Quotes of the Day

About 18 months ago, Liu Junling, an upwardly mobile single Chinese woman, had a conversation with her boss, the CEO of a large, politically connected real estate developer in Shanghai. For the previous five years, people in China's largest city had lived and breathed the property market—buying apartments, if they could afford to, flipping them for higher prices, and buying again. The government really wanted to cool off the speculation, the boss told her. Probably not a good time to buy. Then, almost as an afterthought, he added: It might be a good time to buy stocks instead. Liu balked. "I don't really understand the stock market,'' says the 35-year-old, "why it goes up or down." Now she is kicking herself. "I can't believe I was so dumb," she says, "but I think it's too late to get in now, isn't it?"

Liu's question—is there a bubble in China stocks?—is of global concern because of the knock-on effect a meltdown could have on markets worldwide. After soaring 130% last year, the Shanghai Composite Index suddenly buckled on Feb. 27, plunging 8.8% and giving investors in the rest of the world a sudden case of the Chinese flu. Since then, however, China stocks have resumed their near-vertical ascent, in recent weeks setting record highs almost daily. By some estimates, there is now more money in the Shanghai stock market than there is in bank savings accounts nationwide—this in a country where the per capita income last year was about $1,750. Yet the mania only seems to grow. On May 9, the total turnover on Chinese bourses exceeded that of all other Asian stock exchanges combined, a first. There are even reports of retail investors borrowing against newly purchased apartments or houses—shades of Japan in the late 1980s—to buy stocks. "I'm afraid this thing is in its final frenzy," says Andy Xie, an independent economist in Shanghai. "People are going to get hurt."

With Shanghai stocks now trading at an average of about 38 times their projected 2007 earnings—a high ratio even for a fast-growing developing economy—China is causing a serious case of the shakes. The issue isn't simply that the little guys are in danger of losing their savings. It's whether a serious market downturn might blunt, or even reverse, China's growth. Mainland authorities have already made it clear that they are concerned about economic overheating, "and the stock market is part of that picture," says an economist at the China Academy of Social Sciences (CASS). On May 18, China raised interest rates for the second time in two months, marking the first time in 17 years that the government had stacked rate increases on top of each other so quickly. Beijing also announced that banks would have to maintain higher reserves—an effort to curb bank lending that is fueling China's 10% annual GDP growth. "People don't think the train is off the tracks yet," the CASS economist told TIME, "but it's going about as fast as it can go."

If authorities hoped the rate increase would tempt small investors to keep money in the bank rather than dump it into an overpriced equity market, they're likely to be disappointed. Savings accounts in China yield about 3%. With annual inflation running at about the same rate, that's no return at all. "Bank savings are ridiculous," snapped Li Gongren, a 55-year-old retired businessman, while he was loitering in a Shanghai brokerage office this week. "Why would you put your money in the bank and make nothing when you can make money in stocks?"

Why indeed? Not everyone is convinced that a bust is inevitable. China's stellar track record of managing its economy over the past decade makes some analysts relatively confident a soft landing can be engineered. A hedge-fund manager in Shanghai notes that AIG, the insurance giant, tried this month to raise $1.3 billion to launch a China stock fund—and fell $400 million short of that goal. "There are signs that this is going to cool off, but not crash," he insists. Jun Ma, a Deutsche Bank economist in Hong Kong, says the recent rate hikes should keep inflation in check, and without inflation, there's no real risk of overheating.

But the Chinese government, however subtly, is clearly trying to convey the message that the stock market isn't a casino, it's a long-term way to build wealth. CCTV, the government-controlled television network, ran a long interview this week with a pleasant, gray-haired retiree named Guo Xiufeng. She says she now has $130,000 in savings thanks to the stock market. She started investing more than 10 years ago with $2,500, she says, "and every time the market went down a bit, I would just buy a little more." Everybody got that? When the market went down, she bought. Soon enough, millions of small investors in China may be able to put Ms. Guo's little words of wisdom to the test.

• Bill Powell