Deflating the China Bubble

Decoupling, recoupling or just plain old late in the global economic cycle -- take your pick. There are myriad ways of describing China's dependence on U.S. growth.

Our guest host this morning Nick Carn at Odey AM describes a bubble trap for the complacent: He sees an unwinding of asset prices in China over the next 12 months that will be painful for investors in that market.

It will also be hard for the government to step in to halt the unwinding as it preaches a desire to cool inflation. The ramping of IPOs via bargain pricing can only work when momentum is still with the buyers.

Chinese stocks are off already this year, but are investors in the BRIC funds that have ridden the growth story ready to see market levels fall to pre-boom numbers?

The government is clearly also getting the message. Premier Wen expressed concerns about the U.S. economic outlook and the market volatility created by the Bear Stearns collapse.

Quite an irony (Marx would be spinning in his grave) that the head of the world's biggest socialist country should be expressing anxiety about the fate of the world's biggest capitalist economy. These are indeed strange times.

Students of the Asian currency crisis would do well to delve back into their memories. China's stellar growth has been achieved on huge investment spending -- some of the capital will have found its way into productive plants, assets and businesses, much will have disappeared in the mirage of business hopes, ambitions and the reality of money squandered on generally having a good time.

But all chickens eventually come home to roost.

And just as it did in 1997-98, the market will start asking some tough questions about multiples.

Are Chinese manufacturers still viable during a weak dollar and weak U.S. economy? Is Beijing prepared to let the currency revalue to cool inflation? (A recent ECB report suggested the current policy could cause long-term damage to the economy). Does Beijing have the tools and expertise to manage domestic economic and market stress?

Watch this space, and take another look at those BRIC holdings. Do they still look good in the portfolio?

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