Tuesday, September 7, 2010

Will the Chinese Government Outdo the Federal Reserve?

As reported by the Wall Street Journal this past weekend (Sept. 4-5, 2010 edition, p. A10), the Chinese government is aiming to forestall a looming bubble in China's real estate markets. Since April, the government has been trying to cap the market, tightening credit standards and discouraging speculators. Prices flattened for a couple of months, but have started to rise again. Many urban Chinese, an all important political constituency, can no longer afford to buy. The government is set on pushing prices down.

The Chinese government is doing what the Federal Reserve has resolutely refused to do: pop an asset bubble. Indeed, Fed Chairmen and Governors have insisted there is no way to spot an asset bubble before it bursts. The Chinese government takes the opposite tack.

Even though the Communists in China are no longer Communist, ideology plays a role in their thinking. They switched over to capitalism when it became clear Communism wasn't working. Ever pragmatic, the Chinese government has used market forces as tools to speed up industrialization and growth. But it does not worship market forces, and is willing to second guess them when they start to produced undesired effects.

For the last 23 years, the Federal Reserve has been chaired by free market Republicans, and free market laissez faire thinking has dominated. The Fed has too readily viewed market forces as sacrosanct and not to be interfered with. That's puzzling, since market forces are simply one aspect of human activity. As a society, we have no problems regulating and second guessing all manner of human activity. Just get in your car and take a short spin. You'll encounter all kinds of rules, regulations, restrictions and prohibitions. If we see the logic of regulating the interactions of people as drivers, why not regulate their interactions in financial markets? Drivers aren't sacrosanct. Investors, speculators, lenders and other financial markets players shouldn't be, either.

The Chinese economy is growing around 10 or 11% a year right now, which is part of the reason for the real estate bubble there. The government hopes to knock home prices down, while slowing the economy to around 8% or 9%. If it can produce a Goldilocks effect--a real estate market and economy that are not too hot and not too cold--the Chinese government will have done what the Federal Reserve has insisted can't be done.

The Chinese government has studied Western economies and Western financial systems carefully, and applied many of the basic principles of free markets to China. China has prospered. The Chinese learned from the West, and now their economy is growing faster than Westen economies. It may not be a bad idea for the West to learn something from China: when investors and speculators go bonkers in the market--especially through the use of leverage--it's probably a good idea to rein them in.

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