Watch For a Bust in Chinese Asset Markets

“There is a bubble going on…Investors should be concerned about the risks. But in a bull market, people will invest relatively irrationally. Investors think they can win…many will end up losing. But that’s their risk and their choice.” So says Cheng Siwei, vice-chairman of the National People’s Congress of China.

Cheng was speaking off the cuff at a conference in Dubai. He also said that only about 30% of the companies listed on the Shanghai exchange “are good to invest in by Western standards.” What about the other 70%?

China’s Shanghai Composite Index was up 130% in 2006, and down 7% last week. So is it a bubble? And is it going to bust? And if what, so what? And if the “so what” matters, “what now?”

First things first. China’s capital markets are just starting to grow. The rate is astonishing. There are 82 million stock market trading accounts in China. In January alone, according to government statistics, another 1.38 million trading accounts were opened. What to make of this? Is the Chinese stock market becoming a giant national casino, where Chinese savers can more efficiently lose all their savings and make money-shufflers rich?

The answer is that the money-shufflers always get rich when the financial services industry grows. But China *does* need a healthy domestic capital market for its economy to grow. Fixed-asset investment in China-in things like roads, real estate, bridges, and rail-has been booming as a percentage of GDP. That investment has literally built the infrastructure of China’s economy (and made Aussie resource companies very rich.)

But what comes next for China’s economy on its ascent to 21st century prominence is so-called “soft infrastructure.” These are the things we take for granted in the industrialized West…transparent laws, well-regulated financial services, and a banking sector which does not require heavy state subsidies to offset non-performing or loss-producing loans. Watch for a bust in Chinese asset markets. But don’t expect it to destroy the Chinese economy.

Dan Denning

Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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