China's Olympian stock-market sprint

By Jim Jubak

I read something in The Wall Street Journal last week that really scared me (besides the editorial page, I mean): "In Beijing, investors talk of a one-way bet on the market until at least next year's Olympics."

In other words, even though the Shanghai stock market is up 52% this year, was up 130% in 2006 and is up 305% since this rally began back in June 2005, and even though everyone knows this speculative bubble isn't sustainable, it's smart to keep pouring money into Chinese stocks -- no matter their price -- because the government won't intervene and risk crashing the market until after the showcase Beijing Olympics are over.

So invest as much as you can in anything you can until Aug. 24, 2008, the day the Beijing games come to an end. Then run -- don't walk -- in an orderly fashion to the exit.

Yeah, like that will work.

Watch out for stampede

Speculative markets that think they've got a green light to run from excess to excess until a specific date scare me. The possibility of a stampede for the exits on the Shanghai exchange starting a wave of fear that spreads around the globe scares me. And the very real possibility that the Beijing government will make a mistake and crash the Chinese stock market scares me.

Everything is not black, however. Because the Chinese stock market is, so far, only tenuously connected to the global financial market, any crash in Shanghai is likely to have only modest global effects.

With those cheery thoughts fresh in mind, let's take a look at why speculators in Shanghai think they've got a green light until August 2008.

Any explanation starts with China's massive 40% savings rate. There simply aren't very many places where the average Chinese can put that money.

Real estate has been a popular choice recently, but the government has cracked down on speculators in that sector. Most Chinese can't invest abroad. And banks don't pay much in interest.

The Chinese government recently raised the interest rate that a bank can pay on a one-year deposit to 3.06%, a jump of 0.27 percentage point from the prior rate. Inflation is China is running at about 3%, officially. And since bank interest is taxable, the return on a one-year bank deposit is actually negative.

Everybody's doing it

So no wonder that anyone in China looking for a positive rate of return -- and who isn't, beside financial masochists? -- has turned to the domestic stock markets in Shanghai and Shenzhen. There are now 100 million brokerage accounts in China. Sixteen million of those were opened in just the first four months of 2007. Trading volumes have soared. In April, trading volume on the Shanghai exchange was twice as high as in January 2007, and in the first four months of this year volume has been seven times volume in the first four months of 2006. On May 16, trading volume in Shanghai exceeded the trading volume on all other Asian markets -- including Tokyo -- combined.

There are no signs the Chinese stock market is slowing down. What seemed astonishing when brokerage companies in China opened 300,000 accounts in a day seemed old hat when a few days later brokerages report opening 550,000 accounts in a day. The press in China is full of stories of average citizens who have doubled their money. The Chongqing Morning Post recently featured a 60-year-old cleaning woman who had doubled her 20,000 yuan (or about $2,800) nest egg in two months. "At a time like this," the paper quoted her as saying, "who can lose money?"

The central government in Beijing isn't happy about this. Officials have tried talking the market down without success. Central bank governor Zhou Xiaochu was quoted expressing "concern" in the People's Daily and no one blinked. Interest rate increases haven't slowed the river of cash flooding into stocks. Leaks that say the government is studying raising the tax on capital gains haven't worked, either.

Why is the government worried? Because China has been down this road before. A boom in 1999 drew in millions of new investors who were then wiped out when prices plunged in 2001.

This boom is even bigger. And the fallout from any sudden bursting of the bubble is likely to be immense.

The stock-market boom has made many Chinese richer, and that has led to a surge in buying: In effect the recent acceleration of the Chinese economy to a better than 11% growth rate has been fueled by the stock bubble. Taking away this stimulus will slow economic growth, although no one knows by how much.

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