Do you believe China's asset markets are in bubble territory? If so, what are the potential implications for the rest of the region, including Singapo

China’s stock markets Great Leap Forward are astounding by any measures and coupling with a hefty real estate price growth, the bubbles are gathering pace in high gear for the world’s third largest economy. The risk of bubbles and excess capacity will grow invariably unless policy is tightened soon. This level of credit expansion is not sustainable and is as surreal as unreal. Any policy action will be towards credit tightening if China has to avert a major credit crisis.



When China’s government announced its stimulus package in November 2008, it is a daring and probably the largest monetary and fiscal stimulus in history. With the injection of liquidity into the economy, bank lending rate grows exponentially and furiously. Such liquidity if properly channeled into infrastructural development and useful investments, it will inevitably prop up the economy but if it is fueling asset prices, the outcome can spiral out of control, complete with a domino effect on the property prices. The impact of credit and liquidity on GDP growth has been declining in China pointing to the fact that excess money may be funneled into speculation in stock and property markets.



If China is to stick to its pro-growth fiscal stance, any withdrawal of its stimulus spending too early can potentially stymied growth. The real aim is to purge the asset market frenzy of speculators, and not the total withdrawal of fiscal and monetary stimulus. The danger is that policymakers may tighten too much, discouraging not only speculation but also business growth and consumer spending, which can precipitate a hard landing for the economy. The jitters in Asia and the rest of the world are rooted in the fear that China will not be able to help pull the global economy from recession if it has a rough and hard landing which can be a big blow to recovery hopes given the inability of the U.S., Europe and Japan to play that role at this time.



The People’s Bank of China has just raised banks’ reserve requirements, but it needs to act more boldly to moderate interest rates upwards and to curb bank lending or at least be selective in its lending. The yuan must be allowed to rise. If China's reckoning does come as a result of the bubble popping, it is hard to say whether it may presage Japan-style deflation, Russian-style hyperinflation or American-style stagnation.



Anyway, bubbles do not deflate gradually; they pop unexpectedly and that is the scary part.