This is more towards the US-China trade rather than the Chinese asset bubble, but I’d still like to share it since we are discussing China.
In early 1990s, the Chinese government pegged their currency to the US dollar. At that time the need was more to create a tinge of stability in globally volatile currency markets. Today however, China continues to peg its currency against the US dollar with an altogether different purpose – to maintain its level of exports or trade surpluses with the US. In the 9 months ending September 2009, US trade deficit stood at $165.8 billion, that is, it imported a whopping $212.3 billion worth of imports while exporting only $47.0 billion to China. In 2008, the trade deficit for the same period in 2008 stood at $197.0 billion. The annual trade deficit by the end of 2008 stood at $268.0 billion, the largest in the world between any two countries.
If the US simply borrowed and spent less; its trade imbalances would grow smaller, right?? Not really…
China sets the value of its currency to equal a set amount of a basket of currencies; one of them being, the USD. When the dollar loses value, China buys dollars through US Treasuries to support it. This keeps Yuan's value always within its targeted range. As long as the value of Yuan is lower than the USD, China's goods will remain cheaper in comparison. This also means that a manufacturer in US will have to either produce goods at a lower cost, or quit business. China has been enabling this behavior for years – buying trillions of dollars in US government debt and mortgage securities as part of its continuing effort to keep the Yuan from appreciating too much against the dollar.
But there’s more to this than what meets the naked eye. China’s purchases of the US treasuries have made it the largest lender to the US government. In July 2009, China owned approximately $800 billion or 23% of US treasuries giving it political leverage over the US. If China decided to stop purchasing these US treasuries, interest rates in the US would start rising, affecting the speed at which our economy recovers. In addition, Obama on his last trip to China had requested large Chinese banks to take-over small and medium troubled banks, giving the Chinese a bigger hand in maintaining stability in the US financial system.
Now superimpose a shaky Chinese economy (I hope I’m right in calling it shaky, considering the asset bubble) onto an already shaky US economy. It doesn't take a genius to figure out how this will end!!!