I am back from San Francisco, where I had the great pleasure of attending and speaking at FAME Symposium, diligently put together by students at San Francisco University. One of the other speakers was a famous international investor, Charles De Vaulx. During a break Charles and I were discussing the Chinese bubble today vs. the Japanese bubble of the late '80s. This conversation got me thinking. In Japan the bubble was the most prominent in commercial real estate and to a lesser degree in residential real estate. The house-price-to-income ratio (just take the average house price and divide by average income) in Tokyo at the height of the bubble was nine, while in China in 2010, in the big cities this number was much greater (Beijing 15, Shanghai 13), and in fact the ratio for the whole of China was over eight. The commercial real estate bubble might have been greater in Japan; it is hard to tell. I remember reading that at the peak of the Japanese bubble the Imperial Palace was worth more than a state of California. But from different reports I've seen, China has plenty of empty skyscrapers.
But China also has a couple more bubbles, in industrial overcapacity and overinvestment in infrastructure. Japan did not have an infrastructure bubble, for several reasons: first, it was a more developed country than China. Second, the government played a much smaller role in the economy -- Japan did not have a command-control economy, and it did not try to build for social/political stability reasons. Japan had your garden variety real estate bubble: easy credit, inadequate banking laws, etc.
Also, and this point is hard to quantify, but the quality of Japanese construction is better than in China. There are many reasons for that: less corruption, no five-year plans (i.e., output-per-capita targets), and the Japanese put a higher value on human life. I remember reading an interview, just a few years ago (before the high-speed-train crash in China) with a Japanese high-speed-train executive. At the time the Chinese were showcasing their high-speed-train system and rubbing in Japanese faces the fact that their trains traveled at higher speeds. The Japanese executive said something along these lines: "Our systems are very similar, since the Chinese stole our high-speed railroad designs. We could run our trains at faster speeds, but we just don't think it's safe." Japan has a population of 130 million people, which is shrinking. China has over a billion people and its population is growing.
The quality of Chinese construction is horrible; you read stories of glass and masonry falling off of buildings, and the latest story was of a girl swallowed by capsized pavement. So they'll have to do a lot more rebuilding in the future, and thus their return on capital, which was already very low, will actually be even lower.
Japanese economy, despite government debt to GDP doubling, has been stuck in a rut for over two decades. Just saying...
Vitaliy N. Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates in Denver, Colo. He is the author of The Little Book of Sideways Markets (Wiley, December 2010). To receive Vitaliy's future articles by email, click here or read his articles here.
Investment Management Associates Inc. is a value investing firm based in Denver, Colorado. Its main focus is on growing and preserving wealth for private investors and institutions while adhering to a disciplined value investment process, as detailed in Vitaliy Katsenelson's Active Value Investing (Wiley, 2007) book.
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