An intertesting new article on China (“Crazy Again”) has been published by former Morgan Stanley Analyst Andy Xie. You can find it here: http://www.my1510.cn/article.php?id=e3fc777cdd24720a. It is worth reading - rather surprisingly, the author is bearish on China and bullish on the Dollar. According to Xie,

Chinese asset markets have become a giant Ponzi scheme. The prices are supported by appreciation expectation. As more people and liquidity are sucked in, the resulting surging prices validate the expectation, which prompts more people to join the party. This sort of bubble ends when there isn’t enough liquidity to feed the beast.

There are certainly some tell-tale signs. The Shanghai Composite has nearly doubled from its November lows, leading to the kind of frenetic trading that are hallmarks of a bubble. According to Canaccord Adams, turnover in China's stock market hit $63 billion on July 29 - exceeding the combined $58 billion combined volume in New York, London and Tokyo that day. 

The stock market is in a final frenzy again. The most ignorant retail investors are being sucked in by the rising momentum. They again dream of getting rich overnight. As in the past, retail investors usually lose, especially like the ones jumping in now. The final frenzy usually doesn’t last. The turning points in China are often related to political calendar. Retail investors hold the popular belief that the government won’t let the market drop before October 1, the 60th anniversary of the PRC. Last time it was the 17th Party Congress in October 2007. This sort of belief is self-fulfilling in the short term

Xie says China’s asset bubble originated in excess liquidity that resulted from a weak dollar and strong exports. As the dollar entered a bear market in 2002, China’s yuan followed it down. The appreciation expectation drove liquidity to China. According to Xie, one fourth of China’s foreign exchange reserves could be due to this factor.

Xie believes that a dollar appreciation, triggering an outflow of capital from China, could burst this bubble:

It is not too hard to understand when the bubble would burst. When the dollar becomes strong again, liquidity could leave China sufficiently to pop the bubble. What’s occurring in China now is no different from what happened in other emerging markets before. Weak dollar always led to bubbles in emerging economies that were hot…

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