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China Is No Dubai Or Enron: Real Estate Rebalance to Buoy Gold

asiablues's picture




 

By Economic Forecasts & Opinions

The Chinese central bank surprised the markets last week by raising the interest rate slightly on its three-month bills from 1.3280% to 1.3684%. This is the first rate increase since August and signaled an effort by Beijing to reduce asset-price inflation after a record surge in credit.

The news, sparking fears in markets that the central bank may hike benchmark interest rates, sent Shanghai Composite Index down almost 2% in one day. Some Asian and European markets also felt the impact.

Construction & Lending Boom

China’s foreign exchange reserves, the largest in the world, increased $141 billion in the third quarter to $2.27 trillion, on top of the record $178 billion jump in reserves in the second quarter. There is a tremendous amount of capital inflow with a lot of them speculative in nature.

The central bank, which has kept its benchmark one-year lending rate at a five-year low of 5.31% after five reductions late 2008, has allowed a record $1.4 trillion of new bank loans in the first 11 months of 2009. (Fig. 1)

Now, China’s policy makers are seeking to sustain its economic rebound, propelled mostly by the construction boom that has been spurred by its unprecedented fiscal stimulus and loose credit.

New Home Loans up 400%

Investment in real estate development is a key driver of economic growth. Total investment in construction projects during the first 8 months of 2009 has increased by 36.2% year-over-year, while total planned investment in new projects in the same period has risen by 81.7%, year-on-year.

Meanwhile, housing starts nationwide rose a staggering 194% year-over-year in November 2009. And the central bank noted new home mortgages in the first nine months of last year totaled about $139.5 billion, quadruple the amount offered a year earlier.

Home price at 80 Times the Average Income

According to Knight Frank, average prices for new homes year-to-date in November 2009 rose by 68% in Shanghai, 66% in Beijing and 51% in Shenzhen. Beijing's Chaoyang district, which represents a third of all residential property deals in the capital, a typical 1,000-sq.-ft. apartment costs about 80 times the average annual income of the city's residents.

The China Daily noted that in terms of house prices as a proportion of incomes, China is now the most expensive place in the world.

Whiff of Dubai ..., Maybe

In addition, signaling a move out of deflation, China’s consumer prices climbed 0.6% in November from a year earlier, the first uptrend in nine months; while the Shanghai Property Index of 33 stocks also has doubled in 2009.

The surge in new bank loans and home prices has prompted concerns that some of the money is leaking into property and equity markets, fuelling bubbles that will eventually burst and derail the economy.

Indeed, there is a whiff of Dubai about the Chinese property market at the moment.  By one estimate, the vacancy rate of Pudong, the central business district of Shanghai, is as high as 50%. However, that did not seem to have fazed new skyscraper construction projects nearby.

Neither A Dubai Nor An Enron Be 

As indicated in my previous article, China is a communist country with capitalistic power. This is not an economy where price signals always decide business strategy. Despite China Bears such as James Chanos, predicting an economic crash in China, there are some strong fundamentals underpinning the market. (Note: James Chanos’ rise to fame came form a critical short call and position of Enron.)

The U.S. financial crisis was mostly a result of the securitization of mortgages, but that is not part of the China’s market structure. So, the impact of a bursting Chinese real estate bubble would likely be more muted, given the government's involvement in its market.

As pointed out by Michael Pettis, an economics professor at Peking University, China's economy isn't nearly as dependent on real estate as the U.S. economy was. The wealth effect of collapses in the real estate and stock markets isn't likely to be big enough to affect consumption. Not only are these markets relatively small as a share of Chinese savings, but ownership is heavily concentrated among the relatively richer.

Moreover, in recent years, incomes have mostly risen faster than house prices on average, and homeowner debt levels are low. Urbanization is another power fundamental force. According to the State Council, as many as 400 million people could move to cities over the next two decades. That’s about 322 Dubai’s.

This is not to say there's not a real estate bubble in China.  Rather, overinvestment and overbuilding is sometimes a prerequisite of an anticipated mass urban migration such as the one China is destined to experience. (See Fig 2: BRIC Real GDP Growth )

Equal Opportunity – Gold & Real Estate

China, still a developing country, lacks a proper social safety net and developed financial markets. So Chinese, individuals and corporations alike, are naturally thrifty. In fact, the Chinese corporate sector has been an important driver of savings growth over the past decade.

With an underdeveloped financial system, companies understandably end up putting retained earnings, or savings, into new investment, which also enjoys state subsidies. Companies in the chemical, steel, textile, and shoe industries reportedly have started up property divisions for a quicker return than their primary business.

Moreover, Chinese traditionally treat real estate as “stores of value”, just like gold. With few other investment options, people put a big chunk of savings into real estate, driving up house prices in plenty of cities.

Government measures and policies including low interest rates, official encouragement of bank lending, and then Beijing's half-trillion-dollar stimulus, tax breaks and low down payment requirement all have buoyed the real estate investment.

And some of the very same fear factors driving up the gold prices, inflation and a bubble that could burst later in 2010, are also fueling the real estate rush.

Rebalance in Progress

Though housing starts in China spiked 194% in 2009, 90% of the new supply is targeted towards the more lucrative luxury market. Chinese Premier Wen Jiabao told Xinhua in an interview on Dec. 27 that the government would use taxes and mortgage rates to stabilize house prices and take measures to clamp down on house speculation.

To discourage speculation, the State Council, China's cabinet Sunday issued a notice rolling out eleven fresh measures for the property market, and is re-imposing a sales tax on homes sold within five years. Tighter rules on mortgages are expected to follow.

However, the government is careful not to crack down too hard because construction, steel, cement, and other sectors are directly tied to the real estate. In November, for example, retail sales of furniture and construction materials jumped more than 40%.

For a soft landing, Beijing needs not only to rebalance its economy, but also to rebalance its housing market. This will likely involve changing the incentives to move investments into much-needed low-income housing and other investment vehicles.

Redirection To Gold

The measures by Beijing to rein in liquidity as well as the overheated real estate sector inevitably would re-direct the capital flow into other sectors.  Given the traditional distrust of paper investments by the 1.5 billion Chinese citizens, and China’s continued economic growth (Fig. 2), god is poised to benefit the most from the expected shift in investment since gold shares most of the "hard assets" characteristics of the real property. 

The gold market is already buzzing that the Chinese government was running ad campaign urging citizens to buy gold and silver, while easing the restrictions of holding precious metals by the individual.

China, the largest gold producer, is also set to overtake India as the world's largest gold consumer. On recent trends, China’s gold purchases have grown 10% from 2008’s record in volume terms, accounting for almost one ounce in every eight sold worldwide.

This trend would likely ensure private gold demand to remain very robust beyond the domestic production, and nudge the global gold market to be less dictated by the Dollar movement.

Base Commodities, Interest Rate & Yuan 

At the December Central Economic Work Conference, officials said real estate would continue to be a key driver of growth. So, this is a reassurance that the base commodities will unlikely suffer a drastic decrease in demand from the tightening of the housing sector.

Although the China real estate bubble burst should have a fairly muted overall effect as discussed here; nevertheless, if loan defaults start to rise, China might need to raise cash to keep its banks afloat. In that case, it might sell a chunk of its $2.2 trillion in U.S. debt, which would likely presure the Dollar and drive up interest rates in the U.S.

BNP Paribas said in a report dated Jan. 7. that the Chinese central bank is likely to implement “a series of hikes” in 3-month and 1-year bill auction yields to guide market expectations of a monetary policy shift and may raise the bank reserve ratio in the first quarter.

Meanwhile, some economists believe inflationary pressures might push Beijing to let Yuan appreciate by mid-2010. However, Premier Wen’s recent statement in a Xinhua interview - "We will absolutely not yield to pressure to appreciate.", pretty much says that China will most likely keep Yuan firm in the medium term to stabilize its recovery by keeping its advantage on exports.

“I find it interesting that people who couldn’t spell China 10 years ago are now experts on China.” ~ Jim Rogers

Economic Forecasts & Opinions

 

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Mon, 01/11/2010 - 23:45 | 190734 HCSKnight
HCSKnight's picture

I stopped reading after "there are some strong fundamentals underpinning the market."


and

 

"The U.S. financial crisis was mostly a result of the securitization of mortgages"

 

Both are NOT correct at all.  The first because NO ONE knows China's real numbers.  And those who think the Chinese gov. has a good handle on those numbers...

As for the second assertion, anyone with a brain knows the assertion "mostly" relegates the writer to either being politically motivated or ignorant.

 

Mon, 01/11/2010 - 12:29 | 189930 Anonymous
Anonymous's picture

As someone who enjoyed 30 years of communism, I agree that China is no Dubai. It is much, much worse.

Mon, 01/11/2010 - 10:55 | 189849 Anonymous
Anonymous's picture

You are just PLAIN wrong on China. Period. "This time it's different." People said the same thing about the Soviet Union. The numbers coming out of China are rigged and it defies all logic that an economy based on exports grows 8%. Use common sense - it is the best way to invest. Within the next 2 years China will collapse, Guaranteed.

Mon, 01/11/2010 - 10:14 | 189819 Anonymous
Anonymous's picture

China is cooking the books in other ways. China calculates GDP based on goods manufactured, not sold. Plenty of product has been transferred to shell companies and not really sold. The China crash will also feature excess inventory of finished products, raw materials and real estate capacity.

Mon, 01/11/2010 - 09:46 | 189790 Anonymous
Anonymous's picture

Having first lived in Beijing as a student in 1985 and doing business around the country these past decades, I am more inclined to side with Chanos in his downbeat forecast. The Chinese government is really good at creating illusions of growth and prosperity: witness the building boom leading up to the Beijing Olympics and the ensuing sights broadcast on television around the world. A simple walk around the city would have revealed the reality: a metropolis of empty apartment and office buildings (a 14-year supply). And along the marathon's path, freshly painted storefront scenes on the walls surrounding empty construction sites. That these illusions are everywhere in China can be attested to by simply checking out youtube: see the Great Mall of China in Guangdong or the new city of Ornos in Inner Mongolia.

All this will end poorly.

Mon, 01/11/2010 - 09:34 | 189774 Bruce Krasting
Bruce Krasting's picture

I am no China expert either. Everyone that I ever met from the mainland was a gambler. They loved the action and the 'at risk' situation gambling puts you in.

I sometimes think the Chinese stock market is powered (in part) by the gamble.

But owning property at 80 times income is beyond a gamble. That is a bad bet. I can't imagine how that could end well.

Mon, 01/11/2010 - 10:14 | 189818 Anonymous
Anonymous's picture

Last summer when I was in Beijing I was at a bank and waited almost an hour so I could exchange some dollars. The holdup was two transactions where in one case a woman left the bank with at least 150k rmb in a shopping bag. The other transaction was at least that big but it was a deposit. When is the last time anybody sent their girlfriend to the bank to pink up that kind of coin.

Apartments cost 10-15000rmb per M3 in Beijing and you could pay a lot more depending on location. There is a kind of wealth in china that even the middle class here cannot really fathom. You have to see it. Communism is also meaningless in the chinese context.

Mon, 01/11/2010 - 11:56 | 189902 Anonymous
Anonymous's picture

The sight of young women with bags and even suitcases in banks exchanging cash is actually a common sight. The country's banks don't really have checking accounts so cash is indeed king.

Some of these women are secretaries from offices while others are what you suspect: girlfriends (or second and third "wives") dealing in loot stolen from the state. At a small Bank of China branch in Guangdong Province a few years back, some two dozen employees absconded with over USD450 million in loot. That, obviously, was not a cash transfer but small thefts do add up.

Mon, 01/11/2010 - 11:52 | 189901 Anonymous
Anonymous's picture

The sight of young women with bags and even suitcases in banks exchanging cash is actually a common sight. The country's banks don't really have checking accounts so cash is indeed king.

Some of these women are secretaries from offices while others are what you suspect: girlfriends (or second and third "wives") dealing in loot stolen from the state. At a small Bank of China branch in Guangdong Province a few years back, some two dozen employees absconded with over USD450 million in loot. That, obviously, was not a cash transfer but small thefts do add up.

Mon, 01/11/2010 - 06:19 | 189718 pros
pros's picture

What is the point of this story?

 

"It's different this time" ?

"It can't happen here" ?

 

ZH starting to post nonsense on their site, like that 10 Commandments of RE yesterday.

 

 

 

Mon, 01/11/2010 - 09:34 | 189777 Chopshop
Chopshop's picture

great points, pros.

if i may: 'anything worthwhile from someone fallible ought be summarily discarded' ~ genius.

thanks for adding so much to the threads these past 72 hours.  your use of google is rather impressive.

personally: i firmly believe RE be dead w/o any chance, much like many other markets, but only time and the hard right edge will tell.

again, thanks for sharing such pithy insight, pros

just bc i don't agree with asiablues' interpretation / outlook above doesn't mean that i fail to respect the well-researched / -thought / -written point of view.

dr. bob of DB (at the very heart of RE / CRE death by a thousand cuts) teaches his students that they ought be reading all views opposing their own married pov's to sharpen their arguments and be apprised of any chinks in the armor / integrity of their pov. 

good advice. look into it.

Mon, 01/11/2010 - 10:30 | 189827 Blindweb
Blindweb's picture

"I distrust any thoughts uttered by any man whose

health is not robust.

All other thoughts are surely symptoms of disease.

Yet these are often beautiful, and may be true within

the circle of the conditions of the speaker.

Any yet again! Do we not find that the most robust

of men express no thoughts at all? They eat, drink,

sleep, and copulate in silence..."

Mon, 01/11/2010 - 05:05 | 189707 Howard_Beale
Howard_Beale's picture

Wow... a four basis point move in rates. Yeah, they are really trying to rein in their spending spree. I would add that mortgages had a part in our meltdown but in reality, we are melting down due to a debt bubble (government, corporate, and consumer) wherein mortgages are just a piece of the puzzle. Chanos is on target. Early industrialized nations go through depressions just like everyone else and China is no different.

Mon, 01/11/2010 - 16:01 | 190212 roadlust
roadlust's picture

I'm with you.  It's basic physics.  What goes up, must go down.  And the faster it goes up, the faster it goes down. 

There is simply no entity that will be able to stop the ball rolling (down) once it starts to roll that way.  (See these 2 plus percent daily moves in their "stock market" at the slightest whiff of rumor.) And that includes RE and equities. 

The fundamentals are not there in China for a healthy "western" style economy.  No modern civil society infrastructure, huge populations of rural poor, and a medieval cultural belief system, all spell trouble ahead. 

Their fragile economy is based on their two main "qualities" right now, hordes of desperate, cheap labor, and a dictatorship that keeps all the economic numbers (wages and "growth" statistics) exactly where they want them to be, rather than "reality," or numbers based on real accounting or market forces as we know them.

That sort of "magic" will be exposed sooner rather than later, and China will become just the former stop of the cheap labor train, as it moves on to another desperately poor country.

Mon, 01/11/2010 - 03:09 | 189679 asiablues
asiablues's picture

My reference of Enron is related to James Chanos who made news headlines lately by predicting China collapse.  He is most famous for making the call and taking a short postion of Enron before its demise. 

 http://www.nytimes.com/2010/01/08/business/global/08chanos.html  

Yes, I was one of the 4,000 employees that got laid off on that December Monday back in 2001.  Regardless if any of us saw that coming, we were all deeply effected, and that includes the City of Houston as well as the entire nation.        

Mon, 01/11/2010 - 11:11 | 189867 dnarby
dnarby's picture

I think Chanos got where he was by analyzing the fundamentals.

Given that residential real estate is usually 3x annual incomes, at 80x that means either wages have to more than triple (without causing inflation to blow the price out on everything else), or real estate has to fall by 96.25% (without bankrupting the newly minted Chinese middle class and causing Chinese debt deflation).

I'm with Chanos, but maybe it's just that my math is all FUBARed and I'm misunderestimating the genius of the pseusdo-Communist Chinese oligarchy...  Maybe.

Mon, 01/11/2010 - 09:32 | 189772 Anonymous
Anonymous's picture

I KNOW that - but I do think it is important for the sake of context whether or not YOU foresaw the Enron collapse.

Because if you couldn't see it coming at a company that you worked for...

Mon, 01/11/2010 - 04:01 | 189699 Anonymous
Anonymous's picture

I wasn't deeply AFFECTED by the Enron debacle. In fact I did not give a shit then, and I still do not give a shit!

When compared to the current global economic disaster, the Enron fraud was mere child's play.

Mon, 01/11/2010 - 02:40 | 189667 vainamoinen
vainamoinen's picture

Interesting the author picked "Enron" for the title. According to his (her?) bio Enron was a previous employer. Did the author see that train wreck coming? I wonder.

Mon, 01/11/2010 - 02:22 | 189660 DoChenRollingBearing
DoChenRollingBearing's picture

Ay yai yai!  To triple play my remarks re China, I would add that China is so opaque and corrupt that caution is the word of the day.  And China has had a grand run over the years.  With all of their problems (pollution, demographics, a dictatorship) I would be very reluctant to advise grasshoppers to put big chunks of their money there.

Let Qualcomm, Intel, PG and the other heavies do that!  Ride along with those who have clout with the GOCh.  Me, no thanks.

Mon, 01/11/2010 - 02:17 | 189657 DoChenRollingBearing
DoChenRollingBearing's picture

Ahh, and as far as China investing in gold (copper in warehouses, mines overseas, etc.), well that is typical of their long-term thinking.  Yet they are vulnerable because they deny their people liberty...  A Greenspan-style conundrum?  DoChenRB does not know.  China is so opaque...

I do not know why a Commie government would uncharacteristcally encourage something like this (encouraging their citizens to buy gold), but it is so.  My thought is that they smell a BULL in gold and/or a BEAR in the USD.  And I think they are right on that point, so buy gold bitches (h/t to the Chumba)!!!

Mon, 01/11/2010 - 04:12 | 189702 Anonymous
Anonymous's picture

Maybe the chinese intend to back their Renminbi with gold!!

That might turn the world downside up ...

Mon, 01/11/2010 - 02:08 | 189652 DoChenRollingBearing
DoChenRollingBearing's picture

Um, OK I am no expert on China.  I read the papers, look at ZH and even buy some bearings from them for our business in Peru.  I did go once there as a tourist (1995) and was impressed..., even with Beijing's air pollution.

My general take on China is two fold: 

1)  China will almost certainly grow vs. the US in its role in global affairs.

2)  But, with cool heads at the top of .gov I think that we can avoid serious problems with them.  China is not historically aggresive and they have many problems (demographic, pollution, etc.).

Bottom line: stay alert re China, but not hysterical.  Be cool. China through history has mattered, but not dominated.  The USA's fate is up to us, WE must chart a path out of too much spending and too much debt.

China matters and is a serious player.  But, it is what WE DO that matters more for us Americans.  Let's hope we choose well....

Mon, 01/11/2010 - 05:35 | 189713 aus_punter
aus_punter's picture

"Um, OK I am no expert on China.  I read the papers, look at ZH and even buy some bearings from them for our business in Peru.  I did go once there as a tourist (1995) and was impressed..., even with Beijing's air pollution"

 

SO WHY DO YOU FEEL COMPELLED TO GIVE SUCH ADVICE ?

Mon, 01/11/2010 - 00:16 | 189575 Anonymous
Anonymous's picture

"90% of the new supply is targeted towards the more lucrative luxury market."

But if that market is bolstered now by people who own multiple units (as a store of uhh...value... well then just where will the "mass urban migration" of 400 million poor peasants end up living?

If they're going to move into those luxury units, the asking prices will be moving wayyyyyyyyy down south.

And the 50% CRE fall in Shanghai: already?

China - learned how to spell it doing Party/commercial enterprise research 25 years ago - it MIGHT be the country of the century, but it is going to be %$#%& up over the course of this decade.

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