How will China deal with its bubble?

Its no secret that China's hitherto successful stimulus has gone mainly into domestic equity and property markets. Currently little is going into the real economy, in a bubble story captured in Tuesday's Financial Times( a more extreme version of this thesis was best articulated at the Contrarian Edge). While a bursting of these asset price bubbles will certainly hurt, but it need not necessarily be the death of the Chinese growth story, as many people are begining to suggest.

Chinese policy makers have probably done the best they could do in response to the financial crisis. What they do next will determine how much longer the good news can continue.

There is solid evidence of Chinese stockpiling of critical raw materials such as copper and oil, as a hedge against the dollar. These stockpiles, largely held by state owned enterprises, must be released into the real economy. With taxi drivers speculating in stocks and flipping condos today, be prepared for a hard landing in Chinese stocks and real estate. The Communist party wants to maintain its power, but releasing resources to the real economy, especially the private sector will the be the key to a sustained, genuine recovery.

>Expect China to continue to seek to provide advantages to domestic users or raw materials, even as they face a challenge at the WTO. The current WTO challenge, from the US and EU captures only the tip of the iceberg. Many more subtle strategies will be employed in the near future. Again, if China is gives too much advantage to the state owned sector, than the long run outcome will be much less sanguine. However if they are succesful at giving advantages to domestic entrepenuers, without facing serious multilateral retaliation, than China may get out of this situation in front.