Seeing the future in the past
By Steven Martinovich
Among Karl Marx's many arguments against capitalism was that there wasn't any long-term tendency towards equilibrium in free markets and that capitalist economies were subject to boom and bust cycles. Given the events over the past few decades one could almost be forgiven for thinking that perhaps the German revolutionary communist and alleged sometime stock trader was on to something. Since the 1990s alone we've seen multiple boom and busts in Latin America, Asia and the United States. What's amazing isn't that they occur; almost every economic theory predicts them, but that few at the time seem to recognize the bubble for what it is.
Global equity investor and Yale University lecturer Vikram Mansharamani would argue it's because we tend to view economies through a single lens and miss some obvious signs. In Boombustology: Spotting Financial Bubbles Before They Burst he argues that a multidisciplinary approach is necessary to spot the ostensibly obvious. Drawing upon disparate soft and hard sciences, Mansharamani asserts it is possible to recognize an inflating economic bubble and plan accordingly. Cold comfort to those who have already suffered through the last few economic dislocations but perhaps a potent weapon for the future.
Mansharamani asserts that booms and the resulting busts are not random events, and therefore can be identified beforehand. By bringing in different lenses from the worlds of fields of psychology, biology, economics and politics, he believes that investors can appraise current economic conditions and react accordingly. After exploring those lenses, he then turns them onto past bubbles including Tulipomania, the Great Depression, the Japanese bubble, the Asian financial crisis, and the recent U.S. housing fuelled boom. In each case, Mansharamani identifies common themes which caused the booms and busts and how they interacted to create each perfect storm.
With that in mind Boombustology argues there are some clear signs that a bubble is forming and it may be time to retreat. Mansharamani notes that unsustainable credit conditions – such as cheap credit, overconfident talk of "new eras" and permanent growth, political distortions of the market and biological factors such as media attention and widespread participation in a market are telling. Indeed, looking back at recent history it's amazing that investors – experts and amateurs alike – didn't see the early warning signs during the dot com and housing market booms, or didn't bother to take heed.
Mansharamani is hardly the first to advocate a multidisciplinary approach to investing but his is a useful exercise for those who tend to invest based on expert advice, the crowd or a single theory. Boombustology underscores the old assertion that the most important assets in investing are information and analysis. Coming up with the correct conclusions is never easy, a survey of business magazines would likely reveal that stock tips from pundits and cab drivers likely have the same rate of error, but the key to investing has always been identifying potential problems. Mansharamani himself would argue that Boombustology doesn't promise perfect knowledge with its tools, only that investors have more variables to consider before deploying their money – making them more informed.
Readers wondering if Boombustology puts the walk into Mansharamani's talk will be gratified to know that he does indeed use his identified tools to view the current economic landscape, but less pleased to learn that he views the Chinese giant as the next likely economic dislocation. While some may hope for China to be knocked down a peg, Mansharamani notes resource-based nations like Canada and Australia, considered relatively safe harbours over the past few years, would suffer with a large Chinese economic downturn – not to mention investors who have bet heavily on the communist nation.
Given imperfect knowledge, politics and human frailty, future booms and busts are all but certain. Past history would suggest that Boombustology will do little to prevent them in the future but Mansharamani should be thanked for giving those interested enough in developing a more nuanced view of investing and economics a toolbox to work with. The question, however, is whether the voice promoting the next tip promising big gains will be louder than the common sense instinct to wonder whether what glitters ahead of us is gold or a supernova about to consume some unlucky people.
Steven Martinovich is the founder and editor of Enter Stage Right.
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