Want To Avoid The Next Crash? Avoid The Cranes…

By The Noble Contrarian on September 8, 2011 in Other

On a sunny August day in 1929, failed presidential hopeful Alfred E. Smith gathered the New York press and announced humble plans to build the world’s tallest skyscraper. The 102-storey cloud tickler, known as ‘The Empire State Building’, would triumphantly rise above the Manhattan skyline as a monument to American capitalism.

It was a sign of the times. The stock market was reaching new heights following the economic boom of the roaring twenties and local businessmen (they were all men then) wanted to leave their mark, developing iconic buildings such as the famous art deco styled Chrysler building, Woolworths and GE Towers.

But barely a month after Smith’s announcement the stock market crashed, dropping a spectacular 23% in two days. Egos were crushed, fortunes lost and America entered the Great Depression.

The question then begs itself, does the location of the world’s newest and tallest building projects indicate where the next financial crisis will be?

A property boom starts with a trigger, such as low interest rates, easy credit or a creditable and real economic growth story. That stimulates investment, and asset values balloon as investment flows increase and lending standards decrease.

Next, the herd, armed with large licks of debt, bids up asset prices significantly beyond their underlying value. Then, when the music stops, property prices collapse, resulting in write-offs and highly geared developers going bankrupt.

Dubai locals, known as Emiratees, are familiar with this sequence of events. Dubai is currently home to more of the world’s tallest buildings than any other city, including the current record holder, Burj Khalifa, which soars almost a kilometre into the sky with a height of 828 metres.

Dubai needed a friendly bail out from neighbouring Abu Dhabi during the global financial crisis due to its property bust. So in both modern Dubai and 1920s New York, we have examples where the announcement of a new record-breaking structure being built has preceded a major economic downturn.

The common thread in this cycle of boom and bust is that massive projects such as the Empire State Building or Burj Khalifa are rarely viable from a purely economic point of view (it was decades before the Empire State Building was full with tenants). Rather, they are built as monuments to human achievement when credit is cheap and egos are inflated.

Most of the tall buildings currently under construction are either in China or the Middle East. Both economies have experienced mammoth growth over the past decade.

The world’s most audacious project yet is a 1,600-metre tower planned for Jeddah, Saudi Arabia (that’s four Empire State buildings stacked on top of each other). Saudi Arabia is not known for its lack of land, again showing that ego rather than economics is driving development. Keep in mind that tall buildings suffer rapidly diminishing returns once they reach a certain height due to technology and engineering constraints.

Despite the lessons of the past, it seems humans are destined to keep repeating the same mistakes. China’s massive stimulus program during the GFC spared Australia from going into recession, but there are plenty of worrying signs emerging out of China, and perhaps the most obvious red flag is its new skyline.