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Chinese Real Estate Bubble Finally Imploding?

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The warnings of successful shorts like Jim Chanos, old Asia hands like Frank Verneroso, and economists like Victor Shih and Michael Pettis have failed to curb enthusiasm for the belief that the rise of China is inevitable and unstoppable. As someone who was deeply involved with Japan when it was seen as destined to replace the sclerotic US, I’ve learned to regard more or less straight line growth projections with considerable skepticism. (Update: I think the US is a mess, but that does not mean that the China bull case is not a tad overdone)

China has accomplished the impressive feat of bringing literally hundreds of millions out of poverty in a comparatively short time frame. It has also studied the Japanese playbook and managed to avoid some of its pitfalls (of course, it has the advantage of not being a military protectorate of the US), in particular refusing to liberalize its financial markets (some accounts of the Japanese bubble and burst give considerable weight to overly rapid deregulation and the growth of what was then called zaitech, or financial speculation). is also hostile to neoclassical economists.

China escaped much of the impact of the global financial crisis by ramping up investment even higher than its pre-crisis level. It now has investment approaching 50% of GDP, an unheard of level on a sustained basis. A big chunk of that is housing related (housing is an estimated 13.5% of GDP), and prices have long been considerably out of line with incomes, a telltale sign of a bubble. In Beijing, admittedly one of the hottest markets, an average priced new apartment was equal to 57 years of average worker savings (and if you tried to pay for it with a super-long dated mortgage, you’d be in hock even longer, since you would also need to cover the interest charges).

Another warning sign is inventory overhang; the Wall Street Journal reports tonight that Standard Chartered forecasts that level of unsold apartments in secondary cities will amounts to roughly 20 months of sales by year end (and that’s before considering that many of the apartments are being acquired as investments rather than for use).

The Journal story tonight provides evidence that the Chinese housing market is going into reverse. A nine-city price index by the firm Dragonomics shows housing prices in April 4.9% lower than the level a year prior (the increase in 2010 was 21.5%). A consultancy, Sofun, has property prices rising an average of 5.1% over the past twelve months, but that represents a slowdown. Standard Chartered projects that housing prices in some second-tier cities will fall 10% to 20%.

The Wall Street Journal describes the broader ramifications:

Real estate is a foundation of China’s phenomenal growth record in the past two decades, and its health is crucial to China’s construction, steel and cement sectors. Real estate is also a favored investment of Chinese looking to get better returns than bank deposits pay. Local municipalities and provinces depend on rising prices for land sales as well to fund infrastructure projects….

If the Chinese housing market slows faster than people had expected, the impact would be felt in a number of markets that export heavily to China. Many Latin American and African economies have shifted their focus toward Chinese demand for their raw materials, and many Western firms, including U.S. retailers and fast-food chains, now bank on Chinese consumers feeling wealthier to make up for stagnating sales elsewhere. Also, plans by local Chinese governments to improve infrastructure loom large for heavy-equipment makers like Caterpillar Inc.

And this development comes on top of other signs of economic slowdown:
Last week, two surveys of purchasing managers showed a slowing of manufacturing activity.

China, the world’s second-largest economy after the U.S., grew at 9.7% in the first quarter from a year earlier. In late May, Goldman Sachs lowered its estimate of Chinese second-quarter growth to 8% from its previous estimate of 8.8% as the government continues to tighten monetary policy to fight inflation and import demand from the U.S. weakens.UBS economist Tao Wang says she thinks the price decline will be short-lived as Chinese investors, with few other options, will again pour money into real estate and as local governments push up the price of land they sell to developers. Real-estate prices will rise for another three to five years, she estimates. A sharp fall then would batter investors, banks, construction firms and other sectors.

In other words, when this party ends, it’s likely to get pretty ugly.

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30 comments

  1. JJT

    This is the contraction that most worries me. Brazil, Chile, Canada, Australia et al will be seriously impacted by a decline in Chinese commodity consumption.

  2. Wu

    I agree (with Wang) that the party is years away from ending. 57 years wages may seem like a lot now but that number will be cut in half every few years as wages rise as they must. Also, there is no where else to park your money, so as long as there is real estate to be sold, it will sell well.

    1. Maju

      The main problem of a housing bubble is not whether there is money to buy it but whether common people, workers, have money to buy or rent it. Once housing prices go beyond what is reasonable considering workers’ salaries, the bubble will bust, slowly (because the oligarchs want to retard it) but unavoidably.

      There should not be housing bubbles and for that there is no option but massive public investment in affordable housing. Affordable housing also keeps salaries low and international competitiveness high. Oddly enough this is not the way chosen by “communist” (???) China, I understand, but by capitalist Germany for example.

    2. DP

      “when wages rise as they must”

      What will all those workers with rising wages be making and who will they be selling it to, to the Chinese workers who lack the income to buy much or to consumers in other countries with stagnant incomes, excess capacity and high employment rates? What industries will absorb the workers who have been building the infrastructure that has gotten far ahead of current demand for it?

      I thought we got a pretty good look at how interconnected the world economies are in the fall of 2008 before the Chinese government went into action reinflating their economy, but it appears the decoupling story is alive and well again.

    3. Just Tired

      I agree with Maju’s analysis but not his cure. I think that Wu has it correct. The middle class must ultimately have enough to be well housed. I lived through the late 70′s and early 80′s and anyone who says that inflation was a big problem to the majority of citizens (the middle class) is being dishonest. There was inflation but incomes went up accordingly. The only ones who were concerned were the eggheads who had their nonsense theories. Finally it was the investor class that got pissed and that’s when things changed. (I can’t wait for an economist to write that my first hand experience and recollections are not accurate) The fed creates inflation period. The only question is where is it going to show up. When the investor class got their way, the fed and the government used policies to dampen middle class incomes and focus everyone’s attention on the ridiculous guage, CPI. As problems arose,the CPI was reconfigured and then when that was no longer possible the Fed again changed the rules and went to “core” inflation. According to their logic, the inflation of the 80′s never happened (using the new metric) and all we had was a panic. IMHO, Wu is correct becuase if China allows inflation to move incomes up and/or assets to be re-priced (that is not the end of the World as Bernanke maintains) homes will become more affordable. My problem with Maju’s position is that it contains the false theory that a government policy can truly provide more affordable housing. Take it from a career homebuilder, the government is the problem and not the solution. This is why virtually all writers who don’t believe in the tooth fairy believe that this ends either in inflation or deflation. Middle class incomes must increase or housing must decrease (deflation). What the Fed wants is middle class deflation and asset inflation, precisely the opposite. As true as their is gravity, it won’t work. The Fed will kick the can until the laws of nature take over.

      The reason I like the Chinese approach is that they seem more flexible than most. They take from us what the can and use what they think works, and formulate their own ideas when necessary. The U.S., Japan and Europe, on the other hand, seem to all be following the same band leader, and playing from the same score. Both the U.S. and Europe cannot admit their mistakes because of their political systems. Ultimately that will be what tips the scales in China’s favor.

      1. gepay

        There was real inflation in the 70s and early 80s. It was a conscious plan of the elites to raise oil prices and put the third world further into debt slavery Also Nixon’s decoupling from the price of gold and the Vietnam War. At that time there were actual unions in the US and public employees and SS recipients had cost of living increases so there was stagflation. Reagan announced he was going to fix that problem with the aircontrollers strike – announcing government was on the side of business vs unions. Now they are completing the job – with the attack on the public sector unions.
        When the elites were tired of the inflation, Volker initiated 2 back to back recessions that were pretty ugly.
        Now of course, there are no pay increases (thank you globalization and outsourcing) to counter the inflation so the government tinkers with the CPI and we are all screwed.

  3. Daniel de Paris

    Thanks for the post,

    Michael Pettis offers some valuable input on that subject. Sure. However on that subject, I side with Andy Xie much more than Pettis and others.

    Why ? Xie is challenging inflation figures more aggressively and openly than anyone else.

    Of course, inflation is much higher than stated officially or even assessed by foreign economists.

    Savers are offered massively negative returns as Pettis often mentions in this posts. In view of the current savings rates this has been of course a recipe and the powder for over-building and a massive long term bubble of anything that can labelled as investment.

    Of course this is acceptable for a period of time. The US have offered such negative rates for quite a while. Nobody cares. But this destruction of value and money did not on such an extent.

    This, of course, is going to end badly. A rich country – with massive external reserves in the hands of the central authorities – and a bankrupt banking system caring for lost people savings.

    As a “collateral damage”,
    1- the chances of a bourgeois-or-midde-class base democracy are getting thinner by the day,
    2- the yuan has certainly lost its short term chances to be anything like a store of value.

    No winner here IMHO!

  4. Fifi

    I’d go short on China right now (if I knew a reliable instrument) for one simple reason : NPR is running this “China: Beyond Borders” series on Morning Edition, on how China is the next hegemon, resistance is futile, blah, blah, blah. Perfect contrarian indicator. Time to leave that boat.

    1. Mat Albert5416

      Agree that NPR is a contrarian indicator, anything they say can, and probably should, be dismissed as corporate BS.

      Still, in case anyone is serious about shorting China….

      FXP (Proshares Ultrashort FTSE China) is way too risky, in my opinion, and it also has a very high expense ratio of 0.95%. (As a general rule, you should never pay over 0.20% for an ETF.) So even assuming you buy FXP from an online discount broker, you’re still getting ripped off by Proshares and then if Chinese stocks rally, you risk getting slaughtered as well.

      A safer way to short China would be simply buy puts on FXI. At least that way, in case you bet wrong, your losses will be limited to the options premium, plus whatever brokerage fees you had to pay.

      1. financial matters

        Fair claims, definitely a speculative investment. 3 yr trading range of 25-920, currently at 27. I like the investment strategy Taleb mentions briefly in his book the Black Swan. He doesn’t like a ‘moderate risk’ portfolio of stocks and mutual funds and bonds (which he thinks is actually much riskier than most people think). He likes 90% ‘super safe’ (cash equivalents, you pick the currency) as a form of wealth protection against ‘negative’ black swans and 10% ‘super risky’ (small bets in a number of speculative areas to try and capture a ‘positive’ black swan. Of course positive and negative depends on if you are the turkey or the butcher. Although by their nature black swans are unpredictable, ‘angel investing’ is a way of nurturing small, promising start-up companies to enhance their potential.

        On an ETF your losses are also limited to what you put into it. There is no time expiration but there is a steady loss of value if the bet doesn’t go your way. Also I think ‘short selling’ in general gets a bad rap. Both ETFs and puts are exchange traded and I think much healthier than the opaque ‘over the counter’ derivative market. One danger is the govt deciding to ban short positions as they tried several yrs ago briefly with financial stocks. As Stiglitz points out in Freefall this was another gift to the financial industry. In a healthy market you should be able to ‘vote’ for or against a company depending on how you feel about it. This let you only place positive votes for the financial industry

  5. weichristineliao

    Many developers held prices artificially high while waiting for the next round of easing policies to come. Thats why we r seeing inventories r rising n fewer n fewer transactions. This game has been played over and over — in the past, central govt will always step in to save the property mkts when it’s looking shakey. Why cut prices if BJ is expected to loosen again? This becomes a game of timing – it will stop and prices will collapse if local govt and developers run out of money before BJ started its easing policy.

    The potential damage of 10% property price decline to the banking system will be HUGE – thats why to some extent, property sector held the central govt hostage! Current 15-16% money supply in China is TIGHT (usually 15% M2 is considered loose monetary policy elsewhere) – but Chinese economy was built with 30%’s M2 growth during 08-09 crisis, n the size of investments overwhelms the availability of credit…

    I still believe that Chinese govt will step in sometime in Q4 when things start to get ugly on the growth front. They can afford another round of bailouts before debts burden brings us a real crisis in 1-2yrs…

  6. Glen

    China will be handicapped in its response. Having an already undervalued currency and a monetary policy that works in lockstep with the US Fed prevents the time honored currency revaluation tool from being used.

    Run for the hills!

    1. Ming

      Thank Yves for this article; it has some good observations about what might happen concerning the Chinese real estate market. Although I agree with the facts, and I beleive that the Chinese will eventually realize that the investment in real estate has extremely wasteful; I would not depend on normal ‘market discoverey processes’ or typical financial constraints to be the catalyst for the bubble implosion. Remember, the Chinese government will run their money supply and bank lending policies to insure social stability, so if ‘tightening policies’ result in too much of a slowdown, they will intervene to propUp the market up and bailout their financial institutions.

      1. Just Tired

        I agree with Ming. What we see is two competing philosophies that are being tried while the world debates ad nauseum. The world is awash with free (or almost free)money. The Chinese are building things which are essential to peoples lives: housing and infrastructure. We use the money not to invest, but to do trades. History will show that those trades were modern versions of gambling and they are less than zero sum at that. The debate rages about Goldman Sachs taking positions against their clients. Who in there right mind would ever call their “big short” an investment? It was no different that putting a billion or so down on the Packers to win the Super Bowl. For awhile we used the free money to build houses. At the end of the day, no matter what happens to the financial sector and the sacred markets, China will have a ton of stuff and we’ll be doing each others laundry. How ironic.

        Let me tell you what I think of the economists who are now become parasites to the financial industry (a parasite cannot live but for the host. That’s in no way an opinion, it is a fact). If I’m wrong, prove it. While remodeling his home,Yogi Berra was discussing the work with his friend, Joe Garagiola and Yogi remarked,”You know how long I waited for those windows that never showed up?” Here is my point. Economists can’t seem to find their voices when the financial industry makes unsubstantiated claims that they must do as they do in the interest of having efficient capital markets. Well economists, where is there a scintilla of evidence to support that claim. All I can say on behalf of literally countless small business persons and mainstream folks is: “You know what the interest rate is on the loans that are impossible for us to get?” How efficient is that. No, it’s business as usual for our economists. Their answer, as always: “Assuming efficiency…..” If I’m wrong, do something besides calling me names — prove it!

        1. Chilango

          You’re confusing the left and right sides of the balance sheet. One has to do with the physical asset, the other with how it’s financed.

          America has plenty of empty houses itself and I don’t see how they so beneficial. In fact, they can be quite expensive to maintain.

          Anyway when making comparisons, try to stay on the same side of the balance sheet, you’ll get more informative results.

          1. Just Tired

            I’m a CPA with over 35 years experience. And you…

            The numbers on both sides are accounting phenomena that have nothing to do with value and everything to do with the (theoretical) prices people elect to assign to them. (Like FASB 167 which was the functional equivalent of a “never mind”) The issue is what is a new perfectly good home worth, in terms of its value, to a person who is unemployed with no money? Now take that very same home and tell me what its worth, again in value, to someone who has four estates, private airplanes and more money than God? The answer is that in the first instance, a person would do whatever he could (lacking the money) to obtain the home. Whereas the second fellow could not care less.

            When you keep quiet, people may think you are a fool. When you speak, your risk eliminating any doubt. That pretty much describes what I think of you. As far as my questins as the basis of your insult to me, I think you are what Oscar Wilde would call a cynic, which he described thus, “A cynic is a person who knows the price of everything and the value of nothing.”

            You were saying?

          2. Kariyushi Aloha


            empty houses itself and I don’t see how they so beneficial. In fact, they can be quite expensive to maintain.

            ~~Chilango~

            Lot of people thinking the same thing. Lot of people thinking, “If you buy unimproved real estate in China, less maintenance. Then again, that may be already priced into the market. You need to be Chinese. You need to be living there to know for sure.”

            China remains an enigma inside a conundrum, within the puzzle of a question from an unknown central realm of mysterious uncertainty.

            ?

    2. Just Tired

      “The warnings of successful shorts like Jim Chanos, old Asia hands like Frank Verneroso, and economists like Victor Shih and Michael Pettis have failed to curb enthusiasm for the belief that the rise of China is inevitable and unstoppable.”

      The article makes many excellent points about the short term prospects of China. But I have to say that Chanos, Veneroso, Shih and Pettis may not really be making any comment about China’s economy coming to dominate inevitably. Chanos in particular is only talking about the trade (as in investment which n his case is a short trade) and I’ve never seen or read anything he has said about the longer term. I would be happy to share the details of the reasons for my view but I doubt anyone would be interested just now. Therefore, I will go on the record here to state that China will suffer a significant decline in economic activity, as will virtually all of the world. China, however having this huge increase in tangible assets (factories, infrastructure, housing, etc., along with enough technology to keep producing) will come out on the other side with the tangible assets intact and from there will re-emerge as the preeminent economic power. At the end of the day, it will be the fact that U.S. claims (money and other claims against assets) will be found to consist of virtually nothing more than claims against future medical care, government, legal services, entertainment, etc. and basis subsistence. (Bread and circuses) In every important category for purposes of projecting where this will eventually lead, China is the U.S. prior to the Great Depression and the U.S. is Europe. This Great Depression 2.1 (we are already in GD 2.0) will end with China where the U.S. was and the U.S. where Europe was (hopefully without ruin similar to WWII.) Bet me.

      1. Nathanael

        I generally agree with your assessment, except that global warming and the associated dislocations and disasters are the “joker” here and I can’t predict what they’ll do.

      2. James

        I disagree. The U.S. only soared ahead of Europe after WWII because most of Europe had been bombed out from the war, and also much of Europe adopted socialist policies after the war.

        China is not the U.S. prior to WWII and the United States Europe prior to the WWII. China has a long way to go before they can match the U.S. on numerous fronts, and because they lack freedom in the way we have it in America (no liberal democracy, no free press, limited economic freedom), they are never going to surpass the American economy until they increase their freedom. Much of the Chinese economy at the moment is socialist, which leads to inefficiency and corruption, and since they are a dictatorship, contrary to the many pundits who claim this makes them more efficient, all it really does is means they are more corrupt and suffer even more misallocation of capital (America’s liberal democracy may seem chaotic and unable to get things done, but that’s just because it is transparent; it’s like comparing the U.S. to the old Soviet government, which may have looked mor efficient, but really had extreme levels of corruption).

        Most of China’s GDP growth right now is in real-estate, and that is real-estate and infrastructure the government is building in a reckless manner in order to create the illusion of economic growth in order to keep the population tamed. This strategy is really going to blow up in their face after a certain amount of time. Every major nation on the rise tends to gain an aura of economic invincibility, until their bubble blows and they get brought down to Earth. It has happened in the United States (where economists thought that recessions were a thing of the past), it happened to Japan, it happened to Dubai, it happened to South Korea, and it will happen to China.

        Additionally, every major bubble garners a “This Time Is Different” title, until it blows up, and then everyone wonders why no one saw it coming. I see China in the same fashion. People believe the socialist brain trust of their government can subvert the laws of economics and walk on water.

  7. TraderGreg

    With price-to-income ratios approaching 30, it is not if but when the bubble will burst. Do you really think that this ratio will go to 300?

    Read about the ‘Greater Fool Theory’. That’s what it is right now in China. I wish them well to survive the coming collapse.

    1. Just Tired

      Of course you mean as compared to our system where Goldman Sachs and them other fellas manufactures…..what’s that called?…Oh yeah, an investment. And then sells them there investments to who? Well, it’s damn comforting that they sell to their customers, and them there customers they’re sooo-phisticated, and not them there Greater Fools. Now that’s the capitalist system’s supposed to work. No greater fools there. No. None. Not a one. Nada if ya hablas Espaniol. What is this shit you’re selling?? You get the “Now that thar’s funny” award for today. So,how long ago was it that you bought your underwater house anyway? Just saying.

      1. Just Tired

        Seriously, the only fools are the ones who think they are better off scamming people selling them hot air as opposed to selling them a home that “they can’t afford”. I know the business. I have advised everyone who can’t make their payments to stay put and work the system just like the banks. Let them hold the paper while you have a real place to live. At the end of the day, no matter what happens to the Chinese financial system, they will have a ton of new homes (not to mention state of the art factories and other infrastructure), and there is no way (politically) they can just leave them empty like we do. I can’t predict exactly how it will happen, but my bet is that they will find a way to get people into those homes and get those people to somehow be productive instead of manufacturing hot air, selling it the real “greater fools” and then saying, sorry we made some mistakes and, until we figure things out, you all are going to have to suffer for awhile. Here in the gold old USA, it’s kind of like the 60′s again when some have to serve their country while the braintrust at home figures things out. Won’t happen in China.

  8. If i must

    “… Chinese investors with few other options …”? Chinese property investors are now pouring money in European markets, such as Cyprus. Safer investment (in euros), and make then eligible for permenant residency.

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