This page has been archived and commenting is disabled.

It Doesn't Take a Genius to Figure Out How This Will End

Reggie Middleton's picture


For all of those who feel China is going to take over the free
world, just remember that when you blow a bubble (particularly a
balance sheet bubble) it is bound to pop. The damage from the pop
invariably does more harm than the boost from the bubble. It has always
been the case, particularly when leverage is involved - which makes the
impact that much more devastating. If anybody can attest to this, it
should be us Americans (British, Spanish, Irish, those from Dubai,

Methinks that before China gets a chance to
become a preeminent world power, their profusely blown asset bubble (by
way of a most accomadating fiscal policy) will blow up in their face
and they will go through what the US, Japan and UK just (is still) went
through, exacerbated by the fact that they are still a net export
reliant economy when the bubble blowing is removed. With the developed
world in sluggish mode, they will have very little to fall back on as
their asset prices collapse to equilibrium and debt from their
steriodal lending system is left under or uncollateralized and unable
to be serviced.

Why does everybody confuse bubbles with economic progress?

From Bloomberg:

Dec. 31 (Bloomberg) -- Li Nan has real estate fever. A 27- year-old
steel trader at China Minmetals, a state-owned commodities company, Li
lives with his parents in a cramped 700- square-foot apartment in west Beijing.

Li originally planned to buy his own place when he got married, but after watching Beijing real estate prices soar,
he has been spending all his free time searching for an apartment. If
he finds the right place -- preferably a two-bedroom in the historic
Dongcheng quarter, near the city center -- he hopes to buy immediately.
Act now, he figures, or live with Mom and Dad forever. In the last 12
months such apartments have doubled or tripled in price, to about $400
per square foot.

“This year they’ll be even higher,” says Li in the Jan. 11 issue of Bloomberg BusinessWeek.Does this scenario sound even remotely familiar???

of Chinese are pursuing property with a zeal once typical of
house-happy Americans. Some Chinese are plunking down wads of cash for
homes. Others are taking out mortgages at record levels. Developers are
snapping up land for luxury high- rises and villas, and the banks are
eagerly funding them. Some local officials are even building towns from
scratch in the desert, certain that demand won’t flag. Straight out of the Dubai make money now and pay for it later handbook of bubblistic speculation! And if families can swing it, they buy two apartments: one to live in, one to flip when prices jump further. Imported speculators from Miami, LA and downtown Brooklyn!

And jump they have. In Shanghai, prices
for high-end real estate were up 54 percent through September, to $500
per square foot. In November alone, housing prices in 70 major cities
rose 5.7 percent, while housing starts nationwide rose a staggering 194
percent. The real estate rush is fueling fears of a bubble that could
burst later in 2010, devastating homeowners, banks, developers, stock markets, and local governments.
Let's get this straight. "Fears of a bubble"!!! A 54% gain in 9 months
does not confirm a bubble???!! What is the long term historical average
in China. Probably 2% to 4% annually, or on pace with inflation, give
or take. So, if pundits are not sure a 25x increase is a bubble, what
would it take to convince them?

High-End Bubble

“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.
Actually, once the bubble pops, their economic growth will collapse,
and trend in reverse. That's what happens when bubbles pop. If the
growth just stopped, then it would make sense to encourage bubbles,
wouldn't it? You can just reignite another bubble when the previous one
pops and start the cycle over again. It appears as if this is the
playbook some of our central bankers are following. Unfortunately, they
are called boom/bust cycles, not boom/stop cycles. Bubbles are not
indicative or true organic growth, they are a sign of growth borrowed
from future time periods that MUST be paid back with hard money
interest. The bigger the bubble, the bigger the "vig".

parallels with other bubble markets, the China bubble is not quite so
easy to understand. In some places, demand for upper middle class
housing is so hot it can’t be satisfied. In others, speculators keep
driving up prices for land, luxury apartments, and villas even though
local rents are actually dropping because tenants are scarce. What’s
clear is that the bubble is inflating at the rich end, while little
low- cost housing gets built for middle and low-income Chinese.This is not hard to parallel. This is exactly what happened in NYC, particularly Manhattan and Downtown Brooklyn. See  "Who are ya gonna believe, the pundits or your lying eyes?"#000000;"> (for pictures) and "Who are you going to believe, the pundits or your lying eyes, part 2" (for numbers and a very shaky video),
I illustrated a trip from Chelsea Piers in Manhattan to Prospect Park
in Brooklyn, capturing the rampant supply of residential, office and
commercial space that is STILL being put up despite the extreme glut
currently in this rapidly declining market. As you look through all of
this visual material, remember banks have supplied the capital for
building all of these empty edifices, at no less than 10x leverage.
None of this inventory was targeted at the middle and lower classes. As
ironic as it may sound, this activity ultimately ends up causing
downward social mobility as asset values collapse under mounting debt.
See Super Brokers form to push Super Broken products to make those with High Net Worth Super Broke for my take on social mobility, downwards style).

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. I'll give this until the end of 2010 to blow up!

Table Talk

Koyo Ozeki,
an analyst at U.S. investment manager Pimco, estimates that only 10
percent of residential sales in China are for the mass market.
Developers find the margins in high-end housing much fatter than
returns from building ordinary homes.

How did this
bubble get going? Low interest rates, official encouragement of bank
lending, and then Beijing’s half-trillion- dollar stimulus plan all
made funds readily available. City and provincial governments have been
gladly cooperating with developers: Economists estimate that half of
all local government revenue comes from selling state-owned land. "Nuff said!

Chinese consumers, fearing inflation
will return and outstrip the tiny interest they earn on their savings,
have pursued property ever more aggressively. Companies in the
chemical, steel, textile, and shoe industries have started up property
divisions too: The chance of a quick return is much higher than in
their primary business. Oh my!

Built on Sand

“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.”

I am leaving out significant
parts of the article, so as not to excerpt too much. I suggest you
follow the link to read it in its entirety. The following portions do
support my suspicions of where all of the alleged consumer activity in
China is coming from, though:

Key to Growth

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

The worst scenario is that the central
authorities let the party go on too long, then suddenly ramp up
interest rates to stop the inflationary spiral. Without cheap credit,
developers won’t be able to refinance their loans, consumers will no
longer take out mortgages, local banks’ property portfolios will sour,
and industrial companies that relied on real estate for a chunk of
profits will suffer. Nahhh! Really!

One difficulty in handicapping the likelihood of a nasty pullback is
the opacity of the data. As long as property prices stay high, the
balance sheets of the developers look strong. And no one knows for sure
how much of the more than $1.3 trillion in last year’s bank loans
funded real estate ventures.


Analysts figure
a substantial portion of that sum went into property, much of it
indirectly. Banks often lend to state-owned companies for industrial
purposes. But the state companies can then divert the funds to their
own real estate businesses or relend the money to an outside developer. Enter the domino/daisy chain effect in case of collapse...

the big banks may be cutting back on their real estate risk by selling
loans to smaller local banks and credit co-ops...

I explored these possibilities about a year and a half ago. See China Macro Update, (also of interest is the HSBC opinion and 2H08 update).Then My view of the China hype bears additional fruit and All of my warnings about China are starting to look rather prescient.


- advertisements -

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Sun, 01/03/2010 - 00:40 | Link to Comment Anonymous
Sat, 01/02/2010 - 08:51 | Link to Comment Anonymous
Fri, 01/01/2010 - 00:38 | Link to Comment pooplagrande
pooplagrande's picture

Thanks's always a pleasure to read your posts. I do agree that China can't be trusted. My prediction is that the BS #s will catch up with them, the bubble with burst, things will get ugly and they will basically tell the world to go fuck themselves. They don't care about the environment, their own people, and certainly not other countries or cultures. This isn't a generalization...this is just reporting everything I have seen (and likely you have too).

Trust me, this will not end well for anyone.

Thu, 12/31/2009 - 23:54 | Link to Comment Anonymous
Thu, 12/31/2009 - 23:23 | Link to Comment Anonymous
Thu, 12/31/2009 - 20:53 | Link to Comment Anonymous
Thu, 12/31/2009 - 20:46 | Link to Comment Scooby Dooby Doo
Scooby Dooby Doo's picture

What amazes me is Reggie the analyst, who can barely figure out the US market is now wading deep over his head into China.

L-outfucking-L! You have got to be fucking kidding me!!

Thu, 12/31/2009 - 19:02 | Link to Comment Anonymous
Thu, 12/31/2009 - 17:41 | Link to Comment Anonymous
Fri, 01/01/2010 - 08:39 | Link to Comment Anonymous
Thu, 12/31/2009 - 16:46 | Link to Comment DosZap
DosZap's picture

Mr. Middleton,

While I respect your vision &  business acumen greatly, I can't help but stop, and look at China as a baby  America in the 1700's.


Sure, they have their issues, but there growing pains...............and they will get thru them. We were the greatest nation on the planet for many decades,until our decadence brought us to now.

I am basically a dunce, but I see China, as a self sufficient nation, with VAST natural reserves of everything they need, w/ exeption of enough water, and fertilizers, oil,

( All to be easily had ).

Easily remedied by their ENORMOUS amounts of Gold reserves, and heavy metals, and land. They are by far the wealthiest, nation on earth in this regard, and IMHO.

As it is, they are purchasing everything they need,in mass quanities, and buying properties, and land outside mainland China,that contain the ingredients needed for their LONG term 50+ yr growth now.

We plan a year at a time, at best,.......................our worst failing.


I can easily see them as almost 98% self sustaining, IF they open up to more Capitalistic goverance, and allow more personal freedoms in the business sectors.

Let their people go to it.

They are as close to being an Entire planet, Eco system, self sutaining, as one country could be..........with minor tweaking, and more personal freedoms.

Again, just my humble opinion.


Thu, 12/31/2009 - 15:57 | Link to Comment Comrade de Chaos
Comrade de Chaos's picture

I agree x 100 with the chinaguy. It may not blow in our conventional sense, however Chinese numbers & hype are way overblown.

a)Growth of 10% forever is unsustainable.

b) Real economic power comes from GDP per ca-pita numbers and those are still horrible in China by the western standards.

The smartest thing their Politburo could have done is to provide tax cuts and assistance to their none existent middle class instead they are hording their reserves and fueling those to well connected within the party.

Thu, 12/31/2009 - 16:50 | Link to Comment chinaguy
chinaguy's picture

I didn't want to get into "looting" in my diatribe, but it's truly rampant in China. 3-4 years ago a PRC state agency reported that 400 bureaucrats had decamped after stealing an amassed 40 billion USD. If an official agency is reporting 40 billion USD stolen, I assume the true amount is many multiples of that. You can draw your own conclusions about how the temptation to steal billions colors policy decisions there.

Thu, 12/31/2009 - 18:18 | Link to Comment seventree
seventree's picture

At the height of the real-estate boom, groups of wealthy Chinese nationals sometimes toured the US looking at high-end residential properties, supposedly for investment. I wonder if any of them ever returned with their 100 million to live the American dream?

Thu, 12/31/2009 - 15:48 | Link to Comment Anonymous
Thu, 12/31/2009 - 18:20 | Link to Comment Reggie Middleton
Reggie Middleton's picture

Could you imagine somebody taking your advice in the 2nd half of 2006, gorging on Miami and Vegas condos???

Thanks for the free advice, but no thanks.

Thu, 12/31/2009 - 16:25 | Link to Comment Anonymous
Thu, 12/31/2009 - 20:57 | Link to Comment Anonymous
Thu, 12/31/2009 - 15:11 | Link to Comment chinaguy
chinaguy's picture


Ok guys, I’m not a China basher, China has been very good to me. I’ve made a fortune working there for 25 years but I’m going to lay down some very fundamental realties about China.  and you can take this diatribe with as many grains of salt as you like.

You can not rely on any statistics coming out of Beijing. None of them. Not growth, employment, power consumption, air quality, number of Chinese traveling abroad. None of it. No Chinese business man would make a critical decision based on stats out of Beijing. They base their decisions on reading between the lines and what they hear from their connections in the Party.

I just laugh when I hear people saying: “well power consumption in China is this amount, therefore GDP must be at this level. Basing analysis on flawed data can only give flawed results.

Any conclusion, about the Chinese economy has to come from first hand accounts (sorry), external audits and counting container loads at Long Beach.

China, in spite of it’s much touted reserves, is really not two trillion dollars liquid.   In 2006 Ernst and Young released a report concluding that the "nonperforming" loans of China's banks totaled $911 billion (40 percent of China's GDP):

This amount was over 500% larger than Beijing’s official position of $164 billion in NPL. Beijing screamed bloody murder. Who knows exactly how much pressure and by whom was placed on E & Y, but they quickly withdrew the report and replaced it with one which exactly agreed with Beijing’s figures.

     Ernst & Young likes very much to work in China. They would not have released this shit storm lightly. Occam’s Razor would say that China’s NPL are at least 900 billion and in 2009 probably over one trillion in NLP. So with China’s foreign reserves at $2 trillion…. you can scratch half of that.


Regarding real estate. I have personally tracked individual sales of several apartment complexes in Hangzhou and Shanghai for years. Residential RE has increased about 300% to 400% in the past four years. We are talking about decent, centrally located apartments in the $500k – $1,000K range in cities where upper management (who would earn low six figure in the USA) make about $20K – $40K. The vast majority of workers are making less. Senior software developers, for example, make about $15k/year How are people affording $500K apartments with these wages? My conclusion is that Chinese residential real estate in an enormous bubble.  Chinese CRE is in the same boat it is here, but probably worse because bank loans do not need to go through any feasibility study if you have the right connections, and, the big players in Chinese CRE have the right connections.

Growth.  I made a survey of industrial areas in Zhejiang, Hubei and Shannxi provinces several months ago. Hubei and Shannxi are provinces where heavy equipment, cars & aircraft are made. Those areas were busy but static, not adding jobs. The new “high tech” corridor in Hangzhou, Zhejiang was sucking wind. My conclusion based on these observations was: “8% growth” no f-ing way.

Extend and pretend. There is no audit of the Chinese central government. None. Decisions are made behind closed doors and the news that is released is whatever they decide to release. That’s just it.

My conclusion is that China is a lot less solvent that we are lead to believe, both commercial and residential RE are in a tremendous bubble and growth is no where near 8%. The largest problem IMO when it comes to making decisions about china is that the salient facts are all hidden. Opaque. There is no way to learn how bad things are and when it will collapse. It might not collapse at all, but China is much worse off than Beijing would like us to believe.

Fri, 01/01/2010 - 01:10 | Link to Comment deadhead
deadhead's picture

Thank you for sharing your insights Chinaguy.

Thu, 12/31/2009 - 21:57 | Link to Comment Scooby Dooby Doo
Scooby Dooby Doo's picture

Chinaguy, here is where you lost me;
"No Chinese business man would make a critical decision based on stats out of Beijing. They base their decisions on reading between the lines and what they hear from their connections in the Party."

There is no way to compare Doing business in China and Doing business in the US. Regional governments are the entities that rule. They are the ones who ignore, modify, or enforce national policy. They collect tax, issue license, and work permits, etc...

As a business person your local/regional connections are your one and only life line. Lets say you are looking for one national report for unemployment, good luck because you have to collect it from all of your trusted regional connections, if you have that many. And no one does.

Thu, 12/31/2009 - 16:12 | Link to Comment seventree
seventree's picture

There has been a lot of talk lately, even in the MSM, that China will overtake the US as a world power. To me a much worse alternative would be economic collapse, followed by social collapse which would trigger a military takeover. So far the military has been satisfied to share the civilian government's ruling-class gravy train, but absent the current economic bubble, would probably close ranks driving progressive politicians and entrepreneurs to extinction. A paranoid war machine supported by a billion slaves would not make for an efficient economic model, but it could last a long time -- like North Korea on a giant scale.

That said, I wish everyone a happy new year.


Thu, 12/31/2009 - 19:30 | Link to Comment Anonymous
Thu, 12/31/2009 - 20:45 | Link to Comment seventree
seventree's picture

Yes of course it's all one big happy dictatorship, but with different power centers. There is always some background sabre rattling, but for now the power elite have more to gain economically than they could possibly take by force. If the generals were running the country it would be a very different picture with more for us to worry about than trade sanctions and renminbi valuation.

In 1989 military leaders decided their civilian counterparts were losing control and took direct action. In addition to the massacre of hundreds of idealistic protesters, several highly placed Party officials were arrested for their part in failing to control dissidence.

In case it wasn't clear, I never suggested that the Chinese military is under even nominal control of the civilian Party leadership. Only that they are satisfied to play along with the "new China" psuedo-capitalist game as long as their pockets get lined also.

Thu, 12/31/2009 - 14:46 | Link to Comment Comrade de Chaos
Comrade de Chaos's picture

well, eventually we do bound to recover. And while numbers do look much better and support at least the notion that we are not collapsing anymore, I am not really sure I trust those numbers to a high extend. After the FED went beyond its main agenda (price stability) just to save its face and pump up RE values, I am rather sceptical about anything they release.  

Thu, 12/31/2009 - 14:41 | Link to Comment Anonymous
Thu, 12/31/2009 - 14:02 | Link to Comment Anonymous
Thu, 12/31/2009 - 13:59 | Link to Comment Bam_Man
Bam_Man's picture

Last time I checked, average annual household income in China was something like $1,700.

And condos in Beijing and Shanghai are selling for $400/sf (approximately $400,000 for a 1 bedroom)?

That is 235 times average income. 235 times.

Even in California when things got completely crazy, prices never got beyond 11 or 12 times income.

This is not just a bubble. It is a MEGA-bubble and when it pops, "Katie bar the door".



Thu, 12/31/2009 - 14:48 | Link to Comment chindit13
chindit13's picture

Ninety nine percent of China's population earns less than 40,000 yuan per year, or less than $6000.  That's the bad news (in terms of consumption).  The good news is that even at $400/sq ft, a three hundred square foot, two bedroom condo can be had when ten people pool their savings.  The bad news is that the line for the bathroom in the morning can be rather long.  The good news is that the bathroom water supply is often not working anyway, so no harm done.

Thu, 12/31/2009 - 20:59 | Link to Comment Scooby Dooby Doo
Scooby Dooby Doo's picture

In about 8-10 years when supply meets demand, $400/sq ft will drop to $75/sq ft.(Mainland) But for now supply is vastly unfulfilled. I have never come across a water issue during any of my visits to my flat in Chengdu. Must be a Hong Kong issue, leave it to the British to screw up something as simple as water supply....

Thu, 12/31/2009 - 13:57 | Link to Comment Anonymous
Thu, 12/31/2009 - 16:15 | Link to Comment Leo Kolivakis
Leo Kolivakis's picture

Long greenback, long oil, short gold, LONG SOLARS for 2010!!!!!!

Thu, 12/31/2009 - 13:56 | Link to Comment JuicyTheAnimal
JuicyTheAnimal's picture

Chinese love to copy.  They are monkey see monkey do.  And if greed is running wild in America you know it is there too, times 10.  Asians LOVE LOVE LOVE money and status. 

This smells like dish soap, is shiney yet clear, is wet and it floats. 

Thu, 12/31/2009 - 15:07 | Link to Comment WaterWings
WaterWings's picture

And the best greasy hangover food since hashbrowns.

Thu, 12/31/2009 - 13:55 | Link to Comment Anonymous
Fri, 01/01/2010 - 08:14 | Link to Comment Anonymous
Thu, 12/31/2009 - 13:53 | Link to Comment Anonymous
Thu, 12/31/2009 - 13:48 | Link to Comment Bruce Krasting
Bruce Krasting's picture

There two things about China that are not being considered. The first is the population growth. Econ. 101 say that population growth is the number one driver of GDP. It is not just the growth in numbers it also the increase in income per individual. These are powerful forces that will sustain economic activity much longer than we might expect.

The RE crisis you fear is really just a banking crisis. There will be big losses at some point as this sorts itself out. But here is my concern. They solve that problem by drawing down on their international reserves to "pay" for it. Chinese reserves are like a "Get of Jail" card. We do not have the luxury of tapping a cookie jar in tough times. They do.

Of course if they did do that, it would just cripple us......


Thu, 12/31/2009 - 20:53 | Link to Comment Winisk
Winisk's picture

Population growth is the number one driver of GDP.

This simple statement is so true and obvious that it's sometimes lost in the discourse of economic growth.  It's the mother of all Ponzii schemes.  But having more and more people shuffling more and more money back and forth doesn't improve living standards when the finite pool of resources is spread thinner and thinner.  Higher GDP may impress economists and money handlers but it hardly is a beneficial course in the long run.  Overcrowded polluted cities that rely on perpetual future growth to keep people from rioting is not much of an advantage in my way of thinking.  Eventually, the carrying capacity of China, India, and the rest will be reached and the primary driver of economic growth will physically stop.  China can race toward the end or it can purposefully slow down to avert a crash.  I'm not sure what the timetable is for this event but it will happen.  

Thu, 12/31/2009 - 14:40 | Link to Comment Daedal
Daedal's picture

The first is the population growth. Econ. 101 say that population growth is the number one driver of GDP.


Population growth does impact GDP, but you must also factor in that we live in a world of limited resources (a detail most economists ignore).

If we are below equillibrium (resources required are less than resources available), then our consumption of resources doesn't matter until we are at, or above, equillibrium. Once that happens, problems arise.

For instance, if resources (like food, water, and energy) weren't obstacles, population growth (like bacteria in a petri dish) would be unempeded -- GDP growth would increase in lock step. But if you look at the consequence of population growth (more energy utlization, more food requirements, etc), then you can have sudden spikes in the cost of food and energy, which would then be a force that works against GDP growth. The oil spike last summer was a good example of that.

Thu, 12/31/2009 - 14:22 | Link to Comment Anonymous
Thu, 12/31/2009 - 13:59 | Link to Comment JuicyTheAnimal
JuicyTheAnimal's picture

And if they cripple us they cripple themselves....ooops.

Thu, 12/31/2009 - 14:00 | Link to Comment Jefferson
Jefferson's picture

I wouldn't be surprised, after all is said and done, if the majority of the Chinese population will become so disillusioned with their experiences with "capitalism" that they revert back to avoiding interaction let alone trade with the outside world.

And we witness a major reformation and purge within the ranks of the Communist party.

So much of the wealth currently being created is obviously being enjoyed by only a small segment of the population who will be totally discredited when the bubble finally does burst. I bet there are hundreds of millions of peasant Chinese who would like nothing better than to stick it to the snotty and soon to be broke urban factory owners and real estate magnates.

I would hazard a guess that corrupt local officials are not held in particularly high esteem either. It doesn't take much imagination to figure out what will happen to said officials when the SHTF after the bubble finally collapses.

This will not end well in China. Or the ROW for that matter.


Thu, 12/31/2009 - 13:38 | Link to Comment Anonymous
Thu, 12/31/2009 - 13:38 | Link to Comment Anonymous
Thu, 12/31/2009 - 13:21 | Link to Comment Anonymous
Thu, 12/31/2009 - 12:54 | Link to Comment Anonymous
Thu, 12/31/2009 - 14:17 | Link to Comment MarketTruth
MarketTruth's picture

Shhh, 'they' do not want anyone to hear how China owns well over 90% of rare Earth metals now worldwide, China's recent oil grab from Canada, countless other oil deals with Russia, Aussie and Iran, gold miners and too many other grabs worldwide. China is buying things like miners and oilies good for longterm while the USA buys up junk paper and prints money for crapola faster than a speeding US MIL complex bullet in Iraq.


Thu, 12/31/2009 - 15:41 | Link to Comment Anonymous
Thu, 12/31/2009 - 15:23 | Link to Comment WaterWings
WaterWings's picture

Make that a depleted uranium bullet. It's all-you-can-eat over in the sandboxes. Poor kids, never had a chance:

Google the pictures of the deformed children if you have the stomach for it. It's a little too much for me to post here.

Do NOT follow this link or you will be banned from the site!