Friday, 5 February 2010

If it looks and smells like a bubble... it's probably garlic

Via the excellent Econbrowser blog comes this intriguing snippet of the garlic market in China (originally from the Washington Post).

Wholesale garlic prices in Beijing are now 15 times as high as in March, and still rising. Jerry Lou, a Morgan Stanley China strategist who has researched the opaque market here, said speculators-- fueled by the abundant liquidity sloshing around China-- have moved into the small market and strategically driven up prices. "You need a warehouse, a lot of cash and a few trucks. That's how it works," Lou said, describing garlic speculators' tools of the trade. "Basically, what you do is try to arrest as much supply as possible, then you bid up the price. Moving garlic from one warehouse to the other, you make millions of dollars."
As I will try to teach our students next term, telling a bubble apart from fundamentals-driven price increases can be really hard... until we take Charles Kindleberger's advice seriously, which is to look not at prices themselves, but at what motivates buyers. He essentially argued that if something is a. not very useful to you b. you only bought it because you think it will go up, there is a good chance that it's a bubble. Early finance models used to rule this kind of thing out with some quick and simple assumptions about arbitrageurs attacking the mispricing instantly, but we have gotten a lot better since - we can now write ever better models in which the Chinese garlic merchants can exist (and even make money). If I had to recommend just two papers, I would go for this and this.

The interesting thing is that garlic seems to stand pars pro toto for a lot of goods -- copper, aluminum, oil all seem to have been hoarded with the same intentions. Apparently, there are a lot of Chinese pig farmers who have been stockpiling copper and nickel. When oil was trading at $130, my friend and co-author Mauricio Drelichman asked me if I thought it was a bubble, and then - after some umming and ahhhing -- said yes, and put some money on it. If someone pressed me today, I would say the same about most industrial metals and oil. Given that a. the government stimulus effect is going to go down a lot very soon b. unemployment is not looking good c. much of the bounce in industrial output was restocking, I am not convinced that oil should be around twice of what it was a year ago...

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