Worrying about asset bubbles is becoming reflexive among the world’s economists and business leaders, as is skepticism when economic growth figures seem too good to be true. Earlier this year a lot of economic forecasters were predicting fairly dismal growth figures for China, some going below 6%. Now they have all revised their figures upwards, but have turned towards warning about asset bubbles and the weak fundamentals underpinning those figures. Today the OECD weighed in, and not for the first time, warning that China needs to restrict new lending to prevent fresh bubbles from forming, in the real estate market in particular. Bill Gross, who runs the Pacific Investment Management Co. (PIMCO), concurred about the bubble. "The Chinese, I suspect, will have a bubble of their own to confront," Gross said. "It’s gearing up for export that doesn’t find an end consumer, that’s the real problem in China."
Clearly there are always risks of asset bubbles forming in a country with so much liquidity and so few investment options. Chinese mutual funds and other institutional investors are underdeveloped, there isn’t much in the way of bonds, and those investing in the equities markets tend to be inexperienced individuals or state-owned enterprises. And then there is real estate. It seems patently insane to some that real estate prices in coastal cities like Shanghai are now comparable to prices in developed Western cities, despite the fact that in the West, property rights are much more secure than they are in China. But US$1.3 trillion in new lending has to go somewhere, and when its not being spent on much needed infrastructure and social services, it is getting plowed into the remaining investment vehicles: houses and stocks.
At the same time, policy on both sides of the Pacific is aggravating the problem. Given that the renminbi peg has remained unchanged since last year, the low-to-no interest rates of US Treasuries – and declining value of the dollar – is effectively exporting inflationary pressure to China.
This is not to say that everyone concurs that real estate and stock prices are, in fact, overvalued. China is in engaged in the largest urbanization project in history. It needs housing. Chinese firms are becoming increasingly competitive, and if the Western economies recover in time, the export problem goes away, so high valuations are not necessarily halluscinatory. At present, the Chinese economy has little choice but to gamble on an eventual recovery in foreign demand – which is not to say no action is necessary.
Assuming that the situation in the US remains the same – and American policymakers have clearly stated they have no intention to increase interest rates in the foreseeable future, Beijing has several options. It can start by tackling credit growth. It has already started cutting back lending and continues to make noise about banks’ capital adequacy ratios and non-performing loans. It can also increase mortgage downpayment requirements – or more strictly enforce existing requirements. All of this has put strong downward pressure on real estate and stock prices in the past, but it also shows how flimsy these valuations are, given their direct dependence on government policy. It can also revalue the renminbi, which foreign investors – and US Treasure Secretary Timothy Geithner – already to be taking for granted. Beijing has already moved to liberalize the private equity markets, which will offer another alternative investment channel, as will the suggested foreign board on the Shanghai Stock Exchange. And of course there is the mantra: "Stimulate domestic consumption." But looking at its record so far, and comparing its actual performance to what foreign naysayers have predicted in the past, China might decide to listen to its own experts first. They’ve done a pretty good job so far.
