29 March 2013

The China Syndrome, Part 2

"I know the vibration was not normal."
-- Jack Godell/1979

Guess what else isn't normal? Chinese are indulging in interest rate inflation the same way we did, by bidding up housing with a flood of moolah. Since the collapse of the US bubble, the Chinese are left to create their own bubble. Good for them. One might wonder whether their quants are putting heavy thumbs on their scales, too.

Remember, this mess all started with Greenspan cratering interest rates in 2001 (not in one swell foop, of course, but the Yellow Brick Road was well paved that early). A significant impetus to move funds from "risk free" instruments such as US Treasuries to housing was simply that industrial investment has become troublesome, in the sense that, at least in silicon based companies, payback period exceeds productive life. That's been an anecdotal assertion. Finally, I found a source that admits this:
Over the past ten years, the semiconductor industry's capital requirements have grown faster than its cash operating profits. As a result, the payback period on invested capital has nearly doubled, from about 0.7 years to about 1.4 years over that same time period (Refer to Appendix for underlying methodology). Product lifecycles in the industry have remained generally unchanged at 18-24 months, however. Soon, the industry will reach a point at which investment is no longer profitable from a cash net present value (NPV) perspective: the payback period on invested capital will exceed the timeframe over which the underlying assets are productive.

In other words, it becomes impossible to actually earn a return on real investment. Oops. Absent profitable real investment, fiduciary investment has the world as its oyster. The problem, of course, is that, ultimately, fiduciary returns are only possible if the underlying payers are themselves beneficially accommodated. This lack of accommodation is why the US housing bubble burst: there wasn't rising median incomes to pay the extra vig. Oops. The Chinese will find that their moolah will be just as wasted on their condos as it was on Florida McMansions. Couldn't happen to a nicer bunch of folks.

I'll mention, again, the NPR piece, "The Giant Pool of Money". The best, and rather early, popular explanation.

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