Convoluted Logic about China’s Stock Market Bubble
It’s a well documented fact that those caught up in the throes of a bubble are usually in denial about it’s existence. Take this and multiply by 10 and you have the current state of psychology inflating (or at least preventing the deflation of) China’s stock market bubble.
But this is just the way I see things – I really would like to hear about what you think of China’s current stock market. Is it in a bubble? What’s going to happen from here? And anything else you would like to add – please leave something in the comments below.
My friend thinks there is a bubble in China’s stock market – but believes it won’t collapse
At least he admits that there probably is a bubble. Yet he has all of his money in the market, convinced that things will pan out exactly as he predicts.
This seems to be the case for a lot of people I have talked to about China’s stock market. Even if they admit there a bubble probably exists, they won’t take steps to avoid financial suicide / pain (at least lightening up on their happenings): I don’t know what’s going to happen from here short term, but I do know that prices are high and are more likely to fall than go up, especially given a slightly longer horizon.
So many people in China are convinced the market will keep rising and rising, even if they think it is already a bubble. Convincing yourself you know something will happen is just plain dangerous: I don’t know if the market will go up or down, I just know it’s already ridiculously expensive.
Many Chinese people in complete denial about a bubble in China stocks
But while I have talked to many who admit there is a bubble in China’s stock market (and yet still remain invested), there are even more who believe the good times have just started.
But what is the logic that supports this kind of bubble thinking? I’m going to take a bit of time to translate the following article, written by èµµæ™“, a professor at åŒ—äº¬ç§‘æŠ€å¤§å¦, whose basic premise is that those who call speculators in China’s stock and property markets irrational are the real irrational ones. It’s a pretty screwy kind of logic, one that is very easily refuted by countless examples of bubbles throughout history (even recent bubbles in China), but it’s worth reading through to try and understand.
The article is translated from this week’s Modern Weekly, though I have added headers to make it easier to read through:
The rational choice
Are all Chinese people caught up in speculating in stocks? Are the people of China “irrational”? I don’t think so.
First of all, when a person calls out other people as irrational, he is making Hayek’s “fatal conceit”. Since he is doubtlessly dressing himself up as the standard of rationality, behaviour he doesn’t approve of will automatically become irrational. Yet one of the basic points of economics is this: you must assume that everyone makes decisions that are rational. Everyone makes the most beneficial decisions particular to their individual restraints and circumstances.
If you think others are idiots you are the idiot
Maybe you cannot fully understand the restraints and circumstances others make decisions under, but you cannot come to the conclusion that others are irrational. If you think others are idiots, and ascribe their decisions to this, you are definitely the biggest idiot of them all.
Irrational group choices are not necessarily irrational individual choices
Rational choices by individuals do not necessarily lead to the best results for the group, hence maximizing individual rationality might be harmful to the group. But if you blame individuals as irrational when what you are really trying to refer to is “group irrationality”, that proves that you have mixed up individual rationality and group rationality. More and more Chinese people are buying houses and trading stocks, but are irrational or rational choices being made? Let’s try to analyze this from a macro-economic standpoint.
Too much money in China
First, the most special characteristic of China’s macro-economy is that it is in a state of excessive liquidity. Jumping out from behind the linguistic veil of complex technical terms, “excessive liquidity” just means there is too much money floating around. How did so much money suddenly appear in China? There are two main causes. The first is that internationally it is recognized that the RMB is undervalued and will rise. There is a lot of room to profit from this. Therefore, a large amount of money has flown in through legal (like QFII) and illegal means – in the first quarter of this year the amount of hot money that flowed into China exceeded US$70 billion.
The second cause is due to international capital, working through the American government and other channels, forcing the Chinese government to allow the RMB to appreciate. After it was allowed to appreciate in 2005, normal interest returns on and the space for the RMB to appreciate further made international capital blood thirsty and hungrily rush into China. The result is that over the past several years China’s foreign currency reserves have increased at a breath taking rate – going from $400 billion in 2003 to the present $1.2 trillion today. This increase of three times over three years is greater than the increase of any other macro-economic measure of China’s economy.
In mainland China, foreign currencies cannot directly be invested and used – they must first be changed into RMB. This has caused the amount of RMB in China to greatly increase. China’s macro-economy to no small extent is already led by the excessive amount of liquidity flowing into China.
RMB worth less and less in China versus capital assets
The direct influence this has on the average Chinese person is that their money buys less and less capital assets in China. The prices of consumer products in China have stayed the same while the price of investment goods have soared – because goods like housing and stocks are usually non-exportable goods. In the past, 500,000 RMB might have been enough to buy a house – but now, because foreign currencies have flowed in to fight for this house, your 500,000 RMB might only be enough to buy half of a house. Chinese stocks are also the same – on the surface what people are buying are pieces of paper but in reality they are buying companies. Since there is a limited supply of good companies, and their rates of growth have limits, the influx of foreign currencies has caused stocks to rapidly advance in price. This also means that the RMB has rapidly been falling in value relative to the prices of stocks.
An irrational choice – refusing to buy stocks and houses
As long as the advance of the RMB has keeps up, the inflow of foreign capital will also continue. Thus Chinese citizens have only two choices. One is to trust the government or some more “rationally minded” people – and believing that they themselves do not have the ability to make rational choices. In this case they will not be in a hurry to buy a house but will rent, and won’t get caught up in the “national stock trading fever”. What is the result of this kind of “rational choice”? The bitterly accrued life savings of thepeople of China melting like an ice cube left out in the sun. Perhaps yesterday, 100,000 RMB could buy 10,000 shares in a given company – but today you can only buy 5,000 shares for the same amount. Tomorrow you might only be able to buy 1,000 shares in the same company for the same amount.
Of course, there will come a day when the prices of houses or stocks will fall as fast as they have risen – but as long as long as the RMB keeps increasing in value this day will not come. And the RMB has a long way to appreciate. Therefore, making average Chinese people wear a heavy winter coat in the blazing heat of summer is too early of a precaution, and will make the people of China die from heat sickness.
Ride that stock horse
The people of China are of course not this stupid. Chinese people have their own rational choices, and that is to prevent losses in their capital by investing in “houses, valuable stocks, antiques, Chinese art” and all assets in China. Think for a moment, if you will, whether a person can beat a horse in a race of a thousand miles. The answer is that there is no one who is able to do so unless they are riding on the back of the horse. The choice of Chinese people to buy houses or trade stocks is not only a rational and beneficial choice, it is almost an unavoidable and the only avaiable choice to avoid the melting of your wealth as an ice cube melts in the sun.
One day the RMB will stop rising on the world stage – but it’s already falling in China
As with everything, the rise of the RMB will also some day come to an end. When this happens, foreign investors and capital will throw aside China as they have thrown away Japan and South East Asia in past crises. But while the disaster to hit China is not near – the RMB, which appears to be appreciating to the outside world, is actually falling quickly in value for Chinese people.
Keeping China’s wealth cool
No one can beat the market – a basic tendency is that predictions of the RMB rising will make it inevitable for its value to fall within China. The market will continue to educate the people, make them understand the market’s truth, and teach people how to make real “rational” choices, to prevent their assets from shrinking. To those who criticize Chinese people for ‘speculating in houses’ or ‘speculating in stocks’ – you are the real irrational ones. Please give a better or easier road for the people of China to follow to prevent the wealth of the common people from melting like an ice cube melts in the sun.
So what do you think of the arguments? Does it make sense or just seem a little bit too “trying to come up with an explanation for what has happened” to you (like it does to me)?