China’s coming magnificent bubble

September 17, 2009

jamessaft1.jpg–James Saft is a Reuters columnist. The opinions expressed are his own–

If and when China makes its currency convertible and opens its financial system the stage will be set for a bubble that should make the dotcom and housing booms look tame.

China has recently signaled its key aspirations: for a greater international role for the renminbi and for Shanghai to become a great financial capital. Neither is imminent, but both imply, if not require, a series of steps that, taken in combination with China’s legitimately great potential for growth, could lead to a bubble of magnificent and dangerous proportions.

Magnificent in that, like the dotcom bubble or the railroad boom in the U.S. in the 19th century, a bubble in domestic China is directionally right and will build useful things which will change the world. A bubble, after all, needs a good story and China has one of the best ever.

Dangerous because, like the housing bubble, it will inevitably go too far and could take down banks and banking systems globally.

Perhaps rather than dotcom or housing, the most useful template for China is closer to home; namely the Japanese bubble which preceded its ongoing malaise, according to Dylan Grice, a strategist at Societe Generale in London.

“In the medium term we face the mother of all asset bubbles in China. The fundamental story is a good one; there are just lots and lots of people to sell to,” Grice said.

“If you drop a ton of liquidity on people it is possible that they will do rational things with it, but more likely they will do something pretty stupid.”

The parallels are strong. Both China and Japan successfully industrialized and opted for high-savings, low-consumption economies which concentrated on exports, exporting capital and keeping their currencies artificially weak. The result in both cases was a huge stockpile of U.S. Treasuries.

Both, too, scared their western clients and competitors witless. Remember U.S. autoworkers ritually burning Japanese cars? This of course was mingled with admiration and a sense that the global balance of power was changing, giving bubble thinking a strong push.

Japan slowly and over a long period liberalized its capital account; allowing the yen to float freely and deregulating financial markets.

Grice points out that during some of the 1980s the world fell in love with the yen, figuring that Japan’s new ascendancy meant that it would rise and rise. As a result Japan Inc. could in effect borrow in dollars, swap it into yen and get paid for the privilege. Much of the money found its way into the stock market, sending stocks to stratospheric levels and reinforcing the bubble illusion.

The Nikkei index of stocks went to the moon and Tokyo residents ended up needing 100-year mortgages to afford tiny apartments.


Of course, that is not where it ended with Japan, which had its bust and which is still struggling with deflation, though that is in part a function of a shrinking workforce.

Japan liberalized its financial system and currency arrangements under strong pressure from the United States.

China almost certainly has more relative real power today and there is every sign that it will open up on its own terms and to its own schedule.

But open it probably will.

Chinese officials have expressed a desire for the renminbi to play a great role in world trade, naming 2020 as a date by which it can play the role of a reserve currency.

That is almost certainly going to require deregulation of financial markets, something also needed if Shanghai is to become a global financial capital.

China now buys Treasuries not because it thinks they are good value, but because those purchases maintain a competitive currency, not to mention protecting existing holdings. As that ends, much of the money will seek out high returns, and as the renminbi strengthens international capital will doubtless pile on and pile in.

That kind of liquidity and deregulation, in combination with strong national pride and a legitimately fantastic story, is a step-by-step recipe for a bubble. So it proved in Japan, so it likely will be in China.

A look at recent experience in China only underlines this. Speculation is rife and billions in government mandated loans have leaked into stock market bets.

China’s government undoubtedly understands all of this and is surely determined to maintain control. They may not find it that easy. Getting rich, as we’ve seen in the United States, is a heady business and it is easy to start to believe your own press.

As the momentum builds and the money rolls in it will be easy to see it as a great country meeting its prosperous destiny.

Given the size of the opportunity and the strength of the story, China’s bubble will be huge. Investors would do well to avoid being in the immediate vicinity when it bursts.

–At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.–


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Eerily sounds like Greenspan the other day, who essentially said ‘it’s within people to do bad things, so expect more bad things to happen no matter what’. What a crock of defeatist nonsense. I love, too, how you dance around the idea that the massive regulation is all that keeps the Chinese markets in check… like it’s a bad thing! As far as I can tell, China is a 3rd world police state with more collective poverty than anyone cares to even consider, a police state that goes out of it’s way to persecute peaceful religious groups (Tibetan buddhists, Falun Dafa, muslims, etc). That doesn’t sound like a feel-good story to me.

Actually, the more I look at it, China today is the direction America is heading – strong central authority that is equally strongly abused and corrupt, massive amounts of poverty and a small cliq of ultra rich that determine the direction of the nation, and a completely off-the-wall set of bourses that move so erratically as to defy logic.

Posted by the Shah | Report as abusive

I’ve been thinking about the same thing for many years. Sadly I think it is inevitable, and even the tightly controlled Chinese economy will go through the same boom bust cycles that have happened throughout history. First we will see hubris and arrogance on a grand scale at the tops, then disbelief and denial during the collapses, finally reluctant acceptance and humility at the bottoms. It’s human nature and Chinese people are no different in that regard to any other group. It is looking like China will become a great power once again, but don’t assume it will get there in a straight line though. It wont, it will take time and a huge effort.

Posted by Huw Williams | Report as abusive

Your article carries a large content concerning Japan. Times have changed, fundamentals have changed, would that not be a false comparison ? Also there is very little actual content about the present motives and dynamics in the Chinese economy.

I thought I was beginning to understand ‘reserve currencies’ and currency trading, but your quote “As a result Japan Inc. could in effect borrow in dollars, swap it into yen and get paid for the privilege” threw me completely.

Nice caption though.

Posted by Casper | Report as abusive

Previously China was stressing for IMF-SDR & to replace US dollars as international reserve currency & later even UN has put a proposal to replace US dollar with another currency acceptable to the world.
I am not sure which way the bubble will burst if that gets materialized & am curious to learn its effect on Chinese economy?

Posted by vksaini | Report as abusive

Wow a rational well reasoned historically based article with no phony doom and gloom sky-is-falling clap-trap. Thanks. Now if someone would just get the connection between the policy of letting asian nations peg their currency as a communist fighting job transfer program and that the Chinese are communists we might get some of our jobs back. LOL, that’s not happening the global “citizens” (aka multi-nationals) don’t care about ideology, only gross margin.

Posted by Frank in midtown | Report as abusive

China has an agricultural base that seems to require a permanent peasant class who apparently must always work great amounts of land manually. All those terraces of narrow rice fields climbing hill after hill, that during the cultural revolution and preceding five year plans were constructed with what was basically slave labor by “reeducated” urban intellectuals, are still significant to China’s food needs. China needed them to maintain its independence in food production so they could invest in industrial capacity instead. In other words- a lot of China’s agriculture cannot be converted to agribusiness type production of machines doing the work of hundreds of laborers.

I recall a figure from a grad school course that noted that China lives with about 1/2 the arable land of the US but can feed four times the population without significant imports. They can get up to four crops per year with their labor intensive agriculture. Many places still use “night soil” as a cheap and readily available fertilizer. That’s a dual savings. Many rural areas don’t have to treat the waste like we do and we seldom use the sludge for any productive purpose. These are the people who invented the multi tier bamboo steamer to cook five or more different courses using one fire. They knew “green” before it became fashionable. At least they knew energy efficiency until they became the factory of the planet.

The developed world seems to know only how to throw more and more money at smaller amounts of production and of cheaper and more dubious quality. A developer in China – noted by the NYT a few years back – actually built three copies of the Maison’s Lafitte that is almost a perfect replica of the original and did it using cut and dressed stone masonry. This country hasn’t been able to do that since the days of the Vanderbilts. If that was done here we would have to use stucco or some other ersatz material.

Doesn’t that imply that China may not want a bubble prosperity of any kind to form in it’s system. That they cannot risk the top and the bottom of the economic heap to start drifting so far apart. otherwise the field workers, hundreds of millions of them – in spite of the fact that they are not without abundant production – may starve because they can’t afford to buy it.

China has a nasty history of mega death when the natives get restless.

What China will probably do is tax the hell out of the more affluent classes and continue to redistribute the income. Isn’t one of the reasons we had our bubble is we didn’t tax the affluent to take some of the pressure out of any “bubbles” that formed? Everyone complains that the banks were greedy and slip shod, but no one is very happy here with the taxation necessary to build public or affordable housing. What did that attitude leave as a choice for home buyers but to accept dubious home mortgages. There are always long waiting lists for public or affordable housing.

Posted by paul v rosa | Report as abusive

I dont think the author has any clue on what he writing about. A former New Yorker, I now live in Hong Kong. Chinese Government has been extremely prudent and methodical about how it approaches the market dynamics and liberalization. There have been bubbles in the property and equity market, but China has been careful in managing them. This great bubble that the author is predicting will be unfounded.

Posted by Javed Rahman | Report as abusive

Good historical analysis and hopefully China will learn from the Japanese mistakes. A big problem in China’s stock market though is majority of the money used to speculate is actually coming from the middle class. The upper class and institutional investors total “dollar amount” invested compared to the middle class collectively is like a mouse to an elephant. Restricting the institutional investors isn’t going to do much in China unlike in the US since they are already very restricted in China.

Posted by Andrew | Report as abusive

China has the option to fund its internal expansion at whatever pace it wishes. So it takes the US bonds, liquidates them and expands it economy internally to offset the increased value of its currency and higher cost of goods. It will take China 50 years to saturate its domestic market with consumer goods. The thing that hurts china is the lack of energy which it can solve with nuclear…. and stop buying oil..and its lack of creativity. I dont know about food and natural resources but it seems china can manage just fine and not explode a bubble… We are in the dilemma we are in because of corruption.. in business (AIG / wall street) and government (Barney Franks / fannie and Freddie and over regulation). Once the USA sheds the current Marxist regime we will be back to business as usual. NEVER SELL THE USA SHORT.

Posted by J Wha | Report as abusive

The comparison of China with Japan ends with your own sentence: “China almost certainly has more relative real power today and there is every sign that it will open up on its own terms and to its own schedule.”

And this is crucial to avoid the same fate as Japan’s.

Posted by Richard | Report as abusive

Paul v rosa has hit the nail on the head with this one.
The Chinese administrations are well aware of the potential on an impending economic collapse. Despite popular opinion in the west they do care for their people. It’s immensely difficult to keep all of Chinas 1 billion people happy. They’re just trying to keep them fed. No easy task, the U.S can’t even provide health care to 50 million Americans despite its vast amounts of wealth and so called freedom.
I’m not saying the Chinese admin is perfect, but at least they know it. China inevitable will do everything in its power to keep the peace amongst its huge population. Its learned too many times from its past what happens when the peasants revolt.
They just need to stay the course and not get bullied by greedy westerners.
Whether the west believes China controls their currency is relevant to them. Their concern is not what we think but internal stability

Posted by Dutch | Report as abusive

I have been going to China for about 10 years. I have seen the changes first hand. On my first trip i noticed many bicycle, some motorcycles, and few cars. On subsequent trips i noticed, much more motorcycles, less bicycles and more cars. Then it changes to many more cars and more motorcycles and less bicycles. Furthermore, the type of cars and the variety are also changing. It went from having one type of cars built by Volks Wagon to having a large variety of sedan and luxury cars.

It went from having one line of products in 20 differnt shops to having different lines of produts and many more shops.

One thing i keep on noticing is the large number of labour used on any given project or having 4-5 sales people in a 10 x 10 feet retail shops, when you only need couple of sales people.

There is no denying that China is moving forward and progressing at a high speed. Yes, they do have their own problems but they also have their own chinese made solutions. The problems and their solutions may seem strange to us in the Western world, but they do find ways to make things work and to benefit and prosper.

As long as people are employed, be it five people in a small retail shop or 20 people paving a sidewalk and as long as people making some money and the hope for better future for themselves and for their children is alife, China and the Chinese people will prosper and become afflunet consumers. China already has a large number of millionairs and a large number of middle class that can afford all things that we afford here in the Western hemisphere and more.

As China and its people progress and move towards market economy and basic supply and demand, they will start to face similar problems to the ones we have in our economies and that will include real estate bubble, which they already have in Shanghai and elsewhere, They will also have banking, interest rates, insurance, stock market, inflation, deflation and employment issues, among others, of which all are similar to the ones we have in North America. In return they will find Chinese made solutions and work throught them similar to any other country.
Theeeee end.

Posted by A. Ghot | Report as abusive

Bubble bubble toil and trouble, China is cooking up a financial pot that when it hits ‘boil’ is going to scald everyone and everything except themselves. Artificially depressed currency, ‘cheap’ and plentiful labor and a HUGE gap between the elite and the peasants. Add a voracious appetite for raw materials and energy and the recipe calls for chaos and a growing stand off between the west and the Chinese over who gets what of steadily decreasing resources. And remember the Chinese do NOT CARE about the people. They care ONLY about the future of the country and think in terms of centuries. If it suits their purpose they would ‘nationalize’ any business foolish enough to operate in their country wit out a second thought. Leaving others to pick up the pieces.

Posted by Sonny | Report as abusive

[…] reuters If and when China makes its currency convertible and opens its financial system the stage will be set for a bubble that should make the dotcom and housing booms look tame. […]

Posted by THE FINTAG NEWSLETTER @ 18 September 2009 | Pastoon | Report as abusive

China is a keen observer & quick learner so let us not under estimate its ability to foresee these issue ahead of time. They are working on multiple direction by hedging their markets & resources globally in much planned way ( Ex: Construction contracts in Poland or 16B Oil deal with Venezuela).History is its guide & recent global meltdown primarily thro reckless financial institutions in US must have forewarned them things not to do.They have been able to raise over 200M above poverty line in past two decade not a small achievement. There will be hiccups but not big bust that only US can make & manage because of absolute greed.

Posted by Ajeet | Report as abusive

Please Shah if youre not sure the real condition about China please dont make wrong statement. I had been staying here for almost 10 years and i dont see that . For the problems like Falun Gong, Tibetian and Muslim issue , if you dont know the truth dont comment as how do you know there peaceful following.

Posted by Winston | Report as abusive

Though I see the validity of some of the arguments here, there are some counter points to the argument I don’t necessarily agree with. Admitedly, I’m not much of an economist, but I do dabble pretty strongly in history, and I see a lot of paralells with China today and America in the late 19th century. You have a relatively cheap labor force, an influx of foreign investment from Western powers, and an economy driven almost exclusively on exportation.
However, there are some key differences in 19th century American economic views and China today. The strongest is that China is a functioning Comunist-Capitolist marriage. America was, much more than today, a hands-off capitolist society. Shanghai has to continually walk the tightrope between it’s Marxist government structure and it’s Western Capitolist money influx.
I see the emergence of China as the largest world economic superpower as following one of two paths. Either power remains centralized in a government-run economy and the bubble stays slow rising, rising only as quickly as the government allows, keeping pay low, working class in line, and labor and production relatively cheap. Or, it could go the route of most Western governments, and Japan, and grow too quickly, falling in love with it’s new wealth, spending and using government programs to keep the working class happy, which will cause the bubble to rise too quickly and burst, taking no less than 20% of the world’s economy with it.

Posted by Joe T | Report as abusive

Living in a clsoed world and beelving that everything else would fall in place just because of the size of the chinese economy is nothing but a dream, just like lehman was too big to fall the chinese currency bubble is just like lehman and would fall for sure just when thats the call to be taken, and specially with the weakening dollar as a global currency and chinese banks holding maximum us treasury stock they are left with no option but to sell along with the over capacity built across years with a strong belief that us would continue to buy chinese goods was just a dream, but the day when the bubble bursts it shall one day sooner or later for sure shall have a an impact so huge on global financial markets that no one can imagine that is the inevitable.

Posted by D B S Dhingra. | Report as abusive

I always wonder why specific stories make the headline on Reuters. When the real estate bubble was at its peak, no one cared. But now everyone wants to predict a bubble in China? What about the Treasury bubble, the bailout bubble? that will be the first to burst…

Posted by d&b | Report as abusive

Are humans supposed to learn from precedents? The Americans learning from the Japanese experience and the Chinese learning from the Americans and before them the Japanese?

Posted by albert ho | Report as abusive

Look at the housing price thesedays in China you will understand what is bubble.

Posted by Frankie | Report as abusive

Einstein famously said, “Two things are infinite: the universe and human stupidity; and I’m not sure about the universe.” This has been demonstrated in the bubbles, panic and mania so evident in economic history.

When it comes to forecasting people tend to believe that good times will last forever and when reality hits them they believe that the end will come tomorrow. China, unlike Japan, is not ethnically homogenous so there could be bumps in the road when the central government tries to move it in one direction. It is also possible that they could turn inward and not follow the Western idea of development.

Posted by Lee | Report as abusive

we have a strong government and we believe in it.i think we can get through it safely,before we fail we will be the bigest economy market at least ! and all Chinese people will get their part.

Posted by Holy | Report as abusive

Interesting analysis James – IMHO free global markets require free floating exchange rates (and ideally free floating interest rates) – so if you are right about Chinese ambition and attitude then your conclusion seems sound.

However, I for one would be interested in James’s ideas on how China could manage this without inflating a mega-bubble.

My remedy would be to accept that bubbles occur but set policy so that they pop regularly before they get too big – basically by pumping more uncertainty into the system – ideally through those free floating interest rates and a massive reduction in the ambitions of central planners – by planning for competition not control.

If Greenspan had never launched the Greenspan-put the markets would have been less likely to get carried away for so long. If government policy had not undermined the principles of competition in free and open markets (by pushing Fannie Mae and Freddie Mac to back liar loans) then property prices would not have got so out of hand.

To prevent the mother of all bubbles China must adopt a Hayekian approach to freedom of choice for the individual and a minimum of state interference in economic and social life.

If they want to do something useful with the billions they have saved they should build super high-speed motorways linking all the regions and all the major towns and cities so as to give individuals and trade maximum freedom of movement within the country. Then sit back and let the free market do the rest.

Blessing for liberalism, capitalism and globalisation.

Father Ignatius Brown

Posted by Father Ignatius Brown | Report as abusive

Bubbles in any economy is to let your money supply increase faster than your real economic growth over time.
Remember the good old M3, the Fed does not publish it anymore under Greenspan’s tenure !

If China impose universal clearing, mark to market and complete fungability to its financial markets; the chance of a financial bubble would be extreamly difficult to create. The system mechanism will automatically keep the system in check, that why wall street is reluctant to implement. ” No wiggle room ”

Let hope China has the good foresight to institute these regulations when it liberalise its market.

Posted by Geoffrey Chang | Report as abusive

Does Mr. Saft actually mean to describe the great American bubble, which went from approx 1946 to 2001? So that this is actually just another example of how China ‘wants to be like Mike’? After all, didn’t we Americans do exactly the same things ? ? ?
I for one, hope China is a little smarter and in this instance doesn’t want to emulate America…. As their culture is over 5000 years old, I remain hopeful.

Posted by edgy | Report as abusive

to everyone that says that it is impossible for a bubble to occur – YOU ARE MISGUIDED. bubbles occur in every country in every economy in every industry, in good times and in bad. this is the nature of nature. no amount of regulation can prevent bad things from happening every once in awhile. the best that we can hope for is that we learn from past mistakes so that the same mistakes do not happen again. no country is perfect, no matter how old the culture (china 5000 years), or how mature the government (usa 200 years).

Posted by Wolf | Report as abusive

There is a strong belief by certain people that certain countries, through use of government regulation, superior intellect, and indomitable spirit will be able to avoid big panics, bubbles, and downturns. These beliefs are part of the problem. When everybody starts chanting the same mantra markets don’t work properly. The U.S. seems to have a major financial or asset bubble about every 10-20 years. If you don’t believe me count them: 1880s, 1890s, 1910s, 1930s, 1950s, 1970s, 1980’s, late 1990’s and finally the real-estate bubble of the 2000s. There are a lot of people that have been burned by such bubbles. These were smart, sophisticated, hard-working people who believed they had the best information at the time. Just because people believe they are immune to disaster by some magical power doesn’t make it so.

China has several things going for it. Namely, international industrial absorption, improving productivity, and the world’s largest workforce. However, in spite of all these factors leaning in its favor the country is ripe for a financial bubble. Just two of these factors could spell trouble. The population doesn’t have enough children to sustain it. The savings and investment rate is too high. Growth in the stock market is unchecked (well beyond the bounds of realistic growth). The currency is not free-floating, meaning that there are no good check-controls to bring it into parity with other countries. On the international market it isn’t even a valid trading currency. There is a Vesuvius style volcano of financial pressure building up here which eventually will have to come back to reality, which because of China’s government control of currency has and may be delayed for a good while but you can be assured it is a bubble, and maybe the mother of all bubbles.

Posted by Adam Smith | Report as abusive

Until now, China has been the big winner from globalisation along with large intl corp but unlike the average US citizens. China wants to play a larger role in all world fora and try hard to cut US legs in the developing world.

Their strategy is to get the US down to its knee, and like learders of North Corea, Iran, Irak, Lybia, China learders will sign treaties with no intention to submit to it. China plays the game of capitalism but with government backed companies. It sells to the world but with an undervalued currency. It buys US debt in order to cut US troat when the time is right. Currently, it pursues an acquisition spree of commodities as it expects the USD to devalue significantly and contrary to most beliefs, it will not help in any form or shape to stop it.

China is on the path to free itself from the US consumer. It has a potential a 3-5x the number of consumer within its own country, in addition to Japanese and European consumers with their superstrong currencies.

As for the Chinese bubble, it should have happen long before today but did not simply because China does not play the free market game with the same rules as us. China controls its evolution with the “small steps” strategy and this strategy allows the authorities to correct mistakes before they blow out, which is much better than our system that corrects violently for the worse of our middle class.

China leaders think and act for their country’s good and they have the means to control it. Our leaders do not control private sector key actors who, on their side, act excusively for the good of “happy fews”.

Posted by gil nado | Report as abusive

I agree with Geoffrey Chang September – posted 18th, 2009 12:47 pm GMT. Especially when money supply, inflation and growth figures are fudged.

I am so tired of this ‘bubble’ word. What does it really mean ? :

1. anything that lacks firmness, substance, or permanence; an illusion or delusion;

2. an inflated speculation, esp. if fraudulent;

3. a sudden, small, temporary change or divergence from a trend.

Surely a ‘bubble’ must be created, monitored, deflated in time or simply pricked before it bursts ?

Posted by Casper Lab | Report as abusive

Hello James,
I wish we would take notice of China bubble burst from the solid foundations of unshakable US economy. Unfortunately US economy is more fragile than ever. My point is that before China bubble burst we will witness US total collapse.

Total US debt (Gov + private) comes to 370% of GDP. Common sense tells that we cannot pay it out. But there is no alternative so people keep buying US/EU debts. As soon as somebody (China) provides alternative XYZ to US debt we will see run of capital from USD to XYZ.
USA the cost of managing debt will jump 10x from current 2%-5% (That rough range for LIBOR). We all know what even 10% LIBOR would do to “conservative” financial institutions with 15x leverage (Goldman :).

Since all my savings in USD I wish somebody can prove me wrong using simple math.

Posted by Sergey | Report as abusive

[…] economic bubble China’s coming magnificent bubble | Analysis & Opinion | This article is from last year, but it describes (like many) the economic situation in China and […]

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