China’s Stock is Sky-High

Chinese stocks are still a long way off their October 2007 record highs, but if sentiment on the streets of Beijing or Chongqing is anything to go by, the one stock at a new all-time high is that of the Chinese government. The country's middle class now has incredible faith in its government's ability to pull off any plan it sets out to achieve.

Many people were obviously shaken by last fall's global financial crisis, and at the beginning of this year, there was widespread anxiety about employment and income prospects. However, the Chinese have been so impressed by their government's staggeringly large policy response and the traction those steps have gained in reviving investment that the dramatic events of 2008 now seem like a blip in the country's long march toward more prosperity.

It is popular in the capital city to contrast the Chinese economy's resilience with the bleaker outlook in Western countries. Cabdrivers, if only half in jest, talk about offering discounts to American and British passengers, while shopkeepers in the old town joke about how sorry they feel for foreign tourists not showing up at their door because the "poor" folks must be out of money.

The animal spirits of local Chinese consumers, on the other hand, are alive and kicking. Nowhere is this more evident than in the property market, where apartment prices in top-tier cities such as Beijing and Shanghai are back up to their 2007 highs. Even Hong Kong's latest property boom, which has seen both transaction volume and prices exceed the 2007 peak levels, is attributed to investors from mainland China. In Macau, gaming revenue touched new record highs in July, driven largely by Chinese money.

Not surprisingly, then, China is one of the first countries in the world where authorities are beginning to take action to rein in growth. Chinese policymakers are concerned that a significant chunk of the more than $1 trillion in new loans extended by the banking sector in the first half of 2009 (a figure that took the total amount of outstanding bank loans to a whopping 150 percent of GDP) has not made its way into the real economy. Anywhere between 10 and 20 percent of the lending is estimated to have gone into the local stock markets. As a result, banking regulators are now cooling lending, and the central bank is withdrawing some of the excess liquidity from the system.

The Chinese government is right to take the economy off steroids and reset policies for a more normal economic environment. China is too far along the development curve to maintain the near 10 percent economic growth rate of the past 30 years. The law of large numbers has to catch up with China just as it did with the other miracle economies, including Japan and South Korea during their industrialization phase. Furthermore, the country's past export boom will be hard to repeat given its already sizable share of the world market and the subdued economic outlook for its major buyers, such as the U.S.