China’s Red Flags
In the aftermath of the credit crunch, the outlook
for most developed economies appears pretty
bleak. Households need to deleverage. Western
governments will have to tighten their purse strings.
Faced with such grim prospects at home, many investors
are turning their attention toward China. It’s easy to see
why they are excited. China combines size – 1.3 billion
inhabitants – with tremendous growth prospects. Current
income per capita is roughly one-tenth of U.S. levels.
The People’s Republic also has a great track record. Over
the past thirty years, China’s Gross Domestic Product has
So what’s the catch? The trouble is that China today
exhibits many of the characteristics of great speculative
manias. The aim of this paper is to describe the common
features of some of the great historical bubbles and
outline China’s current vulnerability.
Section One: Identifying Speculative Manias
and Financial Crises
Can we confi dently identify a speculative mania before
the bubble bursts? Is it possible to spot an incipient
fi nancial crisis before it explodes in our faces? Based
on the performance over the last decade of most leading
economists, central bankers, and Wall Street pundits, the
answer to these questions is surely a resounding NO!
In fact, bubbles can be identifi ed ex ante, as the
economists like to say. There also exists an interesting, if
rather neglected, body of research on leading indicators
of fi nancial distress. A few years ago, many of these
indicators were pointing to rising economic vulnerability
in the United States and other parts of the globe. Today,
those red fl ags are fl ying around Wall Street’s current
darling, The People’s Republic of China.
Past manias and fi nancial crises have shared many
common characteristics. Below is an attempt to list ten
aspects of great bubbles over the past three centuries.
1. Great investment debacles generally start out with
a compelling growt