Calibrating differences between China and Japan’s bubble blow-off top

A post by Edward Harrison.

I was talking to a friend of mine who does emerging market investing for a living and I asked him what he made of recent China-bullish comments by Stephen Roach. 

The Morgan Stanley Asia head was in Germany speaking to German business daily Handelsblatt last week. The guys from Handelsblatt wrote up a piece called “In China bildet sich keine Blase an den Märkten” which translates “China is not creating a market bubble.” Unfortunately, the story is behind a pay wall (and it’s in German anyway). But Gwen Robinson of the FT got the inside scoop and posted “Roach: Pooh-pooh to Chinese bubbles” at FT Alphaville. She writes:

As Roach notes, the Shanghai A-share composite index soared 3.5 times in the year ending October 2007 before plunging more than 70 per cent in the ensuing 12 months.

And every China watcher knows about the surge in nonperforming bank loans that required a major recapitalization of a nascent Chinese banking system less than 10 years ago.

But these problems were mere bumps in the road, in retrospect. Roach explains (our emphasis):

That’s because Beijing was vigilant in preventing asset and credit bubbles from spilling over into the real side of the Chinese economy. This was very different from the Japan endgame of the late 1980s, where the confluence of equity and property bubbles led to a massive overhang of excess capacity.

What’s more, he adds, it stands in sharp contrast to the more recent US experience, where property and credit bubbles pushed up homebuilding and personal consumption to nearly 80 per cent of US GDP prior to the bursting of the subprime bubble.

Of course, China is “hardly the poster child of macro stability” – with exports and fixed investment surging to nearly 75 per cent of Chinese GDP and private consumption at 35 per cent and still falling, China’s macro imbalances are in a league of their own.

But in Roach’s view, these distortions are less of an outgrowth of asset and credit bubbles and more a by-product of a conscious strategy of externally-oriented economic development.

While China can hardly avoid bubbles, he notes, it has been successful in preventing them from destabilising the real economy.

Because of the spate of China currency manipulation/protectionism stories hitting the wires (see my links post), I had been thinking about 1931 a lot recently – more on that later. But when I asked my friend what he thought of Roach’s comments, he said: “I think China is indeed Japan in 89/90, but potentially magnified.”

Let me explain. Contrary to current folklore, the reign of Paul Volcker was not one of extreme inflation hawkishness and anti-bubble moral suasion. In fact, there were serious animal spirits building in the U.S. in part due to a September 1985 Plaza Accord, in which the major countries all agreed to depreciate the US dollar. The exchange rate plunged a fantastic 51% before the carnage was done. And as anyone will tell you, currency depreciation is inflationary – either for consumer prices or asset prices or both.

By February 1987, the U.S. Government was alarmed at the speed of the U.S. dollar’s depreciation and looked to reverse it at the Louvre Accord. The problem, however, was that the U.S. wanted Japan to continue a stimulative monetary policy. Here’s what the accord actually said:

The Government of Japan will follow monetary and fiscal policies which will help to expand domestic demand and thereby contribute to reducing the external surplus. The comprehensive tax reform, now before the Diet, will give additional stimulus to the vitality of the Japanese economy. Every effort will be made to get the 1987 budget approved by the Diet so that its early implementation be ensured. A comprehensive economic program will be prepared after the approval of the 1987 budget by the Diet, so as to stimulate domestic demand, with the prevailing economic situation duly taken into account. The Bank of Japan announced that it will reduce its discount rate by one half percent on February 23.

The Plaza Accord may have helped correct imbalances, but it also put the Japanese economy into a blow off bubble top that sent the Nikkei into the stratosphere above 38,000. The result was a spectacular bust from which Japan has still not recovered.

So, now that we see the Chinese, with their $600 billion stimulus package and massive increase in credit, causing serious malinvestment, one wonders whether we are seeing a repeat of the 1989/90 excess in Japan.

I have repeatedly pointed to enormous levels of malinvestment in China. Here are a few posts of that ilk.

Yet, we see Stephen Roach’s cogent defence of what is going on in China. He is not known as a perma-bull – – quite the contrary.

So what gives? Is China experiencing a massive bubble or not? If so, will the bubble’s inevitable pop spill over into the real economy in a nasty way as it has done in the U.S. and elsewhere?

These are important questions given the central role China plays in the world economy. My own point of reference has been the 1920s and the 1930s more than the 1980s and 1990s. In the 1920s, Great Britain played the role now played by the United States: military power, declining economic power, anchor global currency, and largest debtor nation. The United States played the role now played by China: rising economic and military power and ‘alpha creditor,’ a phrase our Yves Smith coined. (The key difference is that the U.S. was more advanced relative to Great Britain than China relative to the U.S.)

The section in Charles Kindelberger’s seminal book, “The World in Depression 1929-1939″ on French accumulation of sterling also bears noting. Sterling was weak and the French had been accumulating huge amounts of British pound foreign reserves in 1926. This created a problem for the British because the French could threaten to redeem those pounds for gold under the gold standard then in operation. Kindelberger says:

this accumulation put [French central banker] Moreau in a strong position and [British central banker] Norman in a weak one. As an opening gambit, the bank of France began to convert sterling into gold…

There were threats of further conversions of sterling into gold.

Eventually, the French and British reached a compromise which involved the Federal Reserve Bank of New York lowering interest rates to help the British (and the Germans who had just had their travails with hyperinflation).  The result of this easy money was a blow-off top to the U.S. stock market and credit bubble that had almost collapsed after the Florida real estate boom went off the rails.

When I first posted this yesterday at Credit Writedowns, I failed to mention how I see China [and Japan] as the modern-day reserves accumulator. China is effectively doing what France did by accumulating reserves despite fears of currency depreciation. I think this reserve policy is significant because this is what is behind all of the talk of protectionism and currency pegging. The Chinese are afraid that the U.S. are actively looking to devalue the currency while the U.S. are fed up with the peg and the resultant imbalances.

How this gets resolved, I don’t know. Roach, at a minimum, usually points to increasing Chinese domestic demand (especially via increasing income security by expanding the social safety net). This parallels the situation in Europe where the Germans could increase spending to reduce intra-Eurozone imbalances, something France’s finance minister is on to. As for the Chinese, if they don’t do this, we are headed for some serious protectionist escalation in my view. And, as Ambrose Evans-Pritchard points out, the surplus countries take it on the chin in such a scenario, something we saw in Japan and Germany in 2008.

Clearly, the U.S. role of easy money global saviour in the late 1920’s was played by Japan in the late 1980’s and by China in the late 2000’s. Each time, the speculative mania which the easy money fuelled ended in disaster. 

Eventually, the whole system broke down in the 1930s, with the U.S. playing the protectionist card and precipitating collapse.

I have trouble believing this time is any different. If any of you have a different take on these events -especially in regards to protectionism, please respond in the comments.


Statement of the G6 Finance Ministers and Central Bank Governors (Louvre Accord) – University of Toronto G8 Information Centre

Charles Kindelberger – The World in Depression

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About Edward Harrison

I am a banking and finance specialist at the economic consultancy Global Macro Advisors. Previously, I worked at Deutsche Bank, Bain, the Corporate Executive Board and Yahoo. I have a BA in Economics from Dartmouth College and an MBA in Finance from Columbia University. As to ideology, I would call myself a libertarian realist - believer in the primacy of markets over a statist approach. However, I am no ideologue who believes that markets can solve all problems. Having lived in a lot of different places, I tend to take a global approach to economics and politics. I started my career as a diplomat in the foreign service and speak German, Dutch, Swedish, Spanish and French as well as English and can read a number of other European languages. I enjoy a good debate on these issues and I hope you enjoy my blogs. Please do sign up for the Email and RSS feeds on my blog pages. Cheers. Edward


  1. Entelechy

    I agree that there is something, at least seemingly, strange about the Chinese situation and the various opinions. I am also inclined to think that China is in a bubble with dire consequences ahead.

    The network of events today are so complex given the tightly interwoven nature of the the global economy, that I doubt anyone’s ability to truly understand what’s actually happening — even ex post facto. We even argue now about past events which were perhaps somewhat less complicated because of fewer signifcant players. Every time some new layer of complexity is revealed, we understand that we didn’t understand.

    Added to this is the nature of power. Those in power are in most democratic societies are nothing these days but rent seeking parasites that feed off lobbyists and their corporate masters. They will do practically anything to keep their jobs — after all, they are for the most part unqualified to do anything else but work in the government/media industry. So to keep their jobs, they will do anything to keep the public appeased so they can be elected. I never thought it possible that the government would take the actions that it has in the past years, but they have, and nothing will restrain it unitl the resulting imbalances are so overwrought that the entire system breaks — maybe for all time.

    Looking, at China, I see the exact same thing happening. The Communist party elites will do anyting to keept their power. Whatever instrument they have available, including deception as a whole, will be used to keep themselves in power and the populace quiet. At the same time they are busy raping and pillaging their own economy in every way they can think of, with the desperate sense that it they need to get theirs and flee when the whole ediface comes crashing down.

    So what is happening in China? Is it a bubble? Likely. But those in power have huge incentives to keep the bubble up for as long as they can – and their creativeness may keep the bubble growing for far longer than any conventional thinker may believe to be possible – which then will validate those people who say that it’s different this time .

    1. Vangel

      I think that we can defend the position that there are bubbles in China if we look to commercial real estate or residential real estate in a few of the very large cities. But the most obvious examples of overvaluation are not replicated in many areas. For example, when I looked during my last visit the price of equivalent housing units was around three times higher in Beijing than it was in Xi’an. From what I could see, the data indicated that bubbles were local rather than national in scope.

      But I am not entirely certain that we can’t see much of the infrastructure building continue. While many Chinese roads are superior to what is seen in the US it is clear that China needs a great deal more road building for the next decade or more. As urbanization trends continue for a while there will be even more housing units required and more schools, rail roads, water treatment plants, bridges, power plants, etc. This means that China can continue to consume a great deal of the world’s supply of commodities for quite some time.

      I think that is why we will see a revaluation of the RMB over the next few years. China will find it in its interest to be able to decrease the cost of raw materials and to increase the purchasing power of its citizens, who will be in a better position to purchase a greater proportion of the goods that are currently produced in China and exported to the West.

      Now it is possible that China revalues sooner rather than later and that the revaluation causes a temporary bump along its road to prosperity. Such an event may be even more favourable to China over the long run because it would allow a much greater investment in needed infrastructure and could bring to power a leader who will provide a unifying vision that leads to a less intrusive government and more individual liberty.

      I can’t see how a revaluation or trade war actually helps the US because either will tip the economy into a deep recession and is likely to cause interest rates to increase by a large amount (or the currency to lose most of its purchasing power.) If the government devalues the USD it will be much harder to fund the required infrastructure build in the US. (American roads, railway stations, subway systems, and airports are very old and run down when compared to what one sees in Asia and most of the developed world.) The lower purchasing power would push many families over the edge and is likely to cause social turmoil, particularly when most consumers figure out what Obama’s trade war means to their ability to buy the goods and services that they were used to.

      I think that a trade war will push the US into default and will make it a has been power, much like Britain became after WWI. The decline will be rapid and within a generation the US will be a shadow of its once great self unless it manages to go back to the limited-government/individual-liberty principles on which it was founded.

  2. JeffC

    That posting represents a very nice perspective. Much appreciated.

    Small correction re Kindleberger’s book. I haven’t read that particular book, but “sterling was weak” looks incorrect. My understanding is that sterling was overstrong, pegged to too much gold in a hopeless attempt to restore the pre-WWI rate. This led to Brits importing way too much and therefore to their gold (or pounds… same thing then) fleeing the country and piling up elsewhere, including in the US. Benjamin Strong at the NY Fed tried to counter the latter by printing cash to push back at the London-NY flow through the flow-of-funds identities that have been so discussed here of late. What we got as a result was a horrible 1925 Florida real-estate boom that went national and then a margin-driven stockmarket boom that bankrupted ordinary people induced to gamble all on the “sure thing.” We know how it ended.

    1. Edward Harrison Post author

      Sorry about the terminology, Jeff. That’s what I meant, that sterling was a weak currency in need of a devaluation because the peg was set too high to gold. And they did eventually devalue.

  3. Fair Economist

    I’m amazed that Roach can say the Chinese easy money/currency manipulations has not “spilled over into the real side”. China is increasing an already unsustainably high fixed investment rate by massive investment into sectors like steel and aluminum where usage is already at deeply recessionary levels. Never mind the empty skyscrapers and even empty cities that have gotten so much press.

    Everyone seems to have forgotten how incredibly strong a country going through a blow-off bubble looks, right up to the crash. That’s really odd since Japan 1989 is recent enough that most economic and business writers active today saw it. Doesn’t anybody remember how sure we all were that Japan would own the world? Even when the Nikkei first started to slip I remember people saying it was because all that Japanese money was ready to charge out and buy the world.

    China looks like it will rule the world economy right now but even a casual looks shows it’s just another blow-off top. It will remain the largest manufacturer, just as Japan remains the queen of lean manufacturing and cutting-edge consumer electronics, but a big bust is coming.

    1. Nathanael

      Ah, but the government is currently steering all the “malinvestment” away from skyscrapers and into:
      (1) trains
      (2) electrification
      (3) solar and wind power

      I wouldn’t be surprised if they pushed sewer and water systems next.

      If they manage to have a big economic “crash” just after upgrading all the infrastructure in the entire country, on the whole nobody will *CARE*. They might have to overreact to income shortages with agriculture subsidies, but isn’t that what the entire industrialized world did? :-/

      1. Martin

        You have the proportions wrong.
        And China isn’t even a big market for solar. Just a few years ago China was the largest solar panel maker in the world, but >90% was for export. And still today most is for export.
        Solar is too expensive to be reasonable currently in China. China needs to push for energy efficiency much more than for alternative generation of energy (while not as strongly, this is as well partially true for the US. Alternative energy currently makes the most sense in Western Europe and Japan). And this is a more complex process.

        The high speed trains don’t help as well so much. Industry needs good commuter trains and long range cargo trains. Long range people trains don’t add much to productivity, and are too expensive for the vast majority of Chinese.

        If you were correct, the Soviet Union would have won the cold war. The reality however is, that the gov’t can not do all the investment in a society over a longer period of time.

  4. Jesse

    I trust nothing that Steve Roach has had to say about China for a long time. He is on the sell side with respect to them.

    1. Charlie Brigante

      Well put, although I’d say he’s on the ass-kiss side. He doesn’t want to piss off the Chinese leadership and you really can’t blame him.

      1. Christian

        “He is not known as a perma-bull – – quite the contrary.”

        I remember Roach as a bear on the USA and OECD for the most part (IIRC he had a brief fling with optimism on the US economy in 2005). On the subject of China, he’s been a bull for a very long time now.

        That seems to have been the correct perspective during the current crisis, but it may not hold for the future.

  5. Mickey Marzick in Akron, Ohio

    “Protectionism” for whom and when is highly unlikely given the liberalization of trade promoted by this country since 1945. It would take a political earthquake to undo this.

    Neither political party is in a position to play the protectionist card without first offing the globalists in its camp – not likely. For the Republicans there has always been an uneasy tension between the small business, entrepreneurial, local/regionally oriented business versus the large, modern, bureaucratic global corporation free trade crowd – the globalists. The former tend to be more socially conservative, more inclined to favor less government and lower taxes a la Tea Party adherents but at the same time finds itself up against the wall of cheap imports and increased requirements for creditworthiness. The perception is that they are being squeezed by big business! The latter is more liberal on social issues and may pander to many of the same policies but not if it translates into protectionist measures to restrict free trade. The small business wing may have the footsoldiers – the numbers – but the globalist wing has the deeper pockets. Crony capitalism favors the latter.

    The Democrats do not fare much better. The “marriage” between the more probusiness SLC Clintonian Democrats and the more left leaning Democrats allied to the blue collar trade unions has always been tenuous. As the latter have hemorrhaged jobs the protectionist banter has increased. Yet a full blown divorce is not likely. The Democrats cannot afford to be seen as beholden to this special interest, particularly among INDEPENDENTS with a visceral anti-union or libertarian bent. Yet without some mechanism to create jobs, the troops will cast their votes elsewhere. Witness the recent election in Massachusetts. The union leadership endorsed the Democratic candidate and the voters went south…

    The wildcard in all this is the electorate. And here regionalism will play a big role. While the containers offloaded at the ports of Long Beach/LA and Seattle may be seen as the cheap IMPORT problem responsible for the loss of manufacturing jobs in Ohio or Michigan further east, the EXPORT of Montana coal, northwest timber, grain, foodstuffs, etc from these same ports will be viewed differently by those employed in such industries. Likewise in the South where transplant assembly plants may be “foreign”, when they’re the only game in town, it sure beats workin’ down on the farm! Working for the Japanese or Koreans is still more preferable to not working at all.

    Calls for LIMITED GOVERNMENT and LOWER TAXES are not consistent with calls for PROTECTIONISM. Only if the advocates of protectionism from both the left and the right can get beyond the more shrill debates that divide them will the political elites in either party have a problem. Then the elites in both parties will have to protect more than trade… as the Washington Consensus enjoined by both will have been repudiated with ramifications far beyond domestic politics.

    1. alex

      “not if it translates into protectionist measures to restrict free trade”

      Please stop speaking of yuan revaluation as though it were protectionist or a restriction of free trade, because it’s actually the exact opposite. China’s peg is what’s highly protectionist, and eliminating (or at least moving it) would promote free trade.

      Your points about political clout are accurate unfortunately. The “globalists” are MNC’s and finance, which benefit from an undervalued yuan. But we have to stop buying into the Orwellian notion that Chinese protectionism is free trade.

      1. Mickey Marzick in Akron, Ohio


        To believe that free trade exists is ORWELLIAN… Just like free markets… all theory with little historical evidence. Mercantilism has been the rule not the exception.

        We cannot go back to free markets or free trade/exchange without dismantling the MNCs. That has about as much chance of happening as the proverbial snow ball in hell.

  6. Burntout

    With all due respect to great economic minds debating the above, one thing that NOBODY cares to think about is that before the end of 80’s, USA was the defacto protector of Japan and Europe and the “free world” and could strong arm anyone into signing off any accord. The countries behind iron curtain were busy in defending their ideologies but were felt to be a threat to the wealthy capitalists all over the world.
    So in essence, we free worlders were also fed an ideological manna- we are free, communism is bad ( the commies boil their kids in oil etc ). This was while our hard earned paper currencies were ( and still are ) being inflated away.
    Every govt. in this world feeds off its citizenry. China/India/Brazil being no exceptions. Look no further than our hon. senator Dodd grovelling in front of the central bankers ( while spoon feeding us the tough talk)
    I see an end to all this. The french gulliotine being in fashion once more. I pray that my kids wont get hurt when it happens. I better stay on the side of peasants.

  7. jake chase

    China is probably not heading for a bubble, because it lacks a free capital market. The government sterilizes dollar balances, chows down unimaginable piles of US government debt and can do nothing else if it hopes to keep its real economy functioning and its acquisition of western technology on schedule. Technology not money is the key to Chinese power. Lenin said the capitalists would sell him the rope to hang them; the Chinese understand the Washington Consensus bribes them to acquire the most advanced technology. Why would it disturb that deal?

    I would expect a bubble in the US stock market instead. That is where all the cheap credit provided by the Fed is flooding. The hope of the politicians is that commodity inflation will follow to validate all the underwater household debt. Without China continuing to do exactly what it is doing, none of this was remotely possible. As for how it ends, the answer is badly, but when and for whom remains unclear.

    1. Martin

      China definitively has a relatively free stock market, which actually is much more volatile than the US one.
      The housing market is even more prone to pure speculation than the US one. There is no property tax, and people buy flats just for speculation, while they don’t even care if somebody lives in those flats.
      Michael Pettis has as well discussed, if in case of a price crash urbanisation could rescue the housing market. The answer is probably not, as China is already quite urbanised. Urbanisation data is measured differently in the US and in China. The US manipulates statistics, but compared to China, US statistics are still very honest.

    2. Martin

      As well, the Chinese gov’t can sterilise only for so long. It is very expensive to do so. As it has to pay higher interest on its yuan borrowing than it gets on its dollar holdings.

  8. Stelios Theoharidis

    I think what you are seeing in regard to China is a split in outcomes. You have a section of the economy which is privately owned very efficient, export oriented, and receiving significant foreign direct investment.

    The other section is state-owned, that is involved in industry and construction, that has made quite a lot of bad investment decisions, that are in many cases well hidden, and is the root of the non-performing loan problem. The latter has helped drive the property bubble and malinvestment in infrastructure.

    However, given the propensity towards savings on the part of its citizenry and willingness of the government to bail these groups out, seeing as quite a few of them are probably influential communist party members. The situation is likely to be similar to the Japanese one and not like more open economies.

    Now the problem is when economic growth begins to stagnate it will put the legitimacy of the capitalist project in China under question, if it does not also severely cut into the legitimacy of the communist party leaders. The levels of inequality in that country will become significantly more striking to the section of the population that was left behind in the Chinese economic miracle.

    China also faces a number of demographic issues that will strain the population further (one child policy, large aging segment of the population, environmental issues that put a strain on GDP, and resource issues related to the rather unstable governments that they acquire significant amounts of oil and other materials from.

    They can likely manage crime related to high inequality, China will have to be expansionist in order to secure resources during a time when the influence of the US deteriorates, particularly if they have a large surplus of males in the population. However, the next generation of Chinese leaders are likely to be a bit more liberal than their predecessors, so we might not take past performance as an indicator of future outcomes.

  9. MacroStrategy Edge

    Edward –

    I really think you are on to something, and it is becoming very clear what the common problem is now.

    The problem in the eurozone is there is neither a price or a policy mechanism that forces a current account surplus country like Germany to reinvest its proceeds in direct tangible productive capital in current account deficit nations. Nor do chronic current account surpluses self correct: as the domestic population grows wealthier, they do not spend more on the tradable products of current account deficit nations.

    The end result is all of the adjustment is forced on to the current account deficit nations, and there can be a tendency for economies to converge downward in a race to the bottom fashion unless dramatic policy interventions (maxi-devaluations of the currency, large sustained fiscal deficits, monetization, etc.) are brought into play in sufficient size.

    This, by the way, is the same story globally, with China and the Asian region pursuing neo-mercantilist growth strategies, and running chronic current account surpluses against other regions. There is no price or policy mechanism to force rebalancing dynamics on the current account surplus nation.

    The gold standard ostensibly took care of this, as gold reserves were drained to current account surplus nations and spending power was relinquished by the deficit nations. There is some debate about whether the system worked effectively in this fashion, but nevertheless, there was an indentifiable mechanism for it.

    Keynes similarly designed into his proposal for Bretton Woods mechanisms that would force adjustment on the current account surplus nations – see Skidelsky’s description of his “bancor” plan, as well as Paul Davidson’s more contemporary iterations of the same. The Americans eviscerated Keynes’ rebalancing mechanisms before installing Bretton Woods.

    So until we can find a price or policy mechanism to serve the purpose of convergence upward/current account surplus nation adjusts first, we are locked into some very messy and unsatisfying corners.

    I strongly urge you to keep pursuing these angles, because finding a way out of this mess lies, I am now certain, along these lines. The proposed EMF is the wrong mechanism. It will simply give the Germans the ability to force fiscal austerity on the entire eurozone. The right mechanism is one that will incentivize the Germans and the Dutch to reinvest their trade proceeds in the periphery in the form of FDI, or buy more tradable products from the periphery. There is little other choice that does not risk private debt deflation emerging from the region, or ever rising fiscal deficits in the peripheral nations (as follows from my NC piece last week, On Fiscal Correctness and Animal Sacrifices).

  10. zaknick

    thanks for the economic history insight.. don’t know if you’re right or wrong about protectionism when we have such globalized behemoths running our fascist apparatus called government but thank God I’m mining alluvial gold in a peaceful and sleepy country not getting fleeced by “free trade” in the US.

  11. zaknick

    You know, there’s another aspect to this: if “protectionism” (the return to a natural economic order where we pay the people who make things for us in our own country) doesn’t return then how is it possible to have full employment and good (damn, even rising!)wages again?

  12. DellaTerious

    Mr. Roach is definitely not a perma-bull, he is, however a good contrarian indicator. Just when the bubble excess of the last debacle was reaching explosive territory, Mr. Roach, whose posts I used to read avidly when he was being accused of being a perma-bear, changed his tune and decided that rising Capex (a term’s that’s completely disappeared, whereas in ’05-’07, it was supposedly the spur to economic growth that would take us beyond the housing bubble … HAH!) investment would keep the global economy growing. His timing couldn’t have been worse.

    Roach is a very smart man and excellent writer, but is a complete captive to his industry; if he comes out strong for something, you should at least hedge your positions, because he’s avidly and convincingly defending that which his human side knows to be false, but that his corporate persona is absolutely blind to.

    Now that he’s been reassigned to the China bureau, he’s gung-ho on China. Would you expect anything different from Stephen Roach? If you do, I’d suggest you look again.

  13. Mannwich

    Mr. Roach is making the classic “insider” mistake. Remember, wasn’t he banished from the U.S. by Morgan Stanley? It’s in his interests to BELIEVE that things are somehow different in China because he’s IN the soup, so to speak.

  14. scharfy

    To the extent growth occurs in cycles, all economies exist in a state of perpetual bubble, or conversely, under-utilization. Yin and Yang.

    In the interest of disclosure, I am a card-carrying China Bubblista. But saying that really says nothing. It is the “stage of the bubble” that we should observe.

    Is China in its infancy, adolescence, or adulthood? The US managed to keep its bubbles going for longer than most had imagined. China probably has a ways to go by that standard.

    Observe though, that much of the fuel for the existing bubble has come from EuroZone and America. That firewood is limited. Can they decouple? Who can say. Certainly a lot of moving parts.

  15. huyu

    How wonderful you guys have developed these China fetish. If you are so concerned, shall we swap jobs? Mine is 3600$US each year and yours probably 40,000$. If not then, stop asking us poor guys subsiding your next Starbucks, and perhaps spare us 100$ instead.

    1. Martin

      Actually the opposite is true. We want you to get more dollars not less. Currently your gov’t is subsidising our coffee, and taking money away from you.

  16. anon

    “If not then, stop asking us poor guys subsiding your next Starbucks, and perhaps spare us 100$ instead.”

    Your own government is the one that is keeping you poor. If they would stop buying US treasuries and let your currency appreciate vs the dollar, you could afford Starbucks and Apple iphones! But many of your exporters would be angry with your government. You will continue to suffer because of it.

  17. i on the ball patriot


    I asked my vachinacologist,
    To tell me what’s going down,
    “Does China have a great big bubble,
    Or is there really no cause to frown?”

    My vachinacologist told me,
    “There is really nothing to fear,
    Its only central banker training,
    Of corporate gangsters over there,

    Bubbles are really debt traps,
    Deployed around the planet,
    They enslave and give control,
    With a force as strong as granite,

    Its not important what causes them,
    What is important is what’s the same,
    The central bankers get a take of the table,
    They always control the game,

    Its the central banks,
    That encourage the churning,
    Its the central banks,
    That encourage the turning,

    It does not matter,
    The gangs ideology,
    Commie or scamerican,
    They still get a fee” …

    Deception is the strongest political force on the planet.

  18. Ishmael

    So, I just got back from working with a Chinese company. All, I got to say is trust nothing they say. Their numbers are so FUBAR it is unbelievable. I am talking about eyes on experience here.

    With that kind of micro experience, then on the macro level how can anyone know where this thing is going. Garbage in results in garbage out.

    My gut feel is that there is massive over capacity in China. When the crap really hits the fan who is going to buy their products? Internal consumption, you got to be kidding me. The average worker gets paid nothing. Then the factories grind to a halt. What are they going to purchase imports with — RMB. You got to be kidding me. No one will take them. They will have to use their currency reserves to buy needed imports. But on top of that, their could be total melt down and chaos when the people their realize the are returning to the stone age.

  19. Bonesetter Brown

    As Mannwich states above, Roach was shipped off to Asia. His tone has been different ever since. I suspect he has an axe to grind.

    I witness the Chinese malinvestment from my business dealings there. For example, a couple years back the largest manufacturer of air conditioners getting into the cellphone business — to challenge Nokia? No, as a means to real-estate speculation. You see, this company wanted to speculate in real estate, but in order to get approval from the government to acquire land (from the government as I recall, at a very low price), this company needed a business justification. They built a massive cellphone assembly facility (1 km on a side). Never had any real intention/need to make money or generate positive cash flow. It was all about the land.

    I could cite countless other examples. Those links with Hendry and the empty buildings are all too consistent with my own experience.

    I have not tracked FDI numbers on China for a couple of years, but back when I read Roach regularly, he and Stephen Jen were pointing out the massive ratio of FDI to GDP. North of 40%. Nothing like it had ever been seen in EM. That’s probably the real ponzi scheme in China.

  20. fromchina

    The difference between Japan 1989 and China now is: the West will not be able to force a Plaza Accord on China.

    Both Japan and China are export oriented economies. Japan peaked soon after the Plaza Accord because its trade surplus started to decline as its currency started to appreciate dramatically. That’s why China is fighting hard not to let the yuan revalue.

    Comparison with 1920s is inappropriate because money is no longer based on gold, and because Confucian economies just function differently.

  21. Nick in Kyoto


    I always look forward to your informative guest posts. Thank you.

    I’ve lived in Japan and Greater China for the past two decades. The differences between these nations is stark. And, to me, here are the two key differences. Chinese are prepared to allow markets to crash. And their citizens still “feel poor” earning a fraction of their Japanese counterparts.

    These two differences must be kept in mind when comparing Japan’s late 80s bubble economy to China’s today.

    To me, China is more similar to Hong Kong in the 60s and 70s. The Hang Seng Index would periodically fall 70-80% (once it fell 90%) only to rebound to new peaks. Cantonese felt themselves to be poor, focused almost single-mindedly upon getting rich, and always kept in mind that everything could, and would, crash again.

    Chinese have always liked to buy options. Lottery tickets sell at a premium. Japanese have sold OTM options since the mid-80s. The implied volatility curve of any yen based financial instrument bears this cultural stylized fact out.

    But there is more to this than culture. Japan has systemically killed off the risk taking spirit of its people. It has prevented financial markets from clearing and has reflexively propped up AD instead of allowing AS to fall.

    For nearly 20 years Japan’s policymakers have traded off short term stability for long term solvency. Japan is headed towards default on its sovereign debt. People here know this. They have internalized it. And it has been impairing capital formation here since the early 90s.

    China’s fate will differ from late 80s Japan.

    China has rigged its exchange rates, and it has severely distorted its internal economy … more so, perhaps, than any nation ever in history. These distortions will not — and cannot — persist. But China will withstand a future 80% drop in its asset prices, and a radical temporary slowdown in its GNP. (The PRC’s output fell 17.3% in 1961. Why couldn’t growth slow to zero in 2011?) But I strongly believe that it will rebound. If HK or Taiwan’s financial history is any guide, the rebound will be very swift.

    I do not expect to see a future Chinese “Lost Decade” (Or should I say Lost Decade with Chinese characteristics?) But I do agree that China is experiencing “bubble aspects” to its economy that rivals those of post-Plaza Accord Japan.

    The standard of living differences and risk taking differences are key. You want to buy the dips in China and sell the rallies in Japan.


    Nick R.

    1. Edward Harrison Post author


      Thanks for your kind words. That is the most convincing argument I have heard in favor of “yes,here’s a bubble but it won’t bring down the real economy.” I had been thinking of Japan or South Korea during the 60s and 70s and wondered what kind of ‘bubbles they had during their long surge to developed nation status. So I see what you’re saying. If anyone has the goods on S. Korea or Japan circa 1966-1976, I’d love to hear your takes.

      As for comments re. 1920s and 1930s, I do think that is relevant for two reasons.

      First, China is pegging its currency in a way that causes it to accumulate foreign currency reserves just as France had done with the British. The dynamic is also the same with the Chinese worried about the value of their reserves (as they were in 2008 – when the pound was 2.11 to the dollar for an extreme example).

      The second area of concern was also relevant in the 1980s and that is protectionist sentiment. In the 1980s only the deficit country (the US) was threatened and wanted to protect. However, in the 1930s, it worked both ways. Moreover, it was the surplus nations who were hit hardest after the crisis began. As a result, it’s not inconceivable that a protectionist war could result in a depression in which China devalues its currency instead of revalues it.

      In any event, Krugman’s advice to go so overtly protectionist is just courting disaster. If you want a trade war to tip us into a depression, that would be the right move.

      1. fromchina

        In China asset markets (stocks and real estate) can function independent of the real economy to a far greater degree than in the West. Assets prices are totally controlled by government policy.

        As for the real economy, again it totally depends on trade surplus.

        If you are interested in predicting movements in Chinese assets, you need to watch government policy, which has a whole lot more to do with power dynamics between central government in Beijing and local/provincial governments than it has to do with production and jobs.

        If you are interested in how the real economy will perform in China, the most important factor to watch is their trade surplus.

    2. KD

      Honestly, I’m not much convinced by Nick’s argument. I don’t understand why Japan has to kill systemically off the risk taking spirit of its people. In the post bubble era, everybody in Japan admits the need for the new industry that would hopefully lead the country off the bottleneck. The government, along with private enterprise, has set the numerous facilities to promote venture firms, but the result is, as you know, meager at best. Does Japan have to stifle the risk taking when everybody needs it? I think the direction of causation in Nick’s argument is opposite. Nick indicates, it seems, that Japan’s lack of risk-taking caused the stagnation. But I think that stagnation itself is the root cause of the lack of risk-taking. Everybody is now shunning away from small firms in favor of big business, believing “too big to fail”. Originally, the share of employers among all workers in Japan is higher than that in the US, indicating that many more are going for start-ups. If you come in Japan, you would be surprised how many small companies are operating with big business. Some would say that it’s inefficient to hold so many small firms in limited areas.

      This is not for Nick’s argument, but I think that we should be aware of the difference of asset price bubble between China and Japan. The most notable similarity between the current China and the bubble Japan is the sharp rise in real estate price. I don’t know how much China puts into construction investment now, but one has to know that Japan’s construction investment rose conspicuously AFTER the bubble burst, not before. Japan threw a tremendous amount of money into public investment to prop up the economy, which all resulted in vain. No rise in asset price has yet come back. Oddly, it seems to me that China is now spending construction investment as recklessly as the post-bubble Japan with the excessive price rise in real estate.

  22. Edward Harrison Post author

    By the way, see China’s property bubble is worse than it looks, an FT Op-Ed. Timely piece. I’m not sure if this is behind a pay wall so I’ll quote the thrust of the piece here:

    What is happening in China now is familiar to any Japanese aged above 45. Japan experienced one of the largest property bubbles in the 1980s. The land price index tripled in five years. (The six-city price index for residential land rose from 39.2 in September 1985 to 105.8 in September 1990. The commercial land price rose from 27.9 to 104.5.) First, the land price rose in central Tokyo, then spread to first-tier suburbs, other large cities, second-tier suburbs and finally to rural land. The recent US housing bubble had a similar process of moving from prime to subprime mortgages. The quality of borrowers progressively worsened. In both Japan and the US, the loan-to-value ratio rose sharply towards the end of the bubble. Is this bubble now being repeated in China?

    1. fromchina

      The real estate bubble in China, in terms of per square footage price relative to income, already exceeds that of Japan in 1990.

      Whether it will pop, however, entirely depends on whether the government wants it to pop. They can sustain the bubble indefinitely if they want to. It’s a command economy.

      By the way, Japan would not have to pop their bubble in 1990 had their currency not been freely floated.

      1. Nathanael

        But will a real-estate-bubble-pop really hurt China?

        Unlike in the US, the average Chinese consumer is not funding his purchases with home equity loans.

        Popping the real estate bubble could simply lead to lots of poor Chinese getting cheap, decent housing, if it were popped competently.

        1. fromchina

          That’s right. Real estate in China is really about wealth distribution between the elite and the masses.

          High prices mean concentration of wealth at the top. Low prices mean a more even or egalitarian wealth sharing.

  23. EmilianoZ

    It’ll all depend on whether the Chinese government bails out the speculators or not when the bubble pops. If they don’t, China’s gonna be OK. If they do, … Well, you know.

    Tip for the CIA: if you wanna sink China forget about the military. Encourage the development of a strong financial oligarchy there. There’s nothing more lethal for a country.

  24. bluffraise

    In 1987 the US $ correction spilled over to the bond side. Long bonds tanked, then the stock market. This happening today would burst a few bubbles. So maybe all we have now is a classic Mexican standoff.

  25. Sundog

    Nice post. I appreciate that Ed is looking at specific historical situations and trying to see how they might shed light on the current Mess.

    My take on Japan is a bit different. The two events I think are most significant are the 1985 Plaza Accord and the 1986 Big Bang of UK financial deregulation. Neither appeared out of the blue, and the Japanese government made careful preparations.

    They had begun cautiously opening their financial sector, believing that pay or play was the only choice and Tokyo was well placed to compete with New York and London as one of the world’s financial premier financial centers. The government began ramping property prices and by the time I arrived in 1987 the real estate boom was a common topic of conversation. The story fed to the Japanese public was that foreign banks had bought loads of space in the central Marounochi financial district and forced up prices, which in turn had rippled out, just like the proverbial stone tossed into a pond.

    Now, I’m not going to go back to the 1890 Imperial Rescript on Education, or the Meiji Restoration around the time of the US civil war, or the Bakufu era, nor even the odd affair of US occupation and the subsequent founding of the LDP in 1955 (on the latter see Legacy of Ashes by Tim Weiner). I should, though.

    Suffice to say that feudal hold-overs in Japan are not to be denied and among them is the primacy of land as wealth. Rather than Roach’s “confluence of equity and property bubbles” what happened was property was boosted and equity values, golf club memberships and all the rest inevitably followed in a Great Enthusiasm, to the point where even a lowly worker bee like Sundog was treated to sushi flecked with metallic gold.

    Rather than Roach’s “massive overhang of excess capacity” what really happened was the society had absolutely no clue how to deal with a Minsky moment in real estate. Futures in rice were being traded in Osaka hundreds of years ago. But land, property, real estate had never really become a commodity. The Economist published some great work through the ’90s about how sticky, opaque, feudal weirdness in property valuation was blocking the resolution of giant zombie financial institutions. That takes the story through 1998, when I left Japan.

    I have some thoughts on how Japan’s experience of the ’80s-’90s relates to the current situation of China.

    First, beware of the “Construction State.” Examine the history of the LDP’s relationship with construction companies and organized crime. Don’t make the same mistakes. Construction is the easiest path by which The Powers That Be can hold down unemployment, run up debt, and maintain power. Could that money be more productive elsewhere?

    Second, beware of sectors that are not exposed to foreign competition. The Japanese financial sector is a case to be studied in terms of how it was cosseted by the state in the years before 1985 and the consequent disaster.

    Third, understand that as long as China maintains a currency peg to the dollar, its entire economy is cosseted by the state. China deserves better. Plus, it’s that much easier to blame foreign speculators when things go bad.

  26. russel1200

    Its a nice tidy monetarist story, but it ignores or downplays a number of other of other factors in the great depression:

    Increased productivity helped to keep down the pricing portion of the inflation and masked the amount of liquidity.

    There was an earlier bubble (WW1 spending) that Europe and the US were trying to resolve at the same time.

    There was a slow decline in international trade relative to the underlying world economies.

  27. eurostoxx

    So I guess we are all waiting for the Chinese bubble to pop, but what will prick it? I think this is the important question but I just dont see anything on the horizon….surely a US style drop in property prices would do the trick but unless lenders there also have some dubious subprime re-set type problem I cant see the market crashing just yet, especially since it just rebounded.

    Also its interesting to note that there was a recent article in BusinessWeek that described how China is now the hot spot for MBA’s to go. MBA’s are the best contrarian indicator around, they always get sucked into the last phases of the most exuberant parts of the economy.

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