…the private sector in the west is in a higher savings and slower growth mode. The only way that the government can net save at the same time is via an increase in net exports to the emerging economies. The FT’s Geoff Dyer is right when he writes the “G20 looks to Beijing to drive global growth.” For the global economy, it’s China or bust.
So China had better be growing healthily, hadn’t it?
There’s been a steady drumroll of comment about the burgeoning real-estate bubble in China for a year or ten now, from many quarters. Mike Shedlock is a handy source for the doomier end of the recent commentary spectrum; anyone with ideas about trustworthy specialist commentators is invited to put them up. Here, anyway, is Shedlock at the end of last year, rounding up his prior commentaries and showing us video of huge, completely empty property developments in China (some of these have been empty for five years, it seems), accounts of massive speculation in metals by Chinese private investors and balance sheet manipulations by Chinese banks. His summary:
China is in a Scylla or Charybdis scenario. If China continues to inflate it will overheat. If it doesn’t, unemployment and unrest will soar, and the economy will implode. Either way, there is no winning solution.
Rebuttals of this gloomy position by semi-insiders don’t look terribly convincing. From the FT in March, in an article by one of JPM’s local China specialists, Jing Ulrich, optimistically entitled “Debunking the myth of a China collapse”:
The worst-case fears concerning the property market are based on a layer of truth and we have previously highlighted the untenable nature of price increases in some big cities, as well as the possibility that last year’s boom was partly fuelled by misdirected bank loans. However, there are crucial differences between China’s property markets and those of the US or Dubai…
The combination of excessive leverage and mortgage securitisation were at the epicentre of the US sub-prime crisis. Both these factors are absent in the Chinese context.
…The crux of the problem with the Chinese real estate sector is that property is seen by the country’s investing class as a store of value, within an economy that offers its citizens limited investment options. I share many of the concerns about flawed incentives and overheating in the property market – but even if prices were to correct, this would not trigger the devastation that might arise in an over-leveraged economy.
Well, maybe securitisation is absent. But it’s perfectly possible to have a first rate banking crash without securitisation anyway, as the history of banking crashes from the dawn of time to July 2007 attests. You just need leverage; of the kind you can build up by the balance sheet manipulation that Mish describes, for instance.
Even the real insiders don’t necessarily seem that convinced that all is well in China. Yves commented on another sighting, FT in June, from the perspective of monetary policy; the interviewee, Li Daokui, is a member of Chinese central bank’s monetary policy committee. The glimpse of official concern about the state of the housing market is telling (FT via Yves):
“The housing market problem in China is actually much, much more fundamental, much bigger than the housing market problem in the US and UK before your financial crisis,” he said in an interview. “It is more than [just] a bubble problem.”…
Mr Li said the high cost of housing could hamper future growth by slowing urbanisation. Rising prices were also a potential political flashpoint, especially among younger people who felt locked out of the property market.
“When prices go up, many people, especially young people, become very anxious,” he said. “It is a social problem.”
In spite of the sharp slowdown in property sales and the troubles in Europe, he said economic activity was still too strong. “China is running the risk or is on the verge of overheating,” he said. Although he added: “I would say the situation is not out of control.”
Oh good. Now let’s see: you have Chinese who buy property as a store of value (according to Jung Ulrich; that’s what all those empty houses are: they’re owned, but not occupied), and other Chinese who can’t get into the market because of the price rises (according Li Daokui); those price rises are partly induced by the activities of the first group of Chinese, and partly inflationary (inflation which increases interest in value stores, feeding demand from the first group of Chinese again). All this despite breakneck building by Chinese developers and breakneck lending by Chinese banks. That really doesn’t sound like a situation that gets into balance without a smash-up of some kind.
Some more local colour from Mish suggests that the whole bubble may now at last be on the brink: some of it seems to be funded by Ponzis, and the retail investors have had enough. Some sort of confirmation of a turning point comes from this recent report that developers are now cutting prices. If Ponzis are a significant factor in Chinese RE finance, that turn in prices will expose them very quickly indeed, en masse. And that will make some small investors very angry, of course, as well as broke.
And a 15% price drop will expose any extreme leverage that exists, too, tucked away behind respectable looking LTVs.
On the more official end of the financing spectrum, we have the recentish surge in the bond yields of Chinese development companies; and from the FT, this week:
China’s banks are facing serious default risks on more than one-fifth of the Rmb7,700bn ($1,135bn) they have lent to local governments across the country, according to senior Chinese officials.
In a preliminary self-assessment carried out at the request of the country’s regulator, China’s commercial banks have identified about Rmb1,550bn in questionable loans to local government financing vehicles – which are mostly used to fund regional infrastructure projects.
This isn’t too bad by itself, if you believe S&P’s local analyst, as quoted in the FT again:
Rating agency Standard & Poor’s estimates that if 30 per cent of loans to local government vehicles become irrecoverable, it would add 4-6 percentage points to overall non-performing loan ratios at the banks. “The pain will be uneven across the sector; the major banks should be able to keep the impact to a manageable level because of their stronger credit risk controls but smaller institutions could struggle due to their proportionally heavier exposure to local government vehicles and lower profitability,” said Liao Qiang, an analyst with S&P.
But what about property, commercial or residential loans, rather than infrastructure? I’d like to hear from Chinese officials about those. Here’s a credit checking process to admire, plus a comparison that will be recognisable to Floridans, Californians or Brits, quoted in the Washington Post:
Wang Zhongwei, a 35-year-old stock market analyst who owns the apartment where he lives, bought two apartments in 2004 for investment purposes. He borrowed from family and friends to meet mortgage payments twice as big as his take-home pay. But in the middle of last year, he sold the apartments for twice what he paid and made $145,000, a fortune here.
“It’s much easier than working every day to make money,” Wang said. “I work very hard and compete for my so-called career every day, but I don’t make that much money from work.” In November, he bought two more apartments.
What about the balance sheet manipulation by banks, now spotted by the FT, too?
Headline growth in China slowed to 10.3 per cent in the second quarter from 11.9 per cent in the first quarter, and loans to property developers dropped 62 per cent from the first quarter to Rmb121.6bn in the second quarter, according to figures from the central bank.
But analysts say the apparent success of the clampdown on lending disguises a worrying new trend that involves banks co-operating with lightly regulated trust companies to keep loans off their books.
The regulator ordered a stop to this type of lending at the start of the month.
China’s banking system had a non-performing loan ratio of more than 50 per cent a decade ago. Today the country is a breeding ground for the world’s largest and most profitable banks with an average NPL ratio of just 1.3 per cent as of the end of last month.
That sounds like a banking system that is very unlikely to have remotely enough capital in it, with a crash to come sooner, rather than later (six months? 18? Come on, who knows?). And that won’t help growth much, within China, or outside it.