Is China in a bubble blow-off top like Japan post-Plaza accord?

I was talking to a friend of mine who does emerging market investing for a living and I asked him what he made of recent China-bullish comments by Stephen Roach. 

The Morgan Stanley Asia head was in Germany speaking to German business daily Handelsblatt last week. The guys from Handelsblatt wrote up a piece called “In China bildet sich keine Blase an den Märkten” which translates “China is not creating a market bubble.” Unfortunately, the story is behind a pay wall (and it’s in German anyway). But Gwen Robinson of the FT got the inside scoop and posted “Roach: Pooh-pooh to Chinese bubbles” at FT Alphaville. She writes:

As Roach notes, the Shanghai A-share composite index soared 3.5 times in the year ending October 2007 before plunging more than 70 per cent in the ensuing 12 months.

And every China watcher knows about the surge in nonperforming bank loans that required a major recapitalization of a nascent Chinese banking system less than 10 years ago.

But these problems were mere bumps in the road, in retrospect. Roach explains (our emphasis):

That’s because Beijing was vigilant in preventing asset and credit bubbles from spilling over into the real side of the Chinese economy. This was very different from the Japan endgame of the late 1980s, where the confluence of equity and property bubbles led to a massive overhang of excess capacity.

What’s more, he adds, it stands in sharp contrast to the more recent US experience, where property and credit bubbles pushed up homebuilding and personal consumption to nearly 80 per cent of US GDP prior to the bursting of the subprime bubble.

Of course, China is “hardly the poster child of macro stability” – with exports and fixed investment surging to nearly 75 per cent of Chinese GDP and private consumption at 35 per cent and still falling, China’s macro imbalances are in a league of their own.

But in Roach’s view, these distortions are less of an outgrowth of asset and credit bubbles and more a by-product of a conscious strategy of externally-oriented economic development.

While China can hardly avoid bubbles, he notes, it has been successful in preventing them from destabilising the real economy.

Because of the spate of China currency manipulation/protectionism stories hitting the wires (see my links post), I had been thinking about 1931 a lot recently – more on that later. But when I asked my friend what he thought of Roach’s comments, he said: “I think China is indeed Japan in 89/90, but potentially magnified.”

Let me explain. Contrary to current folklore, the reign of Paul Volcker was not one of extreme inflation hawkishness and anti-bubble moral suasion. In fact, there were serious animal spirits building in the U.S. in part due to a September 1985 Plaza Accord, in which the major countries all agreed to depreciate the US dollar. The exchange rate plunged a fantastic 51% before the carnage was done. And as anyone will tell you, currency depreciation is inflationary – either for consumer prices or asset prices or both.

By February 1987, the U.S. Government was alarmed at the speed of the U.S. dollar’s depreciation and looked to reverse it at the Louvre Accord. The problem, however, was that the U.S. wanted Japan to continue a stimulative monetary policy. Here’s what the accord actually said:

The Government of Japan will follow monetary and fiscal policies which will help to expand domestic demand and thereby contribute to reducing the external surplus. The comprehensive tax reform, now before the Diet, will give additional stimulus to the vitality of the Japanese economy. Every effort will be made to get the 1987 budget approved by the Diet so that its early implementation be ensured. A comprehensive economic program will be prepared after the approval of the 1987 budget by the Diet, so as to stimulate domestic demand, with the prevailing economic situation duly taken into account. The Bank of Japan announced that it will reduce its discount rate by one half percent on February 23.

The Plaza Accord may have helped correct imbalances, but it also put the Japanese economy into a blow off bubble top that sent the Nikkei into the stratosphere above 38,000. The result was a spectacular bust from which Japan has still not recovered.

So, now that we see the Chinese, with their $600 billion stimulus package and massive increase in credit, causing serious malinvestment, one wonders whether we are seeing a repeat of the 1989/90 excess in Japan.

I have repeatedly pointed to enormous levels of malinvestment in China. Here are a few posts of that ilk.

Yet, we see Stephen Roach’s cogent defence of what is going on in China. He is not known as a perma-bull – – quite the contrary.

So what gives? Is China experiencing a massive bubble or not? If so, will the bubble’s inevitable pop spill over into the real economy in a nasty way as it has done in the U.S. and elsewhere?

These are important questions given the central role China plays in the world economy. My own point of reference has been the 1920s and the 1930s more than the 1980s and 1990s. In the 1920s, Great Britain played the role now played by the United States: military power, declining economic power, anchor global currency, and largest debtor nation. The United States played the role now played by China: rising economic and military power and alpha creditor.

So, the section in Charles Kindleberger’s seminal book, “The World in Depression 1929-1939 on French accumulation of sterling bears noting. Sterling was weak and the French had been accumulating huge amounts of British pound foreign reserves in 1926. This created a problem for the British because the French could threaten to redeem those pounds for gold under the gold standard then in operation. Kindleberger says:

this accumulation put [French central banker] Moreau in a strong position and [British central banker] Norman in a weak one. As an opening gambit, the bank of France began to convert sterling into gold…

There were threats of further conversions of sterling into gold.

Eventually, the French and British reached a compromise which involved the Federal Reserve Bank of New York lowering interest rates to help the British (and the Germans who had just had their travails with hyperinflation).  The result of this easy money was a blow-off top to the U.S. stock market and credit bubble that had almost collapsed after the Florida real estate boom went off the rails.

Clearly, the U.S. role of easy money global saviour in the late 1920’s was played by Japan in the late 1980’s and by China in the late 2000’s. Each time, the speculative mania the easy money fuelled ended in disaster. 

Eventually, the whole system broke down in the 1930s, with the U.S. playing the protectionist card and precipitating collapse.

I have trouble believing this time is any different. If any of you have a different take on these events, I’m all ears?


Statement of the G6 Finance Ministers and Central Bank Governors (Louvre Accord) – University of Toronto G8 Information Centre

Charles Kindleberger – The World in Depression

  1. hbl says

    “I have trouble believing this time is any different.”


    “Yet, we see Stephen Roach’s cogent defence of what is going on in China. He is not known as a perma-bull – – quite the contrary.”

    The bearish pieces I read by Roach during most of the 2000s were usually focused on current account and trade deficits and his conclusion that they were unsustainable. Looking at wikipedia, he also supposedly has focused on problematic government deficits and hyperinflation potential. Clearly not all “bears” are bearish for the same reasons, and I don’t remember much emphasis from him on the credit bubble / Minsky angle. Also perhaps a moral judgment bias toward “deficits bad surpluses good” (reading between the lines, I could be incorrect) could leave him unduly positive on China and negative on the US, for example.

    So personally I’m putting less and less weight on Roach’s analysis.

    1. Edward Harrison says

      thanks for the feedback. I do like what Roach has to say in general, but your read of things does seem reasonable. I’ll have To fact check where Roach was on these issues in the past.

      1. hbl says

        I hadn’t found the logic of Roach’s argument as covered by FT alphaville all that clear on first read, but looking at it again now, perhaps his arguments make sense. I guess he basically says China’s government hasn’t allowed asset bubbles to spill over in the past and then implies that means they never will (and implies that this result is under their control). Perhaps this is correct — China’s government certainly won’t be under the same political pressures as the historical analogies, and could find new ways to support demand if they understand the situation and can execute successfully even as credit growth slows or reverses. But that doesn’t mean the bubbles in valuations etc aren’t there, it just could mean a different ultimate outcome.

        1. Edward Harrison says

          That’s my reading of his statement a well. And that’s why I find it highly disconcerting. He is essentially saying the Chinese can and wil control the effects of this thing in a way that the U.S. was not able to do. Is this the benefit of a command economy? Is he currying favor? This doesn’t make any sense to me.

  2. LavrentiBeria says

    Interesting historical analysis. The parallels to which you point ought to be instuctive, the sequence, United States-Japan-China, particularly. So what’s the precipitating event in this case?

    1. Edward Harrison says

      I see more parallels to the 20s and 30s than to Japan. The key is the imbalance whereby France was accumulating reserves in the same way that China has done.

      Kindelberger claims this put Britain in a poor negotiating position, but they simply needed to devalue and France would be left holding depreciated currency. The same is true again today with China and the U.S.

      Also, in a links article from today, Evans-Pritchard points out that the bust in the 1930s was greatest in the surplus nation (America). We saw a similar dynamic in Japan and Germany after the Panic of 2008, so China is vulnerable here – one reason it holds firm to the peg.

      What precipitates this is unknown, Lavrenti. But, as I have often said, protectionism is the real threat IMO.

      1. LavrentiBeria says

        Given the obvious and continuing interest in the health of international trade by the ruling class, “protectionism” has been considered the bugaboo in this situation for as long as I can remember, Smoot Hawley, specifically. Ask anyone whose off-shored a factory to China or Brazil and you’ll get this story. But the role of accumulating reserves is never mentioned. Today, as long as the competitive position of a corporation can be benefited somehow by arranging for the provision of slave labor, every possible effort is made to accomodate the slave-providing nation. There is a willful ignoring of the human cost of this practice at both ends and all in service of what farcically is called, “development”, and the bullhorns in the purchased media cheer loudly. This certainly has been the case with China, the questionable origins of this strange relationship notwithstanding. On both sides, everything possible has been done to facilitate the progress of these designs and no one knows this fact better than the ghost towns of, say, Youngstown and Elyria, Ohio, and the ubiquitous, noxious, soot clogged, factory environments of China. Yet any talk of requiring China to act the part of a responsible – and equal – international player is quickly hushed in the interests of not giving offense. Can you imagine the outcry if the United States government were even to hint at requiring healthy environments for Chinese workers before deals could be arranged? Why every Chamber of Commerce and Bankers Association in the country would be up in arms. And so, by the same mechanism, callous self-interest, Chinese reserves have been allowed to accumulate with no meaningful opposition. Yet again the ruling class finds a way to wage war on its people by making no provision for what history has so obviously taught us. This time, they well might not get away with it. We’ve been lead to this pass by pigs and it is pigs that manage the outcome. Ask yourself if that makes you comfortable.

  3. Plan B Economics says

    The stark difference between 1989 Japan, 1929 USA and 2010 China is that Japan and USA stock markets were making new highs. China’s market is still about 50% below its previous peak.

    Events don’t need to play out the same, but it is a notable missing component of the alleged China bubble.

  4. purple says

    China is nothing like the US in the 1929. The US had higher wages than Europe at then, and the largest economy in the world (not the UK). It was was among the leaders in innovation as well – think airplanes, Edison , and many more.

    Almost no leading edge innovation has come out of China for centuries. (Chinese in the US do quite well, but that is different) China is poor on per capita basis. China manufactures stuff that is designed in other places, for companies that are headquarted in other places.

    Not to mention Europe was coming off of a devastating World War 1, which killed off a generation.

    1. Edward Harrison says

      purple, there are never exact historical parallels, especially when you look over the long sweep of history. So I think your statement that “China is nothing like the US in the 1929” is overblown. I have pointed to the parallel already, namely that China was the ascendant alpha creditor.

      Beyond that, I think the France accumulation of reserves bears noting. China is effectively doing what France did by accumulating reserves despite fears of currency depreciation. I think this reserve policy is significant and one reason I mentioned it in this post. This is what is behind all of the talk of protectionism and currency pegging. The Chinese are afraid that the U.S. are actively looking to devalue the currency while the U.S. are fed up with the peg and the resultant imbalances.

      How this gets resolved, I don’t know. Roach, at a minimum, points to increasing Chinese domestic demand just as the Germans could do the same to reduce intra-Eurozone imbalances. If the Chinese don’t do this, we are headed for a protectionist future and protectionist escalation in my view.

  5. John Haskell says

    Historically, Roach has not allowed asset bubbles to spill over into his analysis in the past, until 95% of the move is over (see him circa 2007) when he capitulates and says “this time it’s different.”

  6. Anonymous says


    Read my Article ” Capitalism Reigns ” at, which summarizes China and all of the above posts.

    It’s never different – that because as the Great Jesse Livermore says “Markets never change, because Human Nature never changes”.


    Charlie T.

  7. Edward Harrison says

    See China’s property bubble is worse than it looks An FT Op-Ed. Timely piece.

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