 Irrational
Exuberance in China
Peter Schiff
Feb 9, 2007
Recently-voiced concerns
from the Chinese government that their surging domestic stock
market was crossing into bubble territory helped to set off last
week's sharp decline, including a single day plunge of 6.5% (the
equivalent of more than 800 points on the Dow Jones.) While
a bubble may indeed be forming in Chinese stocks, my guess is
that there is room for a lot more air before it finally pops.
In fact, the recent warnings
in China are reminiscent of Alan Greenspan's infamous "irrational
exuberance" speech in December of 1996. As history has shown,
the Chairman was correct (perhaps for the only time in his tenure),
but Greenspan failed to comprehend just how much irrationality
the markets would bear before they finally gave in. In fact,
after nearly four more years of unprecedented market exuberance,
Greenspan himself took the "new era" bait hook, line
and sinker. Surprisingly, he became one of the market's greatest
cheerleaders. My guess is that before a similar peak is reached
in China, officials there will be snared on the same line.
Just as the bubble in U.S.
stocks resulted from the inflationary monetary policies of the
Fed, the bubble in Chinese shares is being created by the inflationary
policies of the Bank of China. However, as Chinese authorities
are creating yuan mainly to buy U.S. dollars, the Fed is in effect
the driving force behind this bubble as well. As we export our
inflation to Asia, the Chinese stock market bubble may be one
of the few things in Asia that was actually "Made in the
U.S.A."
One major difference between
the rise in the Chinese market in 2007 and the U.S. in 1997 is
that much of the rise in China is actually justified by the fundamentals.
Unlike the U.S., not all of the liquidity is the result of inflation.
Much of it comes from the savings of millions of under-consuming
Chinese workers, whose combined sacrifice has enabled business
to finance capital investment that has led to enhanced productivity,
greater earnings, and higher share prices. Liquidity produced
by savings is genuine and the fact that it fuels legitimate investment
is one of its primary benefits.
However, liquidity provided
by central banks is false as it produces only malinvestment which
must be liquidated in the busts that inevitably follow inflationary
booms. The fact that inflation sometimes lifts asset prices
before lifting consumer prices is one of the main reasons that
it is so intoxicating and so dangerous.
Perhaps no one expressed it
better than Alan Greenspan himself, when in 1996 he wrote the
following with respect to U.S. Fed policy during the 1920's.
When business in the United
States underwent a mild contraction in 1927, the Federal Reserve
created more paper reserves in the hope of forestalling any possible
bank reserve shortage. More disastrous, however, was the Federal
Reserve's attempt to assist Great Britain who had been losing
gold to us because the Bank of England refused to allow interest
rates to rise when market forces dictated (it was politically
unpalatable). The reasoning of the authorities involved was as
follows: if the Federal Reserve pumped excessive paper reserves
into American banks, interest rates in the United States would
fall to a level comparable with those in Great Britain; this
would act to stop Britain's gold loss and avoid the political
embarrassment of having to raise interest rates. The excess credit
which the Fed pumped into the economy spilled over into the stock
market-triggering a fantastic speculative boom. Belatedly, Federal
Reserve officials attempted to sop up the excess reserves and
finally succeeded in braking the boom. But it was too late: by
1929 the speculative imbalances had become so overwhelming that
the attempt precipitated a sharp retrenching and a consequent
demoralizing of business confidence. As a result, the American
economy collapsed. Great Britain fared even worse, and rather
than absorb the full consequences of her previous folly, she
abandoned the gold standard completely in 1931, tearing asunder
what remained of the fabric of confidence and inducing a world-wide
series of bank failures. The world economies plunged into the
Great Depression of the 1930's.
Substitute the United States
for Great Britain, and China, Japan, and the rest of Asia for
the United Sates, and it's the same situation all over again.
Back then, Great Britain was the declining power and America
was the emerging one. Today the sun is setting on American dominance
just as it is rising in the East. In the end, the 1929 Fed recognized
the error of its ways and allowed the pound to fall. Soon Asian
central banks will reach similar conclusions. When they do,
just as America once replaced Britain as the world's dominant
economic power, the Asian block will supplant America. During
the prior transition the world suffered through the Great Depression
and the Second World War. Though the current transition may
be somewhat less traumatic, its implications will be just as
earth shattering.
 For a more in depth
analysis of the precarious state of the American economy and
its dependence on China, order a copy of my new book "Crash
Proof: How to Profit from the Coming Economic Collapse"
from
Amazon.
In addition
make sure to protect your wealth and preserve your purchasing
power before Chinese wake up. Discover the best way to buy gold
at www.goldyoucanfold.com, download my free
research report on the powerful case for investing in foreign
equities available at www.researchreportone.com, and subscribe to
my free, on-line investment
newsletter.
Peter Schiff
C.E.O. and Chief Global Strategist
Euro Pacific Capital, Inc.
1 800-727-7922
email: pschiff@europac.net
website: www.europac.net
Archives
 Mr. Schiff is one of
the few non-biased investment advisors (not committed solely to
the short side of the market) to have correctly called the current
bear market before it began and to have positioned his clients
accordingly. As a result of his accurate forecasts on the U.S.
stock market, commodities, gold and the dollar, he is becoming
increasingly more renowned. He has been quoted in many of the
nation's leading newspapers, including The Wall Street Journal,
Barron's, Investor's Business Daily, The Financial Times, The
New York Times, The Los Angeles Times, The Washington Post, The
Chicago Tribune, The Dallas Morning News, The Miami Herald, The
San Francisco Chronicle, The Atlanta Journal-Constitution, The
Arizona Republic, The Philadelphia Inquirer, and the Christian
Science Monitor, and has appeared on CNBC, CNNfn., and Bloomberg.
In addition, his views are frequently quoted locally in the Orange
County Register.
Mr. Schiff began his investment career as a financial consultant
with Shearson Lehman Brothers, after having earned a degree in
finance and accounting from U.C. Berkley in 1987. A financial
professional for seventeen years he joined Euro Pacific
in 1996 and has served as its President since January 2000. An
expert on money, economic theory, and international investing,
he is a highly recommended broker by many of the nation's financial
newsletters and advisory services.
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