The piece by Jesse Colombo asking whether Singapore is headed to an Icelandic style meltdown received a lot of attention but not a lot of analysis. I think it is important to examine not only the factual basis for the arguments put forth but also the bigger picture philosophical framework for predicting financial crises. Today in the first part, I will place the arguments in a type of philosophical framework and the biases we have with regards to economic and financial analysis.
Event convergence. Plane crashes are fascinating events. They are rare and unpredictable events that are normally a confluence of divergent factors that uniquely converge at one point. Many of the factors that are present in plane crash are common in many flights that never crash. An accumulation of risk factors does not guarantee a catastrophic event but only increases the probability necessitating a catalyst event to cause a crisis.
Many of the financial and economic risks that Mr. Colombo cites are valid concerns, though I do not share his belief about the severity of those imbalances and their probability in causing a financial crises. Real estate prices, excessive debt levels, and monetary stimulus are all elevating risk factors many of which have been acknowledged by the Singaporean government. However, I do not currently believe that these factors are so unbalanced as to cause a financial crisis.
All the world is a nail if you only have a hammer. There is a joke about the stock market that says it has successfully predicted 10 of the last 3 recessions. Since the 2008 global financial crisis, many people carrying forward those lessons have dedicated themselves to forecasting bubbles Unfortunately, irrational exuberance has given way to irrational bubble obsession. A range of analysts, not just Mr. Colombo, have taken to calling just about everything the next bubble. Given the number of bubbles that Mr. Colombo is predicting it is not unreasonable to think that one of them may come to pass though given the number of bubble forecast, that does not validate his wisdom but prove only that he makes lot of predictions.
Mr. Colombo is predicting bubbles across a wide range of economies and individual markets. From Canada to Asia and higher education, social media, health care and housing, the prediction of bubbles everywhere we look is swamping reality. I believe the reality is much more complex and driven by different factors. To give one simple example, most commodity prices have grown relatively slowly post 2008 and enjoy significant new demand from emerging markets like China and rapid supply growth due increased oil and gas output in the United States. If everything you see is a bubble, you miss much of the complexity of the global economic system and the underlying dynamics.
When is a bubble a bubble? Prior to the 2008 financial crisis, there was a debate in central banking circles about whether or not monetary policy should be concerned with asset values like home prices. Alan Greenspan made a cogent argument that bubbles could not be identified before they “popped”. He was not saying the bubble did not exist but only that predicting bubbles was akin to astrology. In fact in his career, Alan Greenspan correctly understood the rapid increase productivity in the late 90’s due to improved information technology but failed to understand the importance of low interest rates in fueling the disastrous housing bubble in the United States.
The Icelandic meltdown was a catastrophic event that was accompanied by large defaults, collapses in real economic GDP, and a fall in the exchange rate. In fact, may countries have had similar economic and financial imbalances without suffering a catastrophic financial bubble crisis. However, Mr. Colombo has predicted a catastrophic event like the Icelandic meltdown and not a slowdown in asset price increases, recession, or other such mitigating process. History tells us instead that financial crises are relatively rare events while it is much more common to have a “balance sheet” recession or reduction in credit due to higher default levels. In other instances, asset prices may fall or slow for extended periods of time without having a full crisis.
Cities are different. There is not a clear answer but major cities, and especially financial centers such as Singapore, operate under slightly different rules than most places. Cities like New York City, London, Abu Dhabi, and Hong Kong suffer from many of the risk factors such as high real estate prices and rapid expansion of credit and yet they continue to flourish and expand. During the financial crises and even in other periods of economic stress, these cities have suffered less even though real estate and other financial factors indicated stress.
Iceland however, never had a financial center but only borrowed in other currencies to reinvest else where for its firms global investment. That makes it significantly more risky than a financial hub like Singapore.
Many cite the old adage that if we do not learn from history we are doomed to repeat it. I prefer a variant of this saying which says, history repeats itself but just differently enough to fool us into thinking we know what we are doing. While I agree with many of the general risks cited with regards to the Singaporean economy, I think it suffers from a variety of defects not least of which are some philosophical or theoretical short comings. Though I am no defender of the economic and financial policies of the current Singaporean government, as anyone knows, I think the risks of a catastrophic financial crisis are extremely over stated.
Note: The second part of this series will deal with the analysis of risks cited and what the risk for a catastrophic financial and economic crisis in Singapore is.