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China's Fragile Economy, Its Housing Bubble, and What It Means To Us: Part I
From The Daily Capitalist
We think that China is an indestructible economic juggernaut but its economy is very fragile and it is sitting on a property bubble which will burst. What China does in response has major implications for their economy and the rest of the world. This is the first part of a three-part series on this topic.
We are told that China has huge housing needs, that demand will continue for decades, and that prices have nowhere to go but up. But that's not how economics works for housing or for any other product. It may be true for China's long term, but the short run can kill you.
Having been in that business, we were told here that America's long term growth potential was almost limitless, that new family formations, immigration, and abundant financing would continue to drive the housing market higher. And remember, they said housing prices had never declined on a national basis in the last 60 years.
"They" were wrong as it has now been painfully revealed to us. There are many factors affecting the supply of and demand for housing. And prices do go down, dramatically. So, when you hear that China's housing market will grow in a linear direction and that its economy will not be impacted by a housing bubble, you can evaluate that statement in light of recent history.
4 Important Things to Know About China
Before I go into the details of what is happening in China right now, there are four things about China to consider.
First, most economic statistics from China are inaccurate. This is the result of state, top-down driven economic planning. The nice thing about a planned economy is that they can pretty well dictate what GDP will be because of the way they calculate it. What they mean by "GDP" is very different than what other countries mean by GDP.
China counts the funds that are distributed from Beijing to local governments and entities as spent when distributed. Retail goods are calculated as sold when factories ship goods, not when they are purchased by consumers. This is an artifact of communist central planning that brought them the ruinous Five Year Plans and the Great Leap Forward (Backward) of Mao Zedong.
Local or regional bureaucrats responsible for allocating resources or implementing policies are often corrupt, inept, and lie about the results of their efforts. What comes to mind is the school in Sichuan province (the so-called "tofu-dregs schoolhouse") that collapsed during the earthquake in 2008 because local officials were bribed, paid off, colluded, whatever, by the contractor who was responsible for the shoddy product. You can multiply that ten thousand times. No one knows what is really spent and what goes into the pockets of corrupt officials.
Second, local and regional governments and state-run enterprises are in serious financial trouble because of the real estate bubble. A big revenue source for local and regional governments is from land sales to developers. We've all heard the stories of landowners and tenants getting kicked off their land to make way for a new block of homes or condos. Their compensation is small, and you can guess where a lot of the money goes. The local entities borrowed lots of money to finance developers. Beijing is so worried about the financial solvency of local governments that Premier Wen Jiabao announced at the National People's Congress last week that it will issue 200 billion yuan worth of bonds on behalf of local governments.
In a “worst-case scenario,” the non-performing loans of local-government investment vehicles could climb to 2.4 trillion yuan ($350 billion) by 2011, Shen Minggao, Citigroup’s Hong Kong-based chief economist for greater China, said yesterday.
“The most likely case is that the Chinese government will engineer a massive financial bailout of the financial sector,” said [Northwestern University Professor Victor Shih] who spent months researching borrowing by about 8,000 local government entities. ...
Su Ning, a deputy governor at China’s central bank, said March 8 that a “fairly high proportion” of total lending last year went to the funding vehicles. Chinese banks extended a record 9.59 trillion yuan of new loans in 2009. Su sees “a big risk” from local-government guarantees for money borrowed to fund infrastructure projects that may not generate returns, he said in Beijing.
Third, much of their "growth" is fake. Money sent to districts and municipalities to spend is not organic economic growth. Much of current GDP growth is a myth since most of it comes from government stimulus. Building roads and bridges is good because China needs to build its infrastructure, but it is very wasteful and inefficient. Whatever it is, it is not real organic economic growth: governments only spends money, they do not make money (actually they do in a perverse sense when they print it).
Fourth, China is still a big, robust, developing country. Despite what I said above, there is real growth and wealth. Deng Xiaoping's "to get rich is glorious" revolution released China's potential. It may be inefficient, and at times corrupt, but it is real. But, they are not immune to the laws of economics.
China's Response to the Recession
China was hit hard by Western consumer cutbacks and their exports, the mainstay of their economy, plummeted. "The global financial crisis left 20 million Chinese migrant laborers unemployed and more than 7 million college graduates seeking work by March last year."
In February 2009, a clash between police and about 1,000 protesting workers from a textile factory in Sichuan province injured six demonstrators, rights group Chinese Human Rights Defenders reported.
In China's zeal to keep their economy going, the government injected about 4 trillion yuan since 2008 (14 percent of GDP) as fiscal stimulus. It expects to have deficit spending equal to 1.5 trillion yuan this year. Since they believe in Keynesian stimulus, and since they still have a quasi-centrally planned economy (the ultimate Keynesian technocrats), they will keep doing this until the crisis passes. You see, there is one thing the Central Politburo fears: their own people. If the economy collapsed, you would see massive unrest, and I believe they fear for their lives.
The extent of their stimulus:
In June [2009], growth in the money supply measure known as M2 surged to 28.5 percent year-over-year--up sharply from a 15 percent rate at the beginning of the year, which was far more typical of the pace of money growth over the past decade.
New loans by banks rose by about $1 trillion, or twice the expected rate, during the first half of 2009 and rose 34.5 percent year-over-year in June from a 30.6 percent growth rate in May. It appears that Chinese policymakers are experiencing difficulties in prompting total spending to match their ambitious growth targets implied by a production growth target of at least 8 percent, and so they have allowed a rapid surge of money and credit at midyear.
The resulting flood of money has--somewhat counterproductively--flowed into stocks, property markets, commodity stockpiles, and consumer durables (with the help of special incentives for purchases of durables).
The Real Estate Bubble
China is having an unbelievable housing boom (bubble, I would say). Read these examples of bubble behavior which, from a distance, are fascinating illustrations of behavioral economics:
In Shanghai, prices for high-end real estate were up 54 percent through September [2009], to $500 per square foot. In November [2009] alone, housing prices in 70 major cities rose 5.7 percent, while housing starts nationwide rose a staggering 194 percent. ...
“Once the bubble pops, our economic growth will stop,” warns Yi Xianrong, a researcher at the Chinese Academy of Social Sciences’ Finance Research Center. On Dec. 27, China Premier Wen Jiabao told news agency Xinhua that “property prices have risen too quickly.” He pledged a crackdown on speculators. ...
In Beijing’s Chaoyang district, which represents a third of all residential property deals in the capital, homes now sell for an average of almost $300 per square foot. That means a typical 1,000-square-foot apartment costs about 80 times the average annual income of the city’s residents. ...
“When you sit down with a table of businessmen, the story is usually how they got lucky from a piece of land,” says Andy Xie, an independent economist who once worked in Hong Kong as Morgan Stanley’s top Asia analyst. “No one talks about their factories making money these days.” ...
The government is reluctant to crack down too hard because construction, steel, cement, furniture, and other sectors are directly tied to growth in real estate. In November, for example, retail sales of furniture and construction materials jumped more than 40 percent. At the December Central Economic Work Conference, an annual policy-setting confab, officials said real estate would continue to be a key driver of growth.
And this:
China risks a “similar asset bubble” to that in 1980s Japan unless lending is reined in, Erwin Sanft, head of China and Hong Kong equities research at BNP Paribas, said Nov. 23. ...
Accountant Wang Jin waited in a downpour for six hours last month to buy into a Pudong apartment project by Shui On Land Ltd., a Hong Kong-traded developer controlled by billionaire Vincent Lo.
More than 800 people lined up outside a sports stadium to buy about 220 units costing about $4,100 per square meter on average.
“I couldn’t believe what I saw when I got there,” Wang, 37, said. “I know the property market is sizzling now, but this?” ...
Çao Guanzhou, a real estate agent in Shanghai, tried to take advantage of the boom. After selling his Pudong apartment in May for 54 percent more than what he paid three years ago, Çao closed his hot pot restaurant and started selling properties.
Business is slow, he said.
“Too many agencies have opened up,” Çao, 51, said. “There’s too much competition now.”
Tomorrow in Part II -- The government's dilemma: to tighten and risk a crash or inflate until it blows up.
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You need to read that paper on Chinese warrants and greater fools theory, then think thousands of empty apartments owned by Chinese speculators in Shanghai. They don't want to rent the properties because that interferes with the feng shui of he space.
Which paper do you refer to? Im keen to read it. BTW im not sure wether feng shui is as imprtant as the belief that the empty apartment will hold its value better than if the tenants' normal wear and tear is subsequently repaired etc.
From the BBC, yesterday:
"China's demand for oil jumped by an "astonishing" 28% in January compared with the same month a year earlier, the International Energy Agency (IEA) says."
"The body added that demand for oil in 2010 would be underpinned by rising demand from emerging markets, with half of all growth coming from Asia."
"But the IEA predicted demand in developed countries would fall by 0.3%."
China's recovery is "fake?" Looks more like OUR'S is fake, if you go by energy input.
India has the same problem as with China, they need to feed and figure out what to do with their population. Just like China if not worse, they have a peasant population over 800 million. Also China is going to burst, if you google China's empty cities and/or Malls (I believe ZeroHedge did an article over this) you will see that they made these building projects, and the only people that could afford them was the speculators who where trying to sell them to other speculators. Most of the population of China is peasants and poor.
China with a population of 1.3 billion people has enormous potential for growth. Like all human beings given the right setting, the average Chinese citizen will naturally choose to improve their lives. A certain level of material wellbeing is a motivating goal. All human beings have an innate drive for self-actualisation. There are examples of over-priced assets, like high-rise apartments in the centre of Shanghai, but these are miniscule blips on the economic radar screen. The current growth rate can continue for many years with the correct management by the authorities. The domestic economy has great resilience. I don't care what the Chinese do as long as they do not become expansionist and contribute to the health of the global economy. Any nation that does not factor China into its foreign policy and economic calculations is negligent.
Yeh and 1.2 billion of em are busted ass poor who earn a third of the poorest in the US. The Chinese government has been successful at hiding it's lies and it's time will come. (As will the US but that's not for this moment)
What about India?
Massive population, exellent education among the top class and good for the middle class. English is everywhere.
Forget China, discover India.
If you think China has corruption problems look up India. India could be the growth story of the century and easily eclipse China but they need to get ride of the corruption and change the government structures. Otherwise I agree, good culture for work and education, but they are not there yet.
I'll be the first to agree that China has loads of problems in front of it. But they are in a better position then most. You mention that the gov is afraid of the people. This in itself is a huge positive. Our "leaders" have no fear of the peoplel, and we are armed while the Chinese are not. Also the problem facing the Chinese is malinvestment and wasteful infrastructure. This happened in America. Look at the railroad and canal boom, they went bankrupt left and right and that infrastructure was used for generations. America had several depressions and a civil war on it's ascendancy. It cannot be expect that China would rise like a rocket and not have some setbacks. Also the gov is using a Keynesian approach which is flawed but at least hey are trying to follow what Keynes said and using savings in good times to buttress the bad. While in the US we have decided that savings are evil and will debt it up good times and bad. I wholeheartedly think that the Keynesian stimulus is a huge waste of resources but at least they have savings for it.
Is China in a bubble especially in real estate and facing overcapacity problems? You bet. Are they going to have a lot of problems in the future? Without a doubt. But even with these problems they will find themselves in a better place then other bubble heavy debt ridden Western warfare/welfare states. China is far from perfect but it's competition is less than stellar. After all we claim their reporting is faulty look at ours. They have an unelected star chamber running the show with no transparency, we have an unelected star chamber running the show with no transparency (Fed Reserve) but at least they are afraid of Joe Sixpack.
You say that the people in China are not afraid of government and that government was afraid of the people?
Have you forgotten who is in charge and that censorship is applied everywhere? Christians are meeting in secret places due to repercussions from government officials.
Lalalalalala the wonderful wizard of Oz...
Chinese are gamblers by nature. The whole culture is into gambling and it shows in every speculative bubble they've created. Even government officials are gambling with the fiscal health of the country.
The US is much less a welfare state than China. How do you suppose communism works? Right, it doesn't work. Nobody trusts government or government services and yet, the services are intrusive and planning all aspects of daily Chinese life including Chinese commerce. It's called a centrally planned economy.
America may have her faults and corruption is showing but at least, there is the entrepreneurial drive and innovation from over 200 years that will not simply go away. Americans are much more resilient and less dependent on government than the Chinese.
Watch Star Trek, see the Borg collective, think of China.
You get the drift.
Parse my words, did I say the Chinese people are not fearful of their government? What I said was the government fears the people. Naturally both groups can fear each other, that is natural. And people should fear their government. We see what not fearing the government gets you here in the US. What the Chinese know from looking at their own history is if you promise people much and then they end up without a job or food then tend to riot, riots tend to spread and might topple governments. Our government has not idea about his because they are completely disconnected from reality.
Ah people are gamblers by nature. Look the the UK and their endless stream of bubbles, it's well docuemtns. Will you be racist and say that those Brits are nothing but gamblers?
Have you studied the Chinese system at all before making these statements? Perhaps you should look up their social welfare system and you will quickly find it's basically non existent. Now they have elements of planned economy. Show me a nation on earth that does not. Their is still quite large but remember private enterprise is new in China. Do you expect them to transform nearly overnight, we are still only 1 generation into this change. I'm not saying China is perfect merely they are heading in the wrong direction while the US is heading in the wrong direction. We are about 1 more terror attack from crossing each other on the scale of freedom liberty anyway.
If you think America's best days are ahead, good luck with that. I hope it's true but the weight of history is against it. America is looking at a brain drain today, which has never happened before to the US, look it up. More taxes, regulation and government intrusion as well as government regulators strangling the little guy to help the big guy will kill innovation.
But feel free to believe that America is magically better then all other countries, and good luck with handling the decline friend. I suggest getting some food and a water filter it will be a bumpy ride. And I also suggest doing more reading and research, China is not the hellish place you think it is. America is not the pillar of greatnest you think it is. Sadly this isn't the 50's anymore.
That's a pretty darn good summary.
We are all traders now.
I've been asking all along...
Who is auditing China?
Their "growth" is supposed to pull us of the dreck when it's actually been the opposite for all those years. Now that we're spent, the Chinese are expected to continue and be "glorious"..
Don't count on it.