My Blog

October 17, 2007

Shanghai-based economist Andy Xie (formerly Morgan Stanley’s chief Asian economist and one of my favorite economists on China), has an interesting Op-Ed piece in today’s FT in which he argues that the Chinese stock market may well be in a bubble but that its bursting will have a minor impact on China’s economy.  Among the points he makes is that whereas the value of Chinese stocks and residential property is equal to 3.5 times China’s GDP, in Japan in 1989 and Hong Kong 1987 their combined values peaked at nearly ten times their respective GDPs.  This means that in GDP terms a collapse in stock or residential property prices will have a smaller economic impact in China than it might have had elsewhere. 

He says for example that a 50% drop in the Chinese stock markets would eliminate as much paper wealth as only a 15% drop in the US stock markets.  Xie’s point is that if there is indeed a stock market and real estate bubble, when it bursts it might not have enough of a fundamental impact on the underlying economy to matter.  He even implicitly argues that given how expensive housing has become, a drop in real estate prices may be positive because it will reduce, not increase, social tensions: “If the property market drops 30 per cent, most people in China will laugh; only the rich and powerful will grumble.”

I often worry that one of the reasons financial crises take us so often by surprise is because we assume that they are caused by misalignments in the underlying economy, whereas I am convinced they are caused by balance sheet misalignments.  For that reason my hackles were a little raised by his comment on the impact of a real estate crash on the banking system.  He says: “The banks may suffer bad debts. But the Chinese government has a tendency to pick up the tab after a party and gets another one going right afterwards. It still has the money to do so.”

Maybe.  Regular readers know that I am skeptical about how much room the government has to pick up yet another tab as glibly as all that.  I think contingent debt levels are much higher than most of us think, and I am pretty certain that if there is a sharp break in the market, people will suddenly want to get a sense of how much debt there really is – and when that happens the lack of transparency will no longer be seen as a virtue.

By the way around a year ago we were saying that stock market capitalization was only 40% of GDP, so a crash would have a minor economic impact.  Now we are saying that stock market capitalization is only 115% of GDP (and only one-third of the shares float, as opposed to one-fifth back then), so a crash would still have a minor impact.  Still, an awful lot of paper wealth has been created, and this wealth creation has not been spread out evenly over China.  Much of it has been concentrated among middle class residents of the largest cities.  I would guess that this is not a group whose opinions can be too easily dismissed.

Comments (4) for "Will a stock market crash ma...

Glad to read your comments on Chinese financial markets. I always prefer bloggers to regular columnists, even more on such issues. and was glad to find your site. The truth is that it is still very difficult to assess the real state of Chinese financial markets from here (in Europe). I do not buy into goldilock scenarii concerning the Chinese development. Nor Am I specifically pessimistic. Still the chances that China will be confronted to some over-capacities in the coming years is just plain logic. Good old economic cycles do apply, even more so on lightly regulated markets. The issue is "when will that happen and what will the consequences be for financial markets, both the chinese one and the global economy?". Have you any pointer on this subject? Figures and facts are definitely missing. Francis By francis - 10/17/2007 1:23 AM

There is a difference between China and Japan in that in Japan the banks owned stocks in companies, which meant that a stock market crash immediately pummeled the banks balance sheets, and you had a nasty feedback cycle that was hard to get out of. In the case of China, a stock market crash would be more decoupled from the wider economy. By Twofish - 10/17/2007 4:52 PM

Francis, thanks for your comments. I think it is hard to get numbers on when a problem is likely to happen because, in my opinion, these are not cumulative processes subject to prediction. If a balance sheet is unstable, a sufficently large shock can cause it to break down. The more unstable it is, the smaller the necessary shock. Since we can't predict the shock, all we can do is watch with concern when we see such rapid monetary gowth being translated into excess credit growth in a very rigid and inexperienced banking system. It is hard to live in China and not feel that everything looks and smells like a bubble. This is not a very scientific statement, but in the end all bubbles in history involved basically the same process of too-easy money conditions leading to too-risky debt investment structures with significant positive feedback imbedded into those structures. By Michael Pettis - 10/21/2007 3:35 AM

Hmmm. The size of China stock market is no longer small (A mkt cap 120% of GDP and free float mkt cap about 25% of household financial asset). If we include China stocks in HK ( increasingly owned by Chiese investor), the mkt cap/gdp ratio is more like 150%. This is a a scary ratio if we consider that FFE ( a major chunk of economy) is not represented much in stock market( they are in S&P 500 or TAIX) major previous stock bubble almost all peaked before mktcap/GDP ratio hit 200%, even we assume nominal GDP rise 15% in 2008, how higher this market can go before gravity set in? By isaac - 10/22/2007 6:36 PM