A Bubble In Optimism While the World Is Sinking

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We are bombarded from all corners of the country, the media, the television, the neighbors, the internet about how India's growth is unstoppable. 

The World Is Flat is a classic and bible of business.  Business titles about management, creativity, success dominate bookstore displays.  Thomas Friedman is the God of Business in a country that is comfortable with many Gods.  Consensus thinking rules and to be skeptical is akin to being unpatriotic.  It is a reasonable and understandable sentiment pervading the country.

Indians spent 50 years of being mauled by government policies that promoted corruption while suppressing  the entrepreneurial spirit of the people.  India is finally an arguably open market. 

The populace is bought into the growth story.  As with all bubbles, this one will only be evident after the fact.  Property prices have risen almost a 100 fold in many instances.  Not 100%, a 100 fold.  Yet the prevailing sentiment is that property prices will continue to rise.  An apartment in Gurgaon costs roughly $400,000 which would be enough these days to buy a mansion on the ocean in California.  Prices in India are no longer cheaper than the rest of the world.  Purchasing power parity has arrived for goods.  Compensation however is not keeping up.  Average salaries still hover under $25,000 a year for all except the businessman and higher level corporate executive. 

India's success came about as a result of India's cost advantages and economic reform.  Economic reforms continue but the cost advantages are starting to disappear.  Companies are now turning to villages to find cheap sources of capital.  But incremental business on the margin is being lost to the Phillipines and South America, Romania.

No country is an island.  Particularly not today.  Europe is struggling with massive debt and potential sovereign defaults.  The U.S. is not far behind but benefits from the ability to print unlimited amounts of the world's reserve currency and have debts denominated in dollars.  Yet I am told that Africa and islands in the southeast are growing and flourishing and will pick up the slack.

The most worrisome aspect is that Europe and the U.S. - the major markets for Indian exports - are in a deflationary vortex and a double dip recession is likely in the cards the second half of this year.  Europe has had a devaluation of its currency by around 20% which is another way of saying Indian exports just got 20% more expensive to that region.  China is slowing down dramatically as it is becoming apparent to the rest of the world that the growth story there was really a bubble that owes its origins to the now moribund U.S. consumer.

Worry not, I am told.  Government spending and domestic demand will pick up the slack.  Unfortunately, the lesson of the past 2 years from the U.S. and countless other countries over decades is that government spending is rarely an efficient use of capital and its effects are temporary and usually not multiplicative.  Much depends on the monsoon and optimism about the monsoon is justified by the weather forecasters, which may be the only profession with predictive powers worse than those of economists.

Investing is about the future, not the past.  The market already recognizes the growth of the Indian market over the past few years and it is priced in the valuation of stocks.  The future however seems far more doubtful. 

Japan was anointed the new superpower before a dramatic 20 year decline that continues.  The Tiger economies were dominant in the 1990s and anointed kings untill a dramatic collapse in 1997-1998.  China was anointed the next heir to the throne but the fall from the throne looks to be quite nasty.  It is India's turn.  Will India deliver where others have failed.  The consensus thinks so.  The consensus is usually wrong.

The China Bubble

The press is starting to warm up to our view that the Chinese situation resembles Japan in the 1980s. 

I'm not going to call it a bubble because the growth positioning of India is enviable, but the prices of property in Mumbai, Gurgaon and other parts of the country relative to income are astounding, humbling and shocking to me.

China rushes towards a Japan-style bubble

By Peter Tasker

Emerging markets, it seems, have had a good crisis. In contrast to the debt-ridden G7 economies, they have quickly resumed their growth trajectory. No surprise, then, that US emerging market mutual funds are experiencing record inflows. The stellar performance of the Brics markets - Brazil, Russia, Indian and China - is due to continue into the distant future.
Such is the narrative now forming among investors. To anyone who has lived through the rise and fall of the Japanese bubble economy, it should set off alarm bells.

Remember that it was in the years following the 1987 "Black Monday" crash that Japanese assets went from being expensive to absurdly overvalued and the Nikkei's dizzy rise to 39,000 forced the bears to throw in the towel.

Then, as now, the logic seemed unassailable. While the western world was stuck in the post-crash doldrums, the Japanese economy had got back on track with apparent ease. Japanese corporations were using their high market capitalisations to finance acquisitions of foreign trophy assets. Japanese banks boasted the world's strongest credit ratings.
But what you saw was decidedly not what you got. The crisis, far from leaving Japan unscathed, exacerbated its structural problems and laid the groundwork for a far greater disaster. And it was the weak western economies, not Japan, that produced healthy investment returns over the next decade.

In reality, 1980s Japan was never going to be terminally damaged by weakness in export markets. Its current account surplus and strong fiscal position provided the macro policy leeway to make any slowdown strictly temporary. The Bank of Japan duly put the pedal to the metal and the recently deregulated banks went on a patriotic lending spree. High-end consumption boomed but the real action was in the asset markets and capital investment, which soared as a proportion of gross domestic product.

Sound familiar? It should, because the same dynamic is evident today in China and some other emerging economies.

At the 2008 peak, the price-to-book ratio of the Shanghai stock exchange was over seven times, well above the five times achieved by Japanese stocks in 1989. After the turbulence of the past 18 months, the ratio has fallen to 3.3 times, still the world's second highest after India, and residential real estate trades at multiples of income that make the US housing boom look tame.

Why would China's rulers embark on a such a disastrous course? Because the alternative - unleashing deflationary forces stored up over years of mercantilist policies - would be too painful to contemplate. That was the choice made by Japanese policymakers, who had 100 years' experience of managing a quasi-capitalist economy.

While we can call these bubbles, based on anecdotal evidence emerging markets investors are convinced that they have survived and are immune to what ails the first world.  Time will tell, but a nagging feeling tells me I've seen this story before.