The bubble burst: Ask China!

Home The bubble burst: Ask China!

Often we come across the term investment. I am sure everyone knows what it means. What most of us don’t realize is at what time can the investment be deemed as enough such that the “feel good” bubble doesn’t happen to burst?

Let’s look at a simple example. Mr. X was a small trader who used to sell 100 saris a month. His inventory was also maximum at 100 at any point of time He then decided to expand his business and invested his hard earned money into it, such that now he could have an inventory of 200. And his decision proved correct: He was now selling 200 saris a month. Mr. X now got overambitious, he invested further and it again got sold. But now after further expansions he had reached an inventory capacity of 1000 saris, but he only managed to sell 600 a month. He decided to scale down his operations. He fired 6 people he had hired before. But with reduced scale, his shop no longer was the talk of the town- He was now selling even less & was forced to scale down even further. He suffered huge losses and lost his credibility in the market. The motto of the above case was very simple- he had stretched himself too far.

 

Over 100 years of economic theory tells us that when nations and people tend to overspend, it leads to inflation. If there is a total of Rs 100 and there are total of 10 persons offering 10 different products or services each will be content with Rs. 10. The problem arises when there is another Rs.100 in the market, thus rising the market capitalization to Rs. 200. Now these 10 persons will fight for a greater share, each will sell at a premium, the one who buys it will resell at a higher premium till the time comes when no one is willing to buy it! And now the most important part: eventual value destruction. The US housing boom and fall can be easily related to this. The export sector is also among the worst hit sectors during inflation, thereby earning you lesser foreign exchange, loss of jobs and ultimately hampering your economy and bursting your bubble. But then isn’t there any way to stop the bubble from bursting? I bet there is.

Let’s look at the great exception to everything that has happened: you guessed right, it’s China! China invests more than 50% of its GDP in its own country and that figure itself is magnanimous by any standards. Even Japan at its peak used to invest 30% of its GDP. But then what exactly makes the China story an exception to the rule? It is the way they are investing in infrastructure and connectivity. They are not building factories, but instead building roads and railways to unleash the entrepreneurial spirit from even the most far flung places of their great nation. In fact one senior Chinese official had recently remarked that they are not building infrastructure for today, but for the next 50 years. Another interesting point to take note of in the China story is that their focus is not on increasing production, but on providing the platform where individuals can take the initiative The only thing of concern for China is that their bad debt percentage is estimated at 30-50% (vis-à-vis India’s 2-3%), but the way they have sustained it for so long there is no reason why they will not be able to do it again and disprove the economic theory as we know it!
The reason China succeeds is because they invested in improving quality of lives of people. The same goes for companies, while investing it is always tempting to go for numbers and increase capacity. The key to prevent it from becoming your nemesis is if your focus is on quality first and not quantity. In that case your bubble can definitely swell, but be sure it will never burst!
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Abhirup
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 MBA, Author of 4 books, Finance guy who loves brands
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