China has clearly begun a new asset-price inflation cycle, but having just emerged from a significant economic downturn, an irrational, speculative bubble remains quite far down the road.
Recent statements by the head of China’s Communist Party and premier Wen Jiabao reinforce my view that Beijing will not be taking tightening steps in coming quarters.
The economic recovery is clearly under way, but also clearly in its early stages. Another cycle of asset-price inflation has also begun, and this is likely to be the biggest round that China has experienced since the command economy was dismantled.
This inflation is being driven primarily by domestic liquidity, not by foreign inflows, and will thus have little impact on exchange-rate policy. I expect Beijing to resume gradual appreciation of the renminbi against the US dollar in mid-2010, once macro growth has stabilised and export growth has returned to positive territory.
The asset-price inflation will help to pull the economy out of a downturn and will provide interesting opportunities for investors. With house prices just starting to pick up after a long, shallow decline, this market is far from a bubble.
According to CLSA’s research, year-on-year price growth slowed throughout 2008 and was negative from November through to June. And while the Shanghai Composite Index has rebounded sharply this year, it remains almost 50% below the October 2007 peak. It’s hardly a speculative bubble – yet.
However, China’s leaders will at some point determine that asset-price inflation is generating a speculative bubble and intervene. As in the past, they will have little success in managing the equity bubble but will succeed in temporarily crashing the housing market.
But that time is probably four or more quarters down the road. This view was reinforced by China’s two top leaders recently vowing to stick with proactive fiscal and moderate monetary policies.
Over the next few quarters, expect to see a lot of economic policy fine-tuning, including measures designed to keep the housing rally running, but no steps that will qualify as ‘tightening’. There will be no need to apply the brakes to an economy that has just entered the recovery stage.