mills Capital was destroyed before it was invested in hopeless useless projects, and panic only reflected the extent of the destruction.

In the frenzy of railway investment in Britain in 1840s, three railways were built between London and Peterborough. But in fact, only one railway is enough. After the technology bubble burst, the new optical fiber network has been redundant for many years. In a recent world economic outlook released by IMF, it is pointed out that the high proportion of investment in GDP often leads to the most serious and long-term economic downturn in the country.

　 4. the rise of corruption is always accompanied by great prosperity.

As Walter Bagehot, a great journalist and economist in Vitoria, said, "everyone is most likely to trust others when they are happiest. When they get the money, they will have an excellent opportunity to deceive them." American economist Galbraith (John Kenneth Galbraith) describes the chain of fraud in the book The Great Crash 1929. "During prosperity, people are always relaxed, willing to trust others, and always have a lot of money. But even if there are more money, there are always some people who want more money. In this case, the proportion of corruption will increase, the probability of being discovered will be reduced, and the stolen money will be more. "

　　 5. loose money.

The strong growth of money supply is another important indicator of the fragility of the financial system. Since the tulip fever incident in 1630s, there has always been a sign of loose money behind all major speculation. Low interest rates allow investors to seek higher returns and more risky investments. Walter Bagehot wrote, "John Bull can take a lot of things, but it can't afford 2% interest rates." He remarked that when interest rates drop to such a low level, people will be driven to invest in some unreliable things with a lot of money saved, such as a canal leading to Kamchatka, a railway to go to Watts, a plan to resurrect Dead Sea, and an enterprise to transport ice skates to the tropics.

　　 6. fixation exchange rate 。

Countries with fixed exchange rates often generate unreasonable low interest rates, which can easily lead to prosperity, but will eventually end with a bubble burst. The founder of the European Monetary Union ignored this point. He brought low interest rates and prosperous real estate to two small member countries, Spain and Ireland. The fixed exchange rate also created the Asian financial crisis in 1997. Massive capital inflow is another important indicator of financial instability.

　　 7., credit is growing crazily.

Crises usually occur after a long period of crazy growth in credit. The debts borrowed during the boom period can not be repaid. Economists from the bank for International Settlements show that loans are seriously out of track, showing extraordinary growth, with a 80% probability of financial crisis. Recent research on credit boom in the past 1.5 years also shows that "long term extraordinary growth in credit is an important predictor of the financial crisis."

8. moral hazard.

Moral hazard is another common feature of huge speculative fanaticism. Because people generally believe that the government will not let the financial system problems, the prosperity of loans tends to go to extremes. Irresponsible behavior has been conniving. During the term of the Fed, Greenspan generally believed that if speculators were in trouble, he would lower interest rates and inject liquidity into the market. The Greenspan strategy is responsible for the technological bubble in 1990s and the real estate boom in the new millennium.

Nine financial structure Become unstable.

The increase in debt is not the only thing to worry about. Economist Hyman Minsky found that during the boom period, the financial structure became unstable. The investment made with borrowed money can not repay the loan. (Minsky calls it Ponzi scheme). As a result, the financial system will become increasingly fragile. Even minor events, such as small interest rates or falling asset prices, will lead to major events. The high leverage investment trust in 1920s and the subprime CDOs in recent ten years are typical examples of Ponzi scheme.

　 10. rapid rise in real estate prices.

Risky loans are often guaranteed by real estate mortgages, so the rapid growth of loans at the same time as the rapid rise of real estate prices can predict the painful bubble burst in the future. When real estate crashes, a lot of new housing will make things worse. Spain, Ireland and the United States have recently provided bloody lessons.

In conclusion, research shows that the rapid growth of credit is the most important leading indicator of the instability of the financial system. The emergence of asset price bubbles is the second most reliable indicator of crisis. Low interest rates and rapid monetary growth are also good warning signs. Because of the capital mismatch caused by investment bubbles, the collapse of the housing market will cause serious and long-term economic recession. Typical speculative fanaticism is often accompanied by a convincing growth story and blind faith in the authorities. All this is exacerbated by moral hazard and rampant corruption.