China facing 'boom, bubble and bust': Buiter

By Simon Kennedy, Bloomberg
China appears on track for an "asset boom, bubble and bust" that may take three years to play out and probably won't be thwarted by tighter economic policy, Citigroup Inc. economists said.
The process will begin in the residential property market before spreading to commercial real estate and ultimately to stocks, the Citigroup economists led by former Bank of England policy maker Willem Buiter said in a report. It may take as long as two years for the asset bubble to form and at least three years for it to burst, London-based Buiter and Shen Minggao in Hong Kong estimated.
Citigroup joins hedge fund manager Jim Chanos, "Gloom, Boom & Doom" publisher Marc Faber and Harvard University professor Kenneth Rogoff in warning of a potential crash in China. The country has yet to raise interest rates or allow its exchange rate to appreciate, keeping in place some of the extraordinary measures implemented during the financial crisis even as inflation and asset prices accelerate.
"What is policy in China doing about the threat of overheating in the financial and real economy?" Buiter and Shen said. "The short answer is: not much, and not enough to prevent the creation of what could become a major asset boom, bubble and bust."
Chinese central bank Governor Zhou Xiaochuan said in a March 23 interview that the country's government needs evidence of a "very certain" recovery before it can roll back stimulus policies adopted during the crisis.
The country's economic growth quickened to 10.7 percent last quarter, helped by a 4 trillion yuan, (US$586 billion) two-year stimulus plan for railways, airports and homes. Property prices in 70 cities climbed 10.7 percent from a year earlier in February.
The Shanghai Composite Index of stocks gained 80 percent last year and is valued at 32 times reported earnings, compared with 52 times at its peak in October 2007 and the Standard & Poor's 500 Index's 19 times.
Higher interest rates and an appreciation in the yuan are necessary to prevent the economy from overheating further, while regulatory steps should be taken to limit the booms and busts in the land, property and stock markets, Citigroup said. China has raised banks' reserve requirements twice this year.
The Citigroup economists said they were "quite confident" assets would boom and later go bust in China because that would mirror the experience of other countries where credit conditions had eased against the backdrop of strong fundamentals, frenetic financial innovation and untested economic policy making.
"This time is unlikely to be different unless the authorities in China act differently from the authorities in China and elsewhere in the past," Buiter and Shen said.
Policy makers probably won't temper investors' exuberance because they don't want to lose political support or hurt the investment growth they view as necessary to ensuring the economy maintains an eight percent growth rate and spurs employment, Citigroup said.
"Few politicians have been successful running against asset booms and bubbles," the report said.
When the asset bubble does break, the impact will be painful for China and its trading partners, Buiter and Shen said. It may still not derail China's economic expansion so long as the nation's leaders seek to make the economy more reliant on domestic demand, they said.

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