The Chinese bubble

Nowadays China plays an important role in our world economy. Its imports and exports heavily influence the world economy and every sign of a weakness has influences on stockmarkets everywhere. This year the Chinese stockmarkets already slumped twice and each time it took the other stockmarkets temporarily down. A study of stock-market history conducted a few years ago (by economists at Yale University) confirmed that global markets are far more correlated now than they used to be, which means that emerging markets like China can have a profound effect on asset prices world wide.

The Chinese economy is booming but the question is how stable is its financial system?

The population does not know so much about stockmarkets. They see that investors make enormous profits and decide that they want to be part of this rally to fortune. They consider the markets more than a gamble, not considering the risks related to their investment. This is due to the lack of education and the lack of experience. Stockmarkets are something quite new for the Chinese population, before these markets have not been easy to access. Today, it is in many ways easier to invest money on the stockmarket and China is not alone with the dilemma of a not-informed population. Vietnam faces the same challenge and so do other neighbouring countries.

This is not surprising. China currently faces it’s biggest-ever stockmarket boom. Everyone, from students to retirees, enters the race supported by the easiness of borrowing money. With inflation at 3.3% the real interest rates are around zero this year which encouraged the withdrawal of savings from banks. People also have wider access to money through mortgages or pawnable assets.

Nothing seems to stop this run, and governmental measures are until present without a great impact due to the poor financial infrastructure which makes it difficult to influence the markets.

What happens now if the market would plummet? The impact on the social stability would be inestimable if the bubble would pop. Low income groups as students and retirees are involved in the current stockmarket boom and if those people would loose their money, they would probably turn their anger on the party.

Today there are 91 million accounts held by individuals at brokers or in mutual funds and in average 200,000 new accounts are opened each day. All this in an environment which has obvious signs of becoming overheated.

Share prices are moving far ahead of companies’ earnings, to a degree scarily reminiscent of Japan in the late 1980s just before its crash. Shanghai’s stocks rose 130% in 2006 and continue to climb.

It is said that there are too few institutional investors because the government continues to impose restrictions on how far for instance insurance companies can invest their money. This leaves the market mainly to individual investors facing listed companies with poor corporate governance and consequently increasing risks of market-jarring scandals.

Is it time to be worried? Since 2004 there are economists claiming that China’s bubble will burst one day. Overinvestment will lead to over production and to an economic crisis. Even though this might be unlikely to happen for the moment, it is possible that the financial market will readjust itself. This means that there will be a certain number of losses and a certain number of losers. It should be interesting to watch the evolution closely and to see how the Chinese government will react face to this situation.