Tuesday, November 3, 2009

The China Bubble

The press is starting to warm up to our view that the Chinese situation resembles Japan in the 1980s. 

I'm not going to call it a bubble because the growth positioning of India is enviable, but the prices of property in Mumbai, Gurgaon and other parts of the country relative to income are astounding, humbling and shocking to me.

China rushes towards a Japan-style bubble

By Peter Tasker

Emerging markets, it seems, have had a good crisis. In contrast to the debt-ridden G7 economies, they have quickly resumed their growth trajectory. No surprise, then, that US emerging market mutual funds are experiencing record inflows. The stellar performance of the Brics markets - Brazil, Russia, Indian and China - is due to continue into the distant future.
Such is the narrative now forming among investors. To anyone who has lived through the rise and fall of the Japanese bubble economy, it should set off alarm bells.

Remember that it was in the years following the 1987 "Black Monday" crash that Japanese assets went from being expensive to absurdly overvalued and the Nikkei's dizzy rise to 39,000 forced the bears to throw in the towel.

Then, as now, the logic seemed unassailable. While the western world was stuck in the post-crash doldrums, the Japanese economy had got back on track with apparent ease. Japanese corporations were using their high market capitalisations to finance acquisitions of foreign trophy assets. Japanese banks boasted the world's strongest credit ratings.
But what you saw was decidedly not what you got. The crisis, far from leaving Japan unscathed, exacerbated its structural problems and laid the groundwork for a far greater disaster. And it was the weak western economies, not Japan, that produced healthy investment returns over the next decade.

In reality, 1980s Japan was never going to be terminally damaged by weakness in export markets. Its current account surplus and strong fiscal position provided the macro policy leeway to make any slowdown strictly temporary. The Bank of Japan duly put the pedal to the metal and the recently deregulated banks went on a patriotic lending spree. High-end consumption boomed but the real action was in the asset markets and capital investment, which soared as a proportion of gross domestic product.

Sound familiar? It should, because the same dynamic is evident today in China and some other emerging economies.
At the 2008 peak, the price-to-book ratio of the Shanghai stock exchange was over seven times, well above the five times achieved by Japanese stocks in 1989. After the turbulence of the past 18 months, the ratio has fallen to 3.3 times, still the world's second highest after India, and residential real estate trades at multiples of income that make the US housing boom look tame.
Why would China's rulers embark on a such a disastrous course? Because the alternative - unleashing deflationary forces stored up over years of mercantilist policies - would be too painful to contemplate. That was the choice made by Japanese policymakers, who had 100 years' experience of managing a quasi-capitalist economy.

While we can call these bubbles, based on anecdotal evidence emerging markets investors are convinced that they have survived and are immune to what ails the first world.  Time will tell, but a nagging feeling tells me I've seen this story before.

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