"Their Pandora's box has been opened."
That's how Yi Gang, the Beijing chief of the People's Bank of China, described what is among the most-tantalizing economic dynamics of our day: the get-rich-quick euphoria coursing through the world's most-populous nation.
"The Chinese people are no longer satisfied with putting their money in the banks after seeing the huge growth and development in the stock and real estate markets," Yi said recently, explaining as well as anyone why China's stock market keeps rising and rising and rising.
It's hard to resist thinking Yi is inadvertently signaling the next phase of two Chinese bubbles one in real estate, one in stocks. China gives the concept of a pyramid scheme a whole new scale. After all, a key rationale for buying Chinese assets is that continued gains will only enroll ever-growing numbers of first-time investors.
In all likelihood, things will end badly. Yet the scheme has already done something quite remarkable: created the world's first $1 trillion company (well, briefly). That honor goes to PetroChina Co., and it may end up being a dubious one. To understand why, look no further than Industrial Bank of Japan.
In the late 1980s, amid Japan's seemingly unstoppable boom, Industrial Bank of Japan briefly became the biggest company by market value. At the time, U.S. corporate heroes such as General Electric Co.'s Jack Welch, were calling Japan's rise "relentless."
That was just before Japan's asset bubble burst, plunging banks into a crisis from which they only recently emerged. Now, analysts are buzzing about whether China's boom will be a replay of Japan's. Similarities include surging asset valuations, strong economic growth, the aggressive exporting of capital and a belief the good times will never end.
There are important differences, too. One is the sheer number of Cassandras, something Japan's rise lacked. Household names such as Alan Greenspan, Warren Buffett and Li Ka-Shing have warned of a Chinese bubble.
Yet there's something China bulls can learn from the chastened Japan bulls of yesteryear the dangers of loose monetary policy.
China is something the world has never seen. Never before has such an underdeveloped economy with so much potential and so many people become a global economic power so quickly. If Adam Smith, John Maynard Keynes or Karl Marx were alive, none of their economic theories would neatly apply.
Even so, China's central bank, along with those in other major nations, is making the same mistake as Japan: holding short-term rates too low for too long.
The recent global credit crunch has really been about choice. Bankers had lots of money to lend and investors had lots of money to put into bonds or stocks, yet they chose not to. The turmoil was less about the supply of money than fear of losses.
By pumping money into markets, central banks sought to calm nerves. Yet those actions didn't treat the real problem, just a symptom of it. It was low rates that fueled irrational risk-taking in markets and allowed banks to make loans that wouldn't have been made if monetary policies were sound.
The Bank of Japan waited until the Nikkei stock average rose above 38,000 before tapping on the brakes. And during the 1990s, it never should have lowered rates to zero. It did so at the behest of politicians looking for an easy way out. We're in the latter half of this century's first decade and the BOJ is still preserving what is essentially a zero-interest-rate environment.
Toshihiko Fukui, BOJ governor since March 2003, has only managed to boost the benchmark short-term rate to 0.5 percent. Japan is still a financial buffet table, of sorts. Investors continue to dine out on cheap yen borrowings that they move overseas into higher-yielding markets. The so-called yen-carry trade is a major source of leverage around the globe.
It's not clear that the Federal Reserve has learned the lessons of Japan either. Fed Chairman Ben Bernanke is looking every bit the market cheerleader that his predecessor, Greenspan, was. European Central Bank President Jean-Claude Trichet is under pressure from leaders such as Nicolas Sarkozy of France to follow.
Easy-money policies have knocked markets out of whack. Currencies such as the dollar are sliding at a time when prices for commodities are reaching record highs. That, too, can only end badly.
As long as equity prices keep going up, many investors figure all's well in the world of capitalism. Yet equity gains are more about loose monetary policies than genuine optimism. Also, just about everyone from central bankers to hedge fund managers to individual investors is betting on a weaker dollar and higher commodity prices. How is that sustainable?
Japan's inability to normalize rates is a cautionary tale. China's growth is fueled by foreign investment that's predicated on an undervalued currency. That has locked China into a Faustian bargain with its $1.4 trillion of currency reserves; it can't really sell them or stop adding to them.
If China repeats Japan's mistakes, it will open an even bigger Pandora's box a global one.