China Is No Bubble: Barton Biggs

For the chattering classes, spotting financial bubbles has become their favorite global sport, and currently China is the hot game. Fears of Chinese "tightening" have terrorized traders, particularly in Asia and commodity-sensitive markets. If Beijing slams on the brakes by raising interest rates and cutting back loans, the locomotive that has been pulling the global recovery train could falter, producing the widely dreaded "double dip" recession. The bears are licking their chops at this prospect.

The first thing you have to realize about China is that nobody knows a true thing about it, including me. It's simply too opaque. But it's also too big to ignore, so here goes my best uneducated guess. I don't think it's a bubble.

By the latter part of 2009 the Chinese economy—thanks, in part, to immense monetary and fiscal stimuli—was expanding at a 10 percent rate. In the late fall, the Chinese authorities began to gently pull back on the fiscal stimulus. Then in early January, the banks made a huge volume of new loans. While loan surges early in a quarter are not unusual, this one apparently was alarmingly large. Meanwhile, headline inflation jumped from 0.6 percent in November to 1.9 percent in December. But with most of that jump coming from food prices, due partly to severe winter storms, this is no cause for panic. Responding to the hints of inflation in an economy growing at 10 to 11 percent, the People's Bank of China moved quickly to slow down the monetary stimulus. The last thing the central bank wants is an economy that overheats and subsequently busts with dire social consequences. They, of course, are aware that there is a chorus of doomsayers and short sellers who are screaming that this is exactly what is about to happen. On the other hand, they have studied the history of the 1930s and don't want to overreact and prematurely abort a still-fragile economic recovery.

Accordingly, the authorities have gently raised the three-month and one-year bill-auction rates and advised the banks to pace themselves on loan growth. The one-year auction rate was raised eight basis points in each of the first two weeks of January. There is no question that this is "tightening," but it's a pretty gentle and tender squeeze. Perhaps to make sure everyone understood, last week one of the most influential deputy governors reaffirmed the commitment of the PBOC to a "moderately loose" monetary policy. Since China runs a "command" economy, admonitions have a lot of weight. For all the obvious reasons, it seems the PBOC wants to engineer a soft landing in which growth slows to 7 to 8 percent, not a hard landing in which real GDP sags to 4 or 5 percent. They are mindful that there are some 200 million to 300 million restless Chinese out there who are unemployed or underemployed.

The bears also argue that China is like Japan in the late 1980s, with gross overinvestment and overvalued asset prices. In actuality, China's profile is more like Japan in the 1970s. Chinese stocks, according to MSCI, sell at a reasonable 13.4 times this year's estimated earnings and 2.6 times book value. Japan in the madness of its bubble traded at 70 times earnings and more than five times book. The Japanese real-estate bubble also was of epic proportions and is still deflating 20 years later. In China, prices of luxury apartments in Beijing and Shanghai soared by 50 percent last year, but the average of home prices in 70 cities rose a more modest 8 percent. Only the richest 25 percent of the urban population are involved, and a quarter of the buyers pay cash. Mortgages are about half of the property value; owner-buyers have to make a 20 percent cash down payment, and investor-buyers must put up 40 percent. Commercial real-estate prices have risen, but financing practices are under similar restraints. The Chinese real estate is being financed by savings not borrowed money.

The bears also say China is investing way too heavily in capital stock, particularly roads, rail, and other infrastructure. But as The Economist has pointed out, China cannot have excess capacity when its capital stock per person is about 5 percent of what America or Japan has. China can't be laying down too many rail lines when it has the same land mass as the U.S. but only 110,000 kilometers of track, compared to the 400,000 kilometers the U.S. had in 1916. As for paved roads, 40 percent of Chinese towns do not even have a paved road to the nearest market town.

What could go wrong? If the U.S., European, and Japanese economies collapse back into a prolonged double dip, of course China's exports will be severely affected. Otherwise both the economy and the stock markets look good to me.