The Illusion of a Chinese Bubble

BEIJING – On the eve of Chinese New Year, the People’s Bank of China (PBC) surprised the market by announcing – for the second consecutive time in a month – an increase in banks’ mandatory-reserve ratio by 50 basis points, bringing it to 16.5%. Shortly before that, China’s government acted to stop over-borrowing by local governments (through local state investment corporations), and to cool feverish regional housing markets by raising the down-payment ratio for second house buyers and the capital-adequacy ratio for developers.

This latest round of monetary tightening in China reflects the authorities’ growing concern over liquidity. In 2009, M2 money supply (a key indicator used to forecast inflation) increased by 27% year on year, and credit expanded by 34%. In January 2010, despite strict “administrative control” of financial credit lines (the PBC actually imposed credit ceilings on commercial banks), bank lending grew at an annual rate of 29%, on top of already strong expansion in the same period a year earlier. While inflation remains low, at 1.5%, it has been rising in recent months. Housing prices have also soared in most major cities.

These factors have inspired some China watchers to regard the country’s economy as a bubble, if not to predict a hard landing in 2010. But that judgment seems premature, at best.

To be sure, China may have a strong tendency to create bubbles, partly because people in a fast-growing economy become less risk-averse. Thirty years of stable growth without serious crises have made people less aware of the negative consequences of overheating and bubbles. Instead, they are so confident that they often blame the government for not allowing the economy to grow even faster.