BOMB SQUAD:

China Stocks: Tick, Tick, Kaboom?: The speculative mania sweeping Chinese stock markets is getting frothy—Beijing will need a smart policy mix (and fast) to settle things down (Brian Bremner, 5/10/07, Business Week)

By any reasonable measure, China's domestic stock markets have moved into Alice in Wonderland territory. The Shanghai Stock Exchange composite index has shot up 50% this year, following a 130% gain in 2006. Even though the so-called "A-share" mainland companies are now trading at rich multiples of about 30 times projected 2007 earnings, Chinese investors continue to shovel more of their savings into stocks, betting this party is anything but over.

Few doubt that the frenetic speculation in Shanghai—and at the smaller Shenzhen Stock Exchange (its benchmark index is up 100%-plus in 2007)—is at big risk of ending in tears if the government doesn't do something soon and effectively. If not, Chinese domestic markets will be in for a major-league blowout, some argue. "We believe it's now critical for the government to take action and prevent the excess from building up further," Goldman Sachs (GS) equity strategist Thomas Deng warned in a note to clients on May 10.

To really have an impact, Chinese President Hu Jintao's government has to send a strong message to investors that shows it is deadly serious about cooling things off. It then needs to follow through with a mixture of tighter monetary policy, perhaps the introduction of a capital gains tax, and an acceleration of state-owned company share sales, more initial public offerings, and secondary stock sales to increase share supply.

Further out, the introduction of a vibrant futures market—in which investors could make money shorting stocks ripe for a fall—would add more stability.

The notion that adding greater freedom in China will bring stability is hilarious. The reguired measures will not just end the regime but begin the disintegration of the Empire.

Posted by Orrin Judd at May 10, 2007 3:53 PM