THE great Charles Kindleberger described the pattern of how bubbles form and then burst in his book "Manias, Panics and Crashes". His model, which was linked to the work of the economist Hyman Minsky, saw the process as having five stages: displacement, boom, over-trading, revulsion and tranquillity. China looks like it is following the model pretty closely, having reached stage four already. The Shanghai Composite rose 130% between September 2014 and June 12 this year and has fallen 31% since then, with another 6% decline today.
To explain the model in more detail, the first stage (displacement) sees some economic change (a new narrative, if you like) that encourages investors to take an optimistic view of the asset class. Think of how the internet was a "new paradigm" in the late 1990s. Prices begin to rise; this draws more investors into the market, pushing prices higher (the boom stage). When prices are booming, even more money can be made by using leverage (options, buying stocks on margin, or buying houses with very little in the way of deposit). Rapid credit growth is common; this is the overtrading stage. At some point, insiders take profits and prices start to fall; leveraged investors, and retail investors suckered in at the top of the market, panic and...Continue reading
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