Why The China Bubble Is No Cause for Investor Alarm

If you’re invested in high-profile Chinese stocks such as Baidu (BIDU), E-House (EJ), CNinsure (CISG), China Life Insurance (LFC) or even a China ETF or mutual fund, then you were likely a bit unnerved by Tuesday’s announcement that the nation’s central bank raised the percentage of deposits that commercial banks must keep in reserve. The increased reserve requirements mean banks will have less money available to lend, which is precisely what Chinese policymakers want.

The motive behind the central bank’s action was in part to help quell fears that China’s economy is entering dangerous “bubble” territory. And while, this move didn’t come as a big surprise to those of us who follow the machinations of the Chinese economy, I do admit that the timing of this move did take many by surprise.

I’ve always argued that China’s central leaders have a very good understanding of financial markets and monetary policies. They are fully aware of the dangers of financial bubbles, and I think that they will continue to take the necessary steps to contain them.  And though I won’t argue that China’s move to rein in capital wasn’t necessary, I do think the whole notion that China’s economy is immersed in some kind of hyperinflated bubble is a whole lot of hot air.

I’m sure you’ve read at least some of the articles written lately about how China is living on borrowed time, and how its financial and housing markets are way overdue for a sharp correction. I think we can aggregate these China bubble arguments into three main categories — arguments that I think are unfounded, and here’s why.

China Bubble Claim #1 – China’s stimulus spending is wasteful and unnecessary

Government waste and inefficiency may be the order of the day here in the United States, but in China, the waste issue isn’t a major problem. Sure, whenever you have any organizational outlay of funds, you’ll find some waste, but the overwhelming majority of China’s $600 billion+ stimulus funds were judiciously and efficiently allocated into Chinese state-owned enterprises and government projects. Much of these funds were used for infrastructure investments critical to buttressing China’s continued economic expansion. 

China Bubble Claim #2 – Excess liquidity  

We all know that excess liquidity leads to bubbles. After all, it happened like that here in the U.S., so why won’t it happen that way in China? Well, first you must realize that the Chinese actually learned from our mistakes. In contrast to vast amounts of liquidity poured into the U.S. financial system by former Fed Chief Alan Greenspan, the Chinese government was, and continues to be, much more vigilant about controlling that liquidity. Case in point was the central bank’s move this week.

The fact is that China’s money supply growth will likely slow to 15% in 2010 from 30% this year. That’s a lot of fiscal braking, and that fiscal braking is likely to help China’s financial system come to a much more controlled speed when compared to the relative dead stop we saw in the U.S.

China Bubble Claim #3 – Economic growth will stall without strong exports

The notion that the Chinese economy is a bubble ready to burst if it doesn’t see strong exports seems to me the weakest — yet it’s among the most prevalent — of the China bubble arguments. Consider that the Chinese economy grew by more than 8% in 2009 even with a 10% decline in exports. This past year proved that China can achieve strong economic growth without a reliance on exports, and it marks the country’s structural transformation from “factory of the world” to “market of the world.”

I think the idea that exports are the key to China’s fortunes is a gross misread on the tremendous power of the Chinese consumer. Despite the relatively low wages in China when compared to the West, the Chinese have much higher savings rates (near 35%) and home ownership rates are approximately 80% — and that’s in the world’s strongest property market. These two factors give most Chinese households tremendous pent-up purchasing power. And when you combine high savings, the positive real estate wealth effect and rising income, Chinese domestic consumption has nowhere to go but up.

I think you can now start to see why I think the China bubble talk is more hype and financial fear-mongering than reality. The fact of the matter is that China’s economic growth will likely continue into 2010 and beyond, and that growth will continue to support investments in some of the best China stocks out there.

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Article printed from InvestorPlace Media, https://investorplace.com/2010/01/china-bubble-is-no-cause-for-investor-alarm/.

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