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Bubbles Brewing in Shanghai, Tokyo, and LondonBy Gary Dorsch "There is a bubble growing. Investors should be concerned about the risks," said Cheng Siwei, vice-chairman of China's National People's Congress in a January 31st interview with the Financial Times. "But in a bull market, people will invest relatively irrationally. Every investor thinks they can win. But many will end up losing. But that is their risk and their choice," Cheng warned. In what might develop into the third biggest stock market bubble in history, ranked alongside Japan's Nikkei-225 of 1986-89, and the Nasdaq's 1999-2000 bull run, the Shanghai Composite "A" share Index, restricted mainly to Chinese nationals, has posted a 140% gain over the past 12-months, after soaring 46% in the fourth-quarter of 2006 alone. And without deliberate market intervention, the A-share market could inflate into a Nasdaq-like bubble. How Beijing decides to deal with the Shanghai bubble, can have a great impact on the outlook for the Chinese economy, global commodity markets, and exporters in the region from Australia, Hong Kong, Japan, and Korea. Will Beijing try to prick the bubble and set-off a steep correction, or carefully calibrate a series of tightening measures to take some steam out of the market and simply flatten it out? Sometimes, markets can boomerang on central banks and torpedo the most carefully designed strategies. Therefore, jawboning is usually the first act of official intervention in the market place, because it's cost free and doesn't change underlying market conditions. Siwei's remarks did trigger a 15% pullback from January's peak, as traders locked in profits from sky-high valuations, figuring that official warnings might turn into concrete steps to cool down the market.  Then on Feb 9th, the People's
Bank of China (PBoC) tried to keep the market off balance, by
warning that it would use a number of tools to keep flush liquidity
conditions in check. "The central bank would use a combination
of open market operations and higher required reserves for banks
in an effort to stave off a credit-fuelled investment boom, and
will make the yuan more flexible," it said.  The PBoC put its verbal threats into action on February 16th, when it lifted bank reserve ratios by half-percent to 10%, coming only six weeks after the last hike, and at faster pace of tightening than expected. The hike in bank reserve ratios should drain about 160 billion yuan ($20.7 billion) from the Chinese money markets, and is less expensive to Beijing's budget, that issuing T-bills or raising interest rates. The reserve ratio hike, the fifth of its kind since last July, was made to deal with "dynamic currency liquidity changes and to consolidate macro-economic controls," said the PBoC in its latest statement. "Imbalanced international payment generated by mounting trade surplus resulted increasing currency liquidity and made another reserve ratio hike necessary," it added. Shanghai Red-chip Rally fueled by Explosive Money Supply The PBoC prints yuan in exchange for foreign currency flowing into the country, and until Beijing abandons its crawling peg of the dollar-yuan exchange rate, the M2 money supply growth rate will remain very high. Hot money will continue to flow in Shanghai stocks, feeding the bubble frenzy. The fifth hike in bank reserve ratios since June has only slowed the annual growth rate of China's M2 money supply from an explosive 19.1% to a robust 15.9% rate last month. So far, the PBoC's open market operations to drain liquidity have only put a floor under Shanghai money market yields rather than pushing them up. The PBoC plays a clever shell game, but is still pegging its 7-day repo rate in a range of 1.50% to 2%, which encourages speculation in stocks. The PBoC bought about $250 billion a year in 2005 and 2006, but only about 75% of such intervention was sterilized.  Until the PBoC lifts interest rates high enough to discourage borrowing, it won't be able to contain the robust growth of the money supply. Official data revealed that yuan-denominated loans jumped 567.6 billion yuan ($74.7 billion) in January, twice as much as last year's monthly average, to 23.1 trillion yuan, up 16% from a year ago. Chinese banks arranged 3.18 trillion yuan in new loans in all of 2006, exceeding the central bank's original target of 2.5 trillion yuan. Therefore, an interest rate hike seems inevitable, as reserve ratio adjustments and open market operations have failed in curbing liquidity and lending. China's 7-day repo rate has erupted to above 4% on two brief occasions in the past 3-months, linked to strong loan demand for stock market IPO's, but it mostly trades below 2%, due to large to inflows of money from foreign investment and exports. To read the rest of this article, please click on the hyperlink below, http://www.sirchartsalot.com/article.php?id=53 Feb 21, 2007 321gold |
