Thursday, April 08, 2004

My friend Bill from UC Berkeley sent me a piece from the SCMP about how even investment banker Andy Xie is now worried about the Chinese economy. I agree with him that we should worry, and added some other comments:

You are absolutely right. If Andy Xie is worried, then we should all be. The investment banking community of course tends to put things in the best light. However, Andy Xie might also be intentionally pessimistic to affect a slight burst of the bubble. Of course, he would have to be an ego-maniac to think that. It is true that housing demand is rising rapidly in urban China, but I doubt that it is rising by 46%.

One thing that Andy said was particularly insightful: the China bubble now has global consequences. Billions of hot money is flowing into China. It would be fine if that money is just sitting in Chinese banks, but much of the money is speculating in mainland fixed assets or the stock market. If the PBOC is forced to take drastic action, such as imposing a lending quota, the bubble will burst, and a lot of hot money will be lost. This could trigger a debt chain in other parts of the world. The problem is we don’t really know where the hot money is coming from. If it mainly comes from off-shore Chinese money which fled China in the early 90s, the consequence might be mild. However, if a substantial amount of the money comes from investors borrowing heavily, then the lost of that money might pose a problem internationally.

For now, the PBOC is prevented from taking any drastic measure, probably for political reason. Traditionally, the CCP elites do not agree to burst a bubble until there is high levels of inflation. Due to surplus in manufacturing goods, inflation is still relatively mild, so there is no consensus in the leadership to harshly crack down on investment. The measures so far are half measures implemented half-heartedly. It will take much more for the PBOC to raise interest rate and even more before they impose a lending quota on the banks.

The SCMP article:

Thursday, April 8, 2004
Economists anticipate bursting of mainland's bubble

ALLEN T. CHENG in Beijing

China's rising importance as a pillar of global growth continues to concern economists.

Some see the hot mainland economy as a bubble waiting to burst, and fear it could cause global problems if it does.

Chief among them is Morgan Stanley's Andy Xie, who issued a report this week warning that the eventual bursting of the mainland's property bubble would send global markets crashing, triggering economic aftershocks far and wide.

There are two bubbles in the world today, according to Mr Xie, who is based in Hong Kong. The first exists in some western economies, where there is over-optimism that interest rates will continue to decline while incomes rise, a point of view which encourages consumers to borrow faster than their income grows.

The mainland's investment bubble is the second.

"It is the cause of the `gold-rush' mentality that dominates businesses and property speculators," he said. "Massive capital inflow is supporting property demand and credit supply. China's growth essentially comes from accumulation of speculative inventory in property and excess production capacity."

According to Mr Xie, gross fixed-asset investment stands at 42.9 per cent of China's gross domestic product, twice as big as in the previous bubble in 1993.

"This bubble is the same as what Southeast Asia experienced 10 years ago: excessive business optimism and massive capital inflow, which in turn will become an investment bubble," said Mr Xie, who believes that what is going on in the mainland today is a pyramid game played on a massive scale.

Local governments are borrowing massive amounts of money, with land as collateral, to build urban infrastructure, hoping that the value of the land will appreciate sufficiently to pay off the debts. Shanghai has used this method in the past.

Mainland officials are taking quick action to clamp down on hot money. Most recent was the implementation last week of a requirement that any individual or entity converting the equivalent of US$50,000 or more in foreign currency into renminbi obtain approval from the State Administration of Foreign Exchange (Safe).

Mr Xie believes Safe may suspend all non-foreign direct investment in the coming months and the People's Bank of China may ratchet up interest rates. "China pricking its investment bubble is becoming the most obvious risk to the global bubble," Mr Xie said.

However, not all economists see a bubble building up in the mainland or the government taking measures to prick it.

Andrew Rothman, an analyst for Credit Lyonnais Securities Asia, said he saw sustainable growth. "The government's focus is on improving quality and focus of the investment rather than just the speed of the growth. There are pockets of overheating, but if you look across the sectors we don't see that."

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