Chris Lau - Seeking Alpha

Thursday, February 04, 2010

Bubble in China

Andy Xie is a former analyst from Morgan Stanley. He graduated from Massachusetts Institute of Technology with a M.S. in Civil Engineering, and obtained a PhD in Economics from Massachusetts Institute of Technology.

Xie is worth listening to. He was one of the few economists who accurately predicted economic bubbles including the 1997 Asian Financial Crisis, dot-com bubble (1999) and Subprime mortgage crisis (2008).

In his most recent post, Xie analyzes the impact of money flow to Chinese real estate, not to productive assets. With government policy promoting speculation, this action inter-connected with the zero interest rate policy found in the U.S. (my emphasis in bold): 

Each belief depends on the key assumption that the Chinese government will let neither exchange rates nor land prices fall. The market psychology that the Chinese government is capping the downside for speculators has emboldened them to speculate in any asset class with a China angle.

Yet the assumption has not been tested because the U.S. Federal Reserve’s low interest rate policy continues to drive money out of dollars and into China-related assets. When inflation forces the Fed to raise interest rates quickly, probably in 2012, this assumption will be tested. In the current speculative game around China, the force is the Fed’s zero interest rate. When that changes, I suspect few of today’s speculators will be around.
Xie  comments on inflation in China:

Money supply cannot grow faster than GDP forever. A prolonged gap between the two usually suggests an asset bubble, i.e. excess money supply is piling up in an asset market. But sustained asset inflation inevitably leads to consumer price inflation, either through the wealth effect on consumption or a cost push on the production side.
Investors in China need to have a plan longer out:

China’s monetary overhang in a more inflation prone environment augurs poorly for the inflation dynamic this year and beyond. The growth outlook, on the other hand, is dimmer. On the demand side, developed economies will continue to suffer high unemployment and property deflation. Despite a strong export showing in December, China’s exports are unlikely to grow as they did in the previous five years. I expect China’s exports will average single digit growth for the next five years, compared to 27 percent between 2003 and ‘08.

His 2012 outlook:

Indeed, 2012 is building up to be another crisis year. Governments and central banks did not handle the last crisis well. They did not reform a global financial system plagued by incentive misalignment and wild speculation. All the money governments and central banks released is turning into global inflation. And they resorted to bailing out speculators, laying the foundation for another crisis.
This is a worthwhile read for investors who want to diversify geographically to other countries thought to have greater growth opportunities than that found in the U.S. A link to the full article is below.

Chinese version:
H/T to: The Big Picture