Serious Money: The 17th National Congress of the Communist Party of China began on Monday. The meeting, which is held every five years, oversees major promotions within the party and membership of the Politburo, writes  Charlie Fell.

The current meeting takes place against a favourable economic background. The economy is set to expand by more than 11 per cent this year and the country's contribution to global growth is set to surpass that of the US for the first time in modern history.

The ongoing economic expansion has contributed to a surge in industrial profits and a sharp improvement in the banking sector's financial health. Not surprisingly, stock prices are soaring, though some, including former Federal Reserve chairman Alan Greenspan, believe that the market is in bubble territory. According to the maestro, "there's going to be a dramatic contraction at some point".

The Shanghai A-Share index, which is restricted to domestic investors, has been red-hot in recent months and closed above 6,000 for the first time on Monday, bringing the cumulative gain over the past two years close to 500 per cent. The parabolic rise has seen the amount investors are willing to pay for a unit of earnings soar from below 20 in early 2005 to more than 60 today and recently exceeded the lofty multiples afforded stocks at the height of the late-1990s technology euphoria.

Furthermore, several names now trade at a substantial premium to the valuations afforded to the same companies listed in Hong Kong. The so-called Shanghai premium resurfaced in 2006 and has since climbed to 100 per cent. The statistics suggest that fears of a crash are justified.

The boom has been driven largely from the ongoing rebalancing of households' financial assets, which has seen too much money chase a limited supply of stocks. Expectations of continued high returns combined with deposit rates that remain negative in real terms have induced households to redirect cash balances away from the banking system to the stock market.

Household deposits as a share of financial assets have dropped from almost 70 per cent in 2005 to 52 per cent in June while one million new stock trading accounts have been opened every week on average since the start of the year.

Official attempts to dampen households' enthusiasm - including tighter restrictions on the opening of new investor accounts and a modest increase in stamp duty on transactions - have proved ineffective and the recent announcement that domestic investors will soon be allowed purchase shares in the Hong Kong market has spread the euphoria to that market as foreign investors are pre-empting the actions of the domestic Chinese.

There are also concerns that the corporate sector is increasingly engaged in stock market speculation, reminiscent of Japanese and American companies during the 1980s and 1920s respectively. Standard & Poor's estimates that roughly half of the 70 per cent increase in net profits recorded by industrial companies during the first half of the year emanated from non-core investments. Thus, valuations are higher than the official figures suggest while corporate China could suffer a reversal of fortune should stock prices head south.

There is no disputing that the Chinese stock market is exhibiting bubble-like characteristics. However, it is curious that Alan Greenspan declared the rise in prices to be a bubble when he was unable to identify the late-1990s technology mania that originated in his own backyard. Indeed, the valuations afforded to Chinese stocks are only a fraction of those awarded to the "sacred cows" of technology during the latter days of the 1990s bull market.

Furthermore, the market capitalisation of free-float shares as a percentage of GDP is just 30 per cent and only 80 per cent if non-tradable shares are included. These figures are low by international standards and compare to 180 per cent in the US at the market peak seven years ago.

The Chinese market is in dangerous territory nonetheless, although there are reasons to believe that the rise in prices will persist for now. The authorities are unlikely to take the tough but necessary action ahead of next year's Beijing Olympics as it could contribute to an unwelcome increase in social unrest. Consequently, deposit rates should remain negative in real terms and households' financial rebalancing should continue.

The limited supply of shares means that the path of least resistance should remain upwards. "A dramatic correction" is likely at some point - but not just yet.