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The Chinese market has been running hard and has been called a bubble by many including some Chinese politicians. I once tried bubble tea, a favorite at the Chinese markets. It is so sickly sweet that suddenly you don’t want any more. That’s what the Chinese market is like right now. Sickly sweet, sometime soon, we may not want it anymore. The market is charging at a pace that is unsustainable: moving up around 1% per day for the several months, 82% to date, after a whopping 130% last year. The press reports: So many employees are spending their time trading stocks online that some companies have introduced fines to deter them. But many continue surreptitiously trading and sharing tips through e-mails, instant messaging and texts. Mobile-telephone users (that is, almost every adult city-dweller) can subscribe to stockmarket alerts and trade shares simply by pressing buttons on their handsets. Much analysis has been written about what’s going on in China but I find that there are really only a few things one needs to know. 1. The Chinese market is closed to foreigners; 2. The Chinese love to gamble; 3. Liquidity is booming, and real rates are zero or negative in China; 4. There is limited supply of equity in the Chinese market. From looking at these 3 factors, I can only come to one conclusion: the Chinese bubble will likely be the biggest bubble we have ever seen. I have had quite a bit of experience with bubbles. Traveling in Taiwan in early 1990 I witnessed first hand the big Taiwanese stock market bubble. That bubble burst and took the market down 90% from peak to trough. Traveling in Malaysia in 1994 I witnessed first hand the Malaysian bubble (I’ve really got to get a new travel agent!). That bubble had people trading so much during their day jobs that trading was banned similar to what is happening in China today. I also have experience of what happens after a bubble bursts, being a big investor in New Zealand just after the bubble burst in 1990. Assets not only become cheap, they don’t go up for years and the market quietly goes out of favour. It goes no bid. It is likely that this is not the last Chinese bubble we will see in our lifetimes because China has all the ingredients of a casino like stock market. The difference is that Malaysia, NZ and Taiwan are minor players in the world’s economy – China is not. I read somewhere that 50% of the trading volume in China is suspected to be government corporations who may have to be bailed out, if they have losses. I guess that’s ok because the Chinese governmentt has a lot of money. and it is unlikely that they’ve had any losses with such a rising market. Let’s look at what happens with a rapidly rising market. It is like a big appetite, it needs more and more: more volume, more price increases, more news, more and more investors. Now let’s look at what we know about China right now: 1. It is undergoing an industrial revolution the likes of which we have never seen before in our lifetimes 2. Economic growth is more than 10% per year 3. Inflation is picking up 4. Asset prices are skyrocketing 5. there are shortages of everything 6. quality is an issue. What do I think will happen? Emerging markets gather steam and momentum over time finding more and more investors in their upward moves. China has been no exception. I was remembering the first time I heard about Chinese demand for metals in the late 1980’s. It took more than 12 years for the result to be actually realized. In the mid 1990’s when I was running emerging money, manufacturing in China was a distant future. People were still talking about places like Madagascar and Malaysia. Then China hit the market and all bets changed. I recently watched the film, Manufactured Landscapes. It was interesting because it filmed a very large factory in China. Panning the factory took the first 10 minutes of the film. I noted very little activity from the workers. Quality controls are also a problem with Chinese goods. We have seen both Chinese pet food and Chinese drugs having poisonous consequences, now we are faced with unsafe toys. A few weeks ago I read in the paper about the discovery of a factory which had slaves and children working in 2 provinces in China. The workers apparently had been beaten, starved and forced to work for long hours for no pay. One was beaten to death. The owner rather than apologizing for his opportunistic behavior stated blankly: “I feel this was not such a big issue, just a matter of beating and cursing workers and not paying wages to them” he was quoted in the newspaper as saying. The lack of outrage by consumers is surprising to me but it may be coming. Sticking my neck out, I believe that we are at the tipping point of a consumer backlash against Chinese goods. The tide has turned and those who can, will choose goods made elsewhere and may even pay a higher price. We are also at the tipping point of the market. It is only a matter of time before people wake up and see the risk they have been taking and decide it’s been too much. The Chinese market has continued upward while the subprime crisis occurs in the US. This is not logical. Americans are the biggest consumers of Chinese goods. Plus, the economic growth in China is likely to subside somewhat with the winding down of the boom for the Olympics next year. When we look back, it is likely we have seen the peak of economic growth at 12%. Expect cracks to appear as the marginal flow of excess capital peaks.
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