The main problem with any information in China is that no one really knows, for the very simple reason that information is controlled. Markets are about choice. To make a choice you need one thing, information. You need to know if a detergent will get your shirts white or if your investment will make money. To get accurate, complete and timely information you need to protect free speech and enforce disclosure. If you do not then the information will be incorrect and the choices will be ill informed. If you have bad choices then you have an inefficient allocation of capital which, over time, will have severe consequences.

A good example is the Chinese stock market. I predicted that the Chinese stock market was a bubble in a letter to the Financial Times on May 15, 2007. What is interesting about the Chinese stock market is that it follows the same pattern of the Saudi market and the Vietnamese stock market. All of these markets have many things in common, the most important is information

These markets are dominated by state owned companies. State owned companies are very difficult to regulate because they are part of the same state that controls the regulator. They also operate for political reasons not for profit. If you want to see another similar example you have only to look at the Fannie Mae, Freddie Mac mess in the US. If there is an economic incentive not to disclose accurate, timely and complete information, and there are few legal or economic disincentives that require adequate information, people anywhere will lie. Since any market dominated by state owned companies have enormous conflicts of interests with the regulator (see Fannie and Freddie), the markets will not have accurate information. The markets will move by rumor and government statements. The result will be an inevitable bubble.

Information is more important in real estate markets, because the product is not fungible. As a result they often are ‘sticky’, but when they move the moves can be dramatic even in systems where the information is the best available. There have been improvements recently with things like the Case Schiller index in the US, but these things are still in their infancy. In emerging markets, they don’t exist especially in China.

The real problem is the lack of institutions, specifically a reliable legal system. Investors want a return on their investment, but even more they want their investment back. When things go sour during down turns, investors and home owners will turn to the law to see that their investments are protected. Without an adequate system, there will be problems. No market goes up forever. No economy grows forever. The real test of sustainable economic growth is how flexible an economy will be in a down turn. The ‘tiger’ economies of South East Asia have never recovered their rapid growth after 1997 basically because their legal institutions including corporate structures have not been able to adapt.

The real problem for China will be social unrest which I pointed out has been rising. De Tocqueville pointed out that the French Revolution did not happen because the poor revolted. It occurred because people were getting rich and had something to protect.