According to the latest State Administration of Foreign Exchange (SAFE) report, foreign exchange reserves grew 37.36 percent year on year and hit $1.2 trillion-the largest reserves in the world-by the end of March.

In the first quarter the figure increased by $135.7 billion. Deducting the $46.4 billion trade surplus and the $15.9 billion of foreign direct investment (FDI) over the same period uncovers $73.4 billion in extra money floating about, leaving many wondering where it all has come from.

Normally, money remaining after deducting the trade surplus and FDI is considered "hot money." Hot money refers to money that is moved by its owner quickly from one form of investment to another to take advantage of changing international exchange rates or to gain high short-term returns on investment.

Tao Dong, Chief Economist with Credit Suisse First Boston, said that the soaring property and stock markets along with renminbi appreciation expectations have lured international hot money to China. "If the hot money is suddenly squeezed out of China, the aftermath would be unimaginable."

According to Tao's estimation, the property market will remain strong for even longer because market regulations in the sector are not standardized yet.

However, Tao also warned of A-share market risks, as the price/earnings ratio hovering in the 30s in that market is twice that of the world average. Someday, the Shanghai Composite Index might cease to be so buoyant.

Financial market deja vu

Though many believe the bullishness of the Chinese stock market is structural, some are having second thoughts. Some experts believe the frequent inflow and outflow of international capital can be disastrous and an asset bubble burst could ruin financial stability.

"An open capital market can easily bear hidden traps and crisis," said Tang Min, Chief Economist with the Asian Development Bank China Resident Mission.

The more open and accessible the Chinese capital market is, the more international capital, including speculative capital, flows into China, pushing asset prices to record highs.

International practice shows that the large-scale influx of international capital drives up asset prices, which then immediately retreats from the market in order to gain on the price discrepancy, an event that can trigger excessive price plunges.

"That's when the financial crisis occurs," contended Zuo Xiaolei, Chief Economist with China Galaxy Securities Co. Ltd., fearing that China could see the same fate as Japan and Southeast Asian countries suffered in the late 1980s and 1990s.

Taking Japan as an example

Due to a lack of controls and relevant supervision measures in the late 1980s, Japan began to show signs of depression. At that time, the Japanese yen was forced to appreciate, triggering a rampant inflow of overseas capital, jacking up housing prices and the stock market. Deceived by the buoyant property and stock markets, Japanese authorities loosened control and supervision over capital controls and bank loans.