Why China Is Prone to Bubbles
Chinese markets have rarely looked more like Vegas casinos. In recent weeks, investors have driven up trading volumes in China to astronomical levels, betting on everything from rebar to eggs. China traded enough steel in one day last month to build 178,082 Eiffel Towers and enough cotton to make at least one pair of jeans for every person on the planet.
These commodity markets aren’t gyrating purely because Chinese are inveterate gamblers. Government policies have made China especially prone to asset bubbles. Even as some of those bubbles are carefully deflated, new ones are sure to emerge unless the policies themselves change.
The issue is surplus liquidity -- what’s been described as China's “great ball of money," which bounces from asset class to asset class as if in a pinball machine. Even Chinese leaders acknowledge it was their effort to fend off the 2009 global financial crisis that allowed that pile of money to grow to epic proportions. By now, credit and money growth has far outstripped any good opportunities for investment in China’s real economy, which is hobbled by excess capacity. And the mismatch is getting worse: Total social financing, China's broadest measure of lending, grew nearly four times as fast as nominal GDP last year.
Money doesn’t sit still; all this increased liquidity is flooding into real estate and financial assets. Last summer, that led to the boom-and-bust of the Shanghai stock market. Now it’s driving up property prices in top cities -- Shenzhen real estate is up more than 50 percent in the past year -- to levels higher than in any U.S. metropolis other than New York.
Yet rather than retreating, the government is doubling down on its strategy. In January, soon after drafting a new five-year plan that focused in part on the need to shrink industries such as steel and coal, the government eased credit yet again, boosting loan growth by 67 percent in January and 43 percent through the first quarter. The money was meant to -- and did -- buy an uptick in GDP growth. But it's also gone into new loans to zombie companies as well as speculation in the commodity and bond markets.
Officials have also maintained their firm grip on the economy, thus encouraging investors to focus on government statements, rather than economic fundamentals, when deciding where to put their money. Prior to the stock market peak in July 2015, top leaders were actively talking up the virtues of equities and boasting of how high the Shanghai index could go. More recently, they’ve extolled the virtues of home ownership and lowered down-payment requirements for some homebuyers. Ever since the government announced a raft of new infrastructure investments in December, prices of construction-related materials such as rebar and cement have shot up.
The government has tried to dampen speculation in commodities recently, by raising the fees and shortening hours for trading, and the measures appear to be having some effect. But the only sure way for China to prevent new bubbles is to tighten credit, slow money growth and allow risk to price assets properly. If the government keeps stepping in to prevent falling prices and to bail out banks or other investors, the possibility of loss is discounted.
The probability of an asset crunch like the ones Japan experienced in the 1990s and the U.S. in 2009 remains low for now, in part because of all that liquidity. But the risks are rising every day. Meanwhile, the money sloshing around the Chinese economy, trapped by increasingly tight capital controls, is putting inexorable pressure on the currency. Smart investors are looking to get out: The returns on offer inside China aren’t enough to compensate for the risks of buying into what look like controlled markets and artificial prices.
Sooner or later, if risks continue to build, there will come a moment where the government will lose the ability to prop up the yuan and to roll over loans indefinitely. In real life, the house doesn’t always win.
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