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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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

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