...of some of the reasons why China is prone to speculative bubbles. In my view, institutionalized and culturally accepted corruption (guanxi) coupled with the implicit public ownership of all wealth has led to an intractable distribution of the massive wealth that was generated for 3 decades. In the United States, there are (at minimum) forums to display one's contempt for the government and demand accountability through either elections, the legal process, or social shame. In China, these forums are called "Dungeons", where you may freely talk to no-one about your views for the rest of your (short and unhealthy) life.
In a matter of days, there was a displacement, an apparent expansion of credit in the underground market, euphoric buying on expectations of ever-higher prices and finally revulsion once reality sank back in. The meteor shower of shooting salt prices over China is not an isolated example of speculation gone awry: The current stockpiling of copper in China’s ports is inflating the global price, which could collapse if regulators put restrictions on the use of the metal as collateral for bank loans. Likewise, Hong Kong’s property bubble is partly a spillover effect from the bubble in some of China’s urban high-end markets. In fact, investors are vulnerable to several factors within the Chinese system that could affect global asset prices.
First, decades of financial repression have resulted in the broad money supply (M2) expanding to 182% of GDP, providing a massive pool of potential liquidity for speculation, while negative real interest rates on deposits encourage savers to seek alternatives. There are sufficient monetary assets to fund a bubble of stupendous magnitude; no excessive loosening is required. From the end of Q3 2006 to its peak in October 2007, the Shanghai Composite Index increased 230%. In the preceding six quarters, M2 growth outpaced nominal GDP growth by less than a percentage point. It was the velocity of money that spiked, not the quantity. Velocity is more difficult for the People’s Bank of China to control, especially with banks’ required reserve ratios already at record highs, and current conditions seem ripe for a bubble.
Second, the Communist Party of China’s dominance over the press, even independent sources, results in low trust of official information, counteracting their ability to dispel unfounded speculative manias. At the same time, heavy reliance on social networks, guanxi, results in an abnormal amount of inside information sharing, and thus speculative opportunities. Positive feedback loops proliferate as investors pile into the same opportunities and bid prices up.
Third, the government’s interference in price setting distorts markets, creating potentially huge divergences from equilibrium. From vegetables to apartments, the government’s efforts to control prices only shifts the adjustment burden to the supply side as markets seek equilibrium. This also creates a whack-a-mole game between speculators and the government as liquidity shifts from one asset class to another.