A Bubble Waiting to Burst

China's exponential growth has been envied by countries all over the world. Consistent GDP growth in the double-digit territory practically every quarter allowed millions to leave the poverty line. This new-found wealth and capital flowed into the world of investments, as millions of Yuans entered the Shanghai Stock Exchange (SSE) and real-estate market.

From 2006 to 2007, the SSE tripled in value. Investors were hungry for wealth and continued to push the value of the exchange for another nine months before it bubbled and popped, wiping out 2/3 of the gains, coinciding with the financial crisis. It was a hard lesson for millions of Chinese investors - Easy come, easy go.

However, unlike the stock market, the real-estate market in China continues to shine. About thirty minutes ago, the Chinese government released data showing consumer prices rose 2.8 per cent in April from last year and property prices rose 12.8 per cent [1].

Concerns in China's real-estate market have been a hot topic for quite some time now. Chinese officials are trying to prevent a property bubble and have implemented many mandates to slow down the market without raising interest rates. China recently banned individuals from having more than two mortgages and second mortgages are charged an interest rate well above the going rate. And yet, prices continue to soar.

But with such strong economic data, what indicators are suggesting the end may be near? Recent remarks by wealthy investors and hedge funds claim that signals of a bubble ready to burst are hiding in plain sight, and we could see the fall of China occur within 9 months. Their reasons point to falling commodity prices and a skewed GDP.

Commodity prices soared in the summer of 2008 during the boom, but lowered demand from China and the rest of the globe have cut the price of oil in half, and prices of metals down 10 to 20 per cent in the last four weeks. They believe this is a clear indication that construction is slowing down in China, which is important because of the skewed GDP.

Recent data showed that approximately 60 per cent of their GDP is based directly to construction. With the Chinese government considering raising interest rates, it could put a serious halt to construction and lead to another Dubai, a country whose property bubble had burst last year. Imagine what a slow down on 60 per cent of their GDP composition would do.

A third argument that I have is that the stock market has always been a leading indicator of an economy. It is a representation of investors expected values of companies in the near future based on forecasted earnings. Investors are showing a lack of confidence in their public companies. As a result, the SSE is down over 12 per cent this year, where as North America and Europe are nearly unchanged (was up 6 per cent before that huge crash last week).

Interpreting the numbers and predicting the fate of an entire nation is a tough task. Professionals have been wrong before, and they will continue to be wrong in the future. However, it is also these same professionals who are the most qualified to paint us this gloomy picture of China's economy and one can not discount the signs as random. Nine months ago, they all said the US economy was recovering, and they were right. Can these same people be right about China as well?

[1] Bloomberg report