I think investors are worried about the wrong kind of crisis in China.
Worry seems to focus on the possibility of an asset bubble and the chance that it will burst sometime in the next two to three months.
I'm more concerned about a slide into a crisis that will be an extension of the Great Recession. That slide could begin, I estimate, sometime in the next 12 to 18 months.
I understand the worry about the possibility of an asset bubble in China. After all, we've just been through two horrible asset bubbles -- and busts -- in the U.S. and global financial markets. And a Chinese bubble is a distinct possibility, one that should certainly figure into your investing strategy.
But China's economy and political system are so different from ours in the U.S. and those in the rest of the developed world -- and its relationship to the global financial market so unique -- that I don't think we're headed toward any kind of replay of March 2000 or October 2007.
A bigger worry is a long-term slide into a lower-growth or no-growth world in which nations strive to beggar their neighbors and all portfolios slump. As crises go, it's very different but ultimately just as painful for investors as the asset bubbles that draw all our attention now.
To paraphrase Leo Tolstoy in "Anna Karenina": Happy bull markets are all alike; every unhappy bear market is unhappy in its own way.
More from MSN Money and MoneyShow.com
Toil and trouble
Most analyses of China's economic troubles begin, rightly, with the river of money flowing into the nation's economy.How deep is that river?
Start with the $585 billion in official stimulus spending. Add in bank lending that more than doubled, to $1.4 trillion, in the first 11 months of 2009 from $615 billion in all of 2008. And factor in continued runaway lending of $88 billion in the first week of January. If that rate were to continue, China's banks would wind up lending 50% more in January 2010 than they did in the first month of 2009.
All this has led to an explosion in the country's money supply. Money supply as measured by M1 was up 35% in December from 12 months earlier.
All that money has to go somewhere. Some of it has gone into productive loans or government-financed capital projects. But, clearly, huge amounts have been siphoned off -- in ways that China's politically connected capitalists know how to do so well -- into speculation in real estate and the stock market.
This has led to the enormous price increases for those assets that have stoked fears of a 2007-style financial-asset bust.
At its 2007 peak, the Shanghai A-share index (A-shares are priced in renminbi and can be purchased only by domestic investors) traded at seven times book value. At its high in the 1990s, Japan's Nikkei 225 ($N225) traded at only five times book value. Right now, the U.S. Standard & Poor's 500 Index ($INX) trades at 3.5 times book value.
The global financial crisis cut the price of Chinese stocks in half, but the subsequent recovery has taken them back into bubble territory. If you factor in an average of earnings over the past 10 years to take out some of the volatility, Chinese stocks now trade at 50 times the average 10-year earnings per share. The comparable figure for U.S. stocks is 15 -- and even that's not cheap by historical standards.
The bubble is even more apparent in real estate. According to figures in a Financial Times column by Peter Tasker, a Tokyo analyst for Arcus Research, the Tokyo real-estate bubble of 20 years ago peaked with apartment prices at 12 to 15 times average household income. In major Chinese cities now, the comparable price for an apartment is 15 to 20 times average household income.
When real-estate speculation exceeds that of the Japanese real-estate bubble, investors are right to worry. And that's why even some minor saber rattling, such as the increase in reserve requirements by the People's Bank of China on Tuesday, is enough to rattle China's stock markets and developing markets around the world.
If you own Chinese stocks or Chinese real estate, you should worry about the bursting of this bubble. It could easily take prices of Chinese stocks down 20% or more. After all, the Shanghai market fell 21% between July 31 and Aug. 31 last year. That was in the middle of the huge rally in global markets.
This is why I'm hesitant to buy into the Chinese stock market now. For my strategy on how to buy emerging-market stocks now, see my Jan. 7 blog post.
Continued: Central planning, with benefits
