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Heed the Lesson of Greenspan

07-14 18:02 Caijing

China's recent asset market boom is caused by excess liquidity. The country risks repeating Alan Greenspan's mistake: injecting excessive liquidity which leads to asset bubbles and eventually a financial meltdown.


By Huang Yiping

(Caijing.com.cn) Former US Federal Reserve Chairman Alan Greenspan retired in 2006 basking in the glory of his smooth 18-year tenure. But since the outbreak of the subprime credit crisis, his policies have been widely criticized.

Greenspan's monetary policy was accused of being too loose and blamed for creating real estate bubbles in the wake of the implosion of the information industry bubble.

Now, criticisms of Ben Bernanke's Fed policy are also mounting. Investors fear that interest rate cuts and excess liquidity will cause serious inflation and asset bubbles. While I think the probability for Bernanke to repeat Greenspan's mistake is low overall, there is a growing possibility that China will follow in Greenspan's footsteps.

Although the global economic outlook is uncertain, China's economy has bottomed out and has nowhere to go but up.  China's domestic growth product hit 8 percent in the second quarter of 2009, compared with 6.1 percent in the first quarter of this year and 6.8 percent in the last quarter of 2008. Undoubtedly, China's economic recovery is underway.

China's GDP growth can be attributed to the government-backed 4 trillion yuan stimulus plan unveiled last November as well as record bank lending starting earlier this year.

Surprisingly, asset prices are soaring. In 2008, the Shanghai A-share market index dropped by 50 percent and fell to under 2,000 points; housing prices also dropped. In 2009, the Shanghai Securities Exchange Composite Index soared above 3,100 points. Housing prices rose month on month in both May and June. Some experts asserted that the asset market downturn is history and signs point to an upcoming bull market.

There are four major possible causes for the bounce in asset prices. First, after last year's falls, stock and housing prices are more reasonable and have become more attractive to investors; second, investors are more optimistic since it is assumed China's economy has bottomed out; third, commodity prices have also bounced, triggering speculation of a global economic recovery; and finally, excess liquidity sparks inflation concerns and leads to investments in the stock and housing markets.

But the rise in asset prices is not backed by economic fundamentals. China's GDP is accelerating, but employment, profit and income are not improving. In the next few months, unresolved overcapacity will cause increasingly tough challenges. If unemployment, income growth and profits continue to worsen, the prediction of a bullish market will turn out to be false.

I personally believe that rising asset prices should be attributed to excess liquidity. In order to ensure an 8 percent growth, the government invested heavily in infrastructure and encouraged bank lending.
In the first quarter of 2009, new lending reached nearly 5 trillion yuan. In April and May, new monthly lending dropped to 600 billion yuan each but rose again in June to 1.5 trillion yuan. It is undeniable that there is excess liquidity.

Ample liquidity is beneficial to economic recovery in the short term – for example, inflation fears may encourage investments and consumer spending. But it is dangerous to push asset prices up through increasing liquidity. High recent stock and real estate prices will still eventually fall if they are not sustainable. Injecting more liquidity into the market will only expand an increasingly precarious bubble. It is actually the same mistake Greenspan made ten years ago.

If we cannot avoid Greenspan's blunder, an even bigger disaster is awaiting. 

Huang Yiping is a professor at the National School of Development, Peking University, and the Crawford School of Economics and Government, Australian National University.

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