Krugman Warns of Chinese Bubble

Economist says investors burned by the collapse in the U.S. property market may be making the same mistakes now in China

By Andy Markowitz

Nobel laureate Paul Krugman, who teaches Economics at Princeton University, has publicly lauded US Federal Reserve chairman Ben Bernanke's efforts to pull the world's largest economy out of the ongoing recession. In a free-wheeling chat with ET NOW's senior editor in Kuala Lumpur, Mr Krugman predicts that the US economy may step out of the worst recession in more than five decades by September, but economic problems and weakness may persist. Excerpts: ( Watch )

Unemployment in the US fell for the first time in more than a year. But you're telling us not to get our hopes up...

The new claims for unemployment insurance are not as bad as they were, but still indicate a worsening labour market. So, we're basically at best stabilising, probably not even quite stabilised. This is just okay, it doesn't look like the world is going to end right now, but it's not a recovery.

Will the recovery be W-shaped or a V-shaped one?

It certainly is not going to be V-shaped. There's no driver for rapid recovery. The W (the double dip)—I guess there might be a W and it will be fuzzy, so you won't be able to see it. But it certainly is looking like a weak recovery with a possible setback. What drives those V-shaped recoveries is the housing sector. We had this enormous housing problem which imploded. Although housing is probably stabilising now, there's still a huge overhang of excess building and there are bad memories of what happened. We're not going to have a traditional housing-led recovery. So, we don't have the set-up for a traditional, strong bounce back.

US households have taken up their savings rate from almost nothing to about 7%. Is that a problem for Asia, which has traditionally depended on the US consumer for buying up its exports?

Yes, we built a system—as I was describing a few years ago—where Americans have made a living by selling houses to each other, which they pay for with the money they borrowed from China. That's over. American savings rate is going to head higher from where it is. Historically, it was 9-10%. And remember, American households took a $13-trillion hit on their wealth between the housing collapse and prices of nearly all assets fell. They have discovered that the rising value of their house is not going to provide for their retirement. Thus, they have got to start saving again.

Some people are saying that over-abundance of global liquidity has already started pushing emerging markets into bubble territory. What is your view?

I think I wouldn't say excess of global liquidity. What I would say is that there was a global rush to safety. And some of that money is being freed up, but it's sort of disillusioned about the things that it was chasing in the past, and is chasing new things. So, there are indications. There may be some equity bubbles out there. There may be some even real estate bubbles in Asia resurfacing, which is frightening. So, people who were terribly burnt on the US real estate market are saying: Well, but this is Chinese real estate and it can't have the same problems, but of course, it can.

What do you think of the Chinese stimulus package?

We are not sure how much of it is real. There has been a surge in public investment, but some of that appears to be credit, which is being used just for speculation. Some of the increase in demand for raw materials seems to have been more speculative build-up, but in inventories, there is really an increase in production.

The Baltic Dry Index has dropped so it looks like that the inventory-building phase maybe coming to an end. And, of course, there are indications of bad spending and corruption. I don't think it's not the beginning of a sustained period of recovery.

So, is China really stoking a bubble here?

I think it is blowing some bubbles. If I was going to buy one unfortunate phrase from Alan Greenspan, I think, it's right that it's froth.

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