is AG blowing a China bubble

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Is Alan Greenspan Behind China's Bubble Too?: William Pesek Jr.
Feb. 11 (Bloomberg) -- Globalization is globalizing the Federal Reserve.

It has 12 districts and acts based on U.S. events, but its influence has never been greater. It
isn't far-fetched to think of Latin America as the 13th district, Southeast Asia the 14th, Russia
the 15th, China the 16th, and so on.

Perhaps it's not surprising, then, that some observers are blaming the Fed for problems in one of
its de facto, satellite districts. China, Asia's second-largest economy, is experiencing a dangerous
asset bubble, one that's making investors antsy.

It seems a reach to blame Fed Chairman Alan Greenspan and his colleagues here in Washington. After
all, Asia isn't a huge blip on the Fed's radar screen these days. The Fed also has taken its share
of flack for the U.S. bubble of the late 1990s. But the U.S. central bank's global reach is being
felt in Asia.

``The Fed commitment to keeping interest rates low for a considerable period of time fueled
speculation in high-risk assets,'' says Andy Xie, Hong Kong-based chief economist at Morgan Stanley
Asia Ltd.

``The byproducts of this speculation,'' Xie explains, ``are the wealth effect on consumption in the
U.S. and the cheap capital-fueled investment boom in China -- the twin engines or bubbles, depending
on your perspective, for the global economy today.''

The cycle, Xie says, will end with either the Fed reversing its policy or with a financial accident
caused by the leverage building up in high-risk assets around the world. ``History would not be kind
to the Fed,'' Xie says. ``Its accommodation and even encouragement of speculative excesses would be
viewed as the primary cause of the massive bubble in the global economy today, the consequences of
which are yet to show.''

The Fed's culpability is debatable. What's not is that speculative capital flows into Asia reached a
record high last year, surpassing the previous peak in 1996.

The big recipients of capital in 1996 were Hong Kong, South Korea and Southeast Asia. This time,
it's China. Just like the capital flow destinations of the 1990s, China is experiencing an
investment bubble.

In 2003, East Asia's foreign-exchange reserves rose $234 billion more than the region's trade
surpluses. That compares with an average of $26 billion in the 1990s and $8.3 billion in the 1980s.
China and Japan were the main capital recipients in Asia last year.

The increase began in 2001, when the Fed cut interest rates aggressively to boost U.S. growth. Like
clockwork, China's foreign-exchange reserves rose by more than its trade surplus for the first time
since 1996. The inflows picked up speed and reached record levels last year.

What can be done about all this? China needs to tighten capital controls to slow the inflow, Xie
argues.

Such a step would be anathema to free-market aficionados and to the Group of Seven nations, which
last weekend renewed its call for flexible exchange rates. But the longer Beijing allows such rapid
inflows of speculative capital, the more difficult it will be to avoid a financial crisis.

Xie's views are contrarian, indeed, but it's hard to dismiss them. The vast majority of world
leaders, economists and investors think China's currency is undervalued and that Beijing should let
it rise. That was certainly the thrust of the G-7's latest communique.

But ``the appreciation of China's currency, which many advocate as the main means to cool the
bubble, would only encourage more speculation, as we saw in Southeast Asia,'' Xie says. ``The
resulting bigger bubble would make a hard landing inevitable.''

China may be presenting economists with a rare throw-away- the-textbooks situation. Established
macroeconomic models hold that more exchange-rate flexibility will squeeze some air out of China's
bubble and keep the economy from overheating. Freeing the yuan may do exactly the opposite.

Beijing has taken steps to cool its economy. The central bank, for example, increased reserve
requirements on commercial banks to curb money-supply growth. Higher interest rates in the U.S.
could help temper China's boom. Global investors are looking for hints on the subject when Greenspan
testifies in Congress this week.

``The massive swings in capital flows into Asia could only be explained by the speculative drives
that rise or ebb with some stimulus,'' Xie says. ``The stimulus is usually Fed policy changes.''

It's doubtful Greenspan is preoccupied with all this. But those speculating on China's rise should
keep two things in mind. One, the Fed's policy decisions here in Washington may have considerable
influence on China's outlook. Two, what markets think they know about China's currency policy could
be 100 percent wrong.



To contact the writer of this column:
William Pesek Jr. in Washington, or wpesek@xxxxxxxxxxxxx

To contact the editor of this column:
Bill Ahearn in New York, or bahearn@xxxxxxxxxxxxxx
Last Updated: February 10, 2004 22:47 EST