Why The Fate Of The World Economy Is In The Hands Of China's Housing Bubble

Tyler Durden's picture

A couple of research reports released overnight by Deutsche Bank and Bank of America, respectively, come to a sobering conclusion: the fate of the global economy may be in the hands of the Chinese housing bubble. As a reminder, China is a serial bubble inflator courtesy of a closed (capital account) economy, and nearly $30 trillion in bank deposits which slosh from one asset class to another, be it the stock market, bitcoin, commodities, farm animals or - most often - housing.

As all China watchers knows, and as DB confirms, the root cause of this bubble is "excessively loose monetary policy set to achieve growth above its potential." Furthermore, while the most recent housing bubble, the third in a row, appears to have recently popped as annual home price growth declined in January for the first time after 19 months of continuous acceleration, the question is how hard will Beijing push to prevent the same hard landing that took place in late 2014 when the bursting of the second housing bubble led to substantial slowdown in China, and sent rippled effects around the globe. 


So why is it so important for China to periodically and consistently reflate this bubble? The answer is simple: a gargantuan wealth effect, to the tune of 24 trillion yuan, or roughly $3.5 trillion.

As Deutsche's Zhiewi Zhang writes when discussing the macro and market consequences of the Chinese bubble, it is nothing more (or less) than "a massive wealth effect":

We estimate that in 2016 the rise of property price boosted household wealth in 37 tier 1 and tier 2 cities by RMB24 trillion, almost twice their total disposable income of RMB12.9 trillion (fig.11).

Such effect even spread to many tier 3 cities (Figure 13).

And, as Deutsche further points out, the (rather fleeting) wealth effect "may be helping to sustain consumption in China despite slowing income growth. A decline of property price would obviously have a large negative impact." And not just in China, but around the globe, as this incremental $3+ trillion in demand provide a material boost to not only China's direct trading partners, but set the economic pulse around the globe via various "soft" sentiment surveys, via transposition of the "EM to DM" growth narrative, as well as via direct purchases of offshore assets by capital controls-circumventing Chinese residents.

In fact, as the German bank explicitly states, the "property sector has become the critical pillar for fiscal revenue and the economy." A sector which as both the Chinese government, and DB, call a bubble.

But why would the government tolerate the bubble - knowing its bursting could have dire consequences on the economy if not contained - instead of seeking to deflate it gradually? There are three reasons:

  • The property and construction sectors accounted for 33% and 15% of local government tax revenue growth between 2010 and 2015. They contributed 43% of local government tax revenue in 2015,  compared to 11% from manufacturing (Figure C3). Besides taxes, local governments also heavily rely on land sales to finance infrastructure projects.

  • Banks, developers, urban property owners, and government all benefited tremendously from the property sector so far. This makes it difficult for the government to tighten monetary policy or roll out straightforward measures such as property tax to contain the bubble. The reluctance to prick the bubble only makes it larger.
  • The government may have the confidence that they can avoid a property bubble burst. It does appear that China has a stronger control over property prices than other countries, because it has a closed capital account, high saving rate, low CPI inflation, high level of reserves, a current account surplus, monopolized land supply, and a financial system largely controlled by the government. Some may argue “why can’t Beijing and Shanghai become Hong Kong?”

So the question the is simple: with the fate of the domestic, and therefore global, economy in the hands of China's housing sector, what happens next. The answer is unclear, however as DB warns, "property bubble bursts in other countries were often preceded by higher interest rates." And in what direction is the world headed? That's right: one where gradually every central bank is starting to tighten and raise interest rates.  As DB further adds, "the chance of rate hikes in China rises in 2018 as we expect higher inflation in China and six more rate hikes in the US over 2017/18. In the longer term, unfavorable demographic trend and slowdown of urbanization are the ultimate constraints."

So while it is clearly Beijing's desire to keep the housing bubble as inflated as possible, it may not have a choice absent further, much looser monetary conditions. The reason for that is as Bank of America's David Cui writes, "China’s housing market is among the least affordable globally. Although this doesn’t necessarily mean a sharp price correction anytime soon, it leaves the government with less scope than most others in our view to manage housing price, should interest rate jump or income growth slow. In addition, we believe that high asset prices, including housing price, is one of the main drivers of capital outflow."

Some further thoughts on what may be the world's least affordable housing market:

Many use the housing-value to GDP ratio to gauge whether a country’s housing market is reasonably priced. We believe that the ratio of housing value over household income is more telling – after all, households spend their income buying houses, not businesses nor the government. Based on this ratio, China’s is the second most expensive market among the countries that we track, all with a reputation of excessive housing price at various times (Chart 1). Other than the high housing price (relative to income), another major contributor to China’s high ratio is a low share of household income in GDP (which, by the way, goes to the heart of China’s imbalanced growth problem in our view).


Does this unprecedented unaffordability mean that a crash is imminent? According to Cui, China’s high ratio currently doesn’t necessarily mean that housing price will drop sharply anytime soon – Japan’s and Ireland’s had reached far higher levels before theirs corrected while Australia’s, Korea’s, and indeed, China’s have stayed at high levels for years without any major price correction so far. However, a few factors could make housing price in China over the next few years more vulnerable than most, including financial system risk posed by a rapid rise of leverage economy-wide, and a lack of exchange rate flexibility.

A far more immediate problem as a result of China's housing bubble may be the acceleration of Yuan outflows.  According to Cui, a major driver of China's capital outflow is high asset prices.

In another word, the local rich may prefer NY condos to Shanghai apartments for better value, for example. From this perspective, for the outflow pressure to ease, either housing price in Rmb terms has to decline or Rmb devalues. This assumes that the government cannot control capital outflow effectively in the long run, a reasonable assumption in our view given how open the Chinese economy is.

How will the government react? BofA predicts that "if it comes down to it, we expect the government to choose Rmb devaluation over asset price deflation" aka a housing hard landing. " Arguably the biggest driver behind high asset prices in China is leverage in our opinion. As a result, any major asset price decline may quickly trigger a debt deflation spiral and financial system instability."

The take home summary: keep a close eye on how Beijing manages to deflate the existing bubble: if it fails to be aggressive enough, home prices will once again spike, leading to an even more precarious bubble. If it is too aggressive, a hard landing is in store, coupled with what a crash in the country's financial system, where the bulk of the banks' $35 trillion in assets is collateralized by housing values. While such a crash may not necessarily lead to a catastrophe for China, where the government ultimately backstops all the banks, the deflationary wave spread around the globe from a housing crash would be dire.

Which is why those who are looking for key inflection points to determine the future trajectory of the global economy, in addition to the global (read Chinese) credit impulse...

... we suggest keeping a close eye on what happens with Chinese housing, which has become a - if not the - top variable for the fate of the both the great inflation-deflation debate, as well as the overall fate of the world economy.

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Raffie's picture

Chinese Ghost cities are full of Ghost and demand will go up.

Business there is B00ing.

froze25's picture

Ecto-plasam is at all time highs.

Raffie's picture

LOL... for sure.

Way bigger than the river of slim under NYC in Ghostbusters.

JRobby's picture

Well that's good news...............What bubble?

Logan 5's picture
Logan 5 (not verified) summerof71 Mar 17, 2017 3:52 PM

There is no Chinese Housing Bubble


There is only ZUUL!


Hongcha's picture

Not finding ZUUL on the NASDAQ ...

CRM114's picture

Try GOZER ;)

(Zuul is just the CEO)

hope_talk's picture
hope_talk (not verified) CRM114 Mar 18, 2017 7:22 AM

I'm making over $7k a month working part time. I kept hearing other people tell me how much money they can make online so I decided to look into it. Well, it was all true and has totally changed my life. This is what I do... http://bit.ly/2jdTzrM

scv's picture

the banks are never to blame even when they fund both sides of the war.

social capitol
cultural currency
local currency
moneyless economies

Logan 5's picture
Logan 5 (not verified) Mar 17, 2017 3:37 PM

Nothing a coupla trillion dollar coins & a DEATH STAR project can't fix...

centerline's picture

White House should have taken ZH up on the Death Star plan years ago.

Logan 5's picture
Logan 5 (not verified) centerline Mar 17, 2017 3:53 PM

I kno right!?

Peacefulwarrior's picture

And once they spend the Trillion dollar coins, next enter a false flag Alien Invasion to channel the stampede once it starts running...

RagaMuffin's picture

How do you say wag the dog in Chinese?

Logan 5's picture
Logan 5 (not verified) RagaMuffin Mar 17, 2017 3:39 PM

Lo Mein Crinton

centerline's picture

Same as wok the dog I think.

RagnarDanneskjold's picture

Chinese are already starting to say appreciation in USD is over. 

Chinese Home Prices Will Not Rise in Dollars

And even though liquidity has been falling, they're still enacting measures to tighten the housing market, ignoring the policy lag. They're going to overshoot again.

Beijing Banks Raising Mortgage Rates, Slow Lending, Downpayment Hiked to 80pc
Offthebeach's picture

When the house is trashed, there is a car in the pool, you son tells you he's marrying a hooker...it's  Central Bank time to take away the punch bowl. 

Batman11's picture

The broad brush of monetary policy causes another disaster.

The FED blows up the global economy.

The ECB wrecks the Euro-zone.

Now China.

Alan Greenspan bought in new ideas of using monetary policy to control economies and his critics said this was far too broad a brush.

Before Governments had used targeted solutions for problems as they arose. 

His critics were right, but like everything in the globalisation project, the neoliberal ideology must hold sway even when it doesn’t work.

After the dot.com boom things start going wrong, but things won’t really blow up until 2008.

After the dot.com crash Alan Greenspan loosened monetary policy to get the economy going again. The broad brush effect stoked a housing boom.

When he tightened interest rates, to cool down the economy, the broad brush effect burst the housing bubble. The teaser rate mortgages unfortunately introduced enough of a delay so that cause and effect were too far apart to see the consequences of interest rate rises as they were occurring.

The end result 2008.

The ECB helped Germany get over its dot.com bust when the Neuer Markt collapsed by 97%.

The low interest rates were lapped up across the Euro-zone leading to a massive increase in borrowing outside Germany. Borrowing creates money and this led to a surge of new money entering these economies, increasing prices and wages with real estate bubbles forming in Greece, Spain, Ireland and Holland.

Holland has yet to blow up its economy and desperately tries to keep its housing bubble inflated in every way it can, it knows what happens when real estate bubbles burst.

Germany itself was in a state of shock after the dot.com bust, it didn’t borrow and tightened its belt becoming more competitive.

This early application of monetary policy caused a further divergence in the Euro-zone economies making Germany more competitive again and the other nations less competitive.

The housing bubbles in Greece, Spain and Ireland wreck their economies.

The Euro-zone problems were compounded by an assumption by the financial sector, everyone would be bailed out by Germany.

Interest rates were almost the same across the Euro-zone and Greek interest rates were marginally higher as this was the weakest economy. Lending to Greece yields the highest profit and Germany would bail it out if it all goes wrong.

This assumption proves false after 2008 and the Euro-zone crisis really gets going. Interest rates rise rapidly in the Club-Med nations, especially Greece, the once sustainable debt is now unsustainable.  

After, 2008 all the Central Banks loosen monetary policy.

Bubbles are blown in asset prices across the globe.

Real estate bubbles inflate further in Australia, Canada, Norway, Sweden ....

Monetary policy is far too broad a brush to control economies.

Never mind let’s blow up some more economies before we can admit it, neo-liberalism is an ideology and it doesn’t matter if it doesn’t work.

China next.

indygo55's picture

On that last graph, the direction its going, I'm sure it'll turn right around on a dime. I'm just sure of it. 

runnymede's picture

Excellent post. Love the part about assumption that Ger would backstop the others.

In the US, the seldom noticed effect of the banks' bailout was that it removed any doubt that the bankers may have had that they would be held accountable for any discovered crimes. It's no longer just assumed--its fact and history that these folks are untouchable. The moral hazard that's been institutionalized is the ground zero shelter that all subsequent crimes are hatched under. It literally pays to be a psychopathic criminal. And it gives you immunity to boot. Nothing good can come of this. Failure of any endeavor or enterprise is assured if based on unsound principles. 

Aug 15, 1971 is the date future historians will reference as the catalyst for the collapse.

Death to money changers. And the giant squid.

Batman11's picture

Historians are going to have a field day with the current era.

An era when collective insanity overcame the ruling class.

Alan Greenspan, the stupidest financier in the history of mankind and there is a lot of competition about today.





blueberry100's picture

I wonder if I can get a job killing the weeds in the Ghost Cities?

roddy6667's picture

Name on Chinese city and tell me why it qualifies as a Ghost City.

radbug's picture

Canberra has kept the property bubble from bursting by encouraging a very high level of immigration. Australian fertility rates haven't been above 2.1 live births/100 since the mid seventies. The PRC doesn't have this option.

Hongcha's picture

There are no worries.  The Party can paper over anything they want, paint it gold and shop it by the pound.  The top 4 largest banks in the world are BACHY, IDCBY, CICHY AND ACGBY.  These stocks can double from here and still be a bargain.  You can also buy YINN if you don't like 5-digit trading symbols.


... or, you can keep drumming your fingers and awaiting The Collapse of China.  Ain't gonna happen.

roddy6667's picture

The Chinese have 25 trillion USD in savings accounts. Only about 10% of the people are involved in the stock market. Personal debt is very low. 82% of the homes are owned without a mortgage. There is no property tax. Car loans are a small part of the market, most people buy cash. College is paid for in cash, no college loans here. Credit cards are just getting started-most people use debit cards like UnionPay. Even those with credit cards don't run a balance. The Chinese save, on average, 36% of their income.
Americans should worry about their economy collapsing, not China's.

Able Ape's picture

China can build ultra modern empty cities, the USA can't even keep lowly, outdated and decrepit malls open and functioning...USA!USA!USA! - What a fucking joke!...And don't even get me started on FACTORIES!....

Offthebeach's picture

"....losed (capital account) economy, and nearly $30 trillion in bank deposits which ..."

 Is that true?  30 trillion US Dollars?

runnymede's picture

No----30 trirrion

Much more manageable 

Let it Go's picture

The importance of the housing market in China's economy should not be underestimated, this is where almost 75% of the country's household wealth is stored and it is deeply interwoven with shadow banking. In China, most apartments are sold with internal walls and electrical outlets in place but everything else, including doors, flooring, and bathroom fixtures need to be built-out by the owner after purchase.

Cheap housing is something you won't find in China. Its housing market is among the most expensive in the world when compared to per capita income. For example, the average price of housing in New York City is around $200 per square foot with an average family income of $72,000 per year. By comparison, the average cost of housing in Shanghai for the year 2007 was nearly $108 a sq. ft. against an average family income of $7,316. More about China's housing market in the article below.


Houses Depreciate's picture

Yet the reality is nobody is paying those prices.


Did you know housing demand is collapsing because of grossly inflated prices?

roddy6667's picture

Yes, most homes are sold as shells. Everybody knows this. There is a huge industry that does the finishing and customizing. In America, you pick out your options and upgrades, and the builder does the work. In China, you have a different group of people do that. There are design centers everywhere where you can pick out fixtures, cabinets, flooring, ceilings, all that. Allow an extra 20%. That's just how they do things.
Using a figure of average home price vs. family income works in America, but is not relevant in China. A family buys a home for their son for when he gets married, around age 30. Most homes are purchased cash, and the family has 30 years to save up for this purchase. Also, the son lives at home until he marries. That gives him 8-12 years to save after high school or college. Most likely the grandparents live in the same household, and they can also pitch in. The Chinese have an average savings rate of 36%, so buying a home cash is not a big deal, even for most blue collar families.Also, prices in the First Tier cities of Beijing, Shanghai, and Hong Kong are often used for articles like this. They do not represent most cities in China. If you travel around China like I do and track prices, you will see that most cities have quite affordable prices. For people who don't have much money, most cities have affordable housing. A certain percentage of new homes must be set aside for that, and the homes can't be resold for a long time. There is a special program in many cities in which the the people pay a very modest rent for 15 years, and then get the title. There is no property tax in China.
Don't read alarmist articles on Doom & Gloom websites and feel like you know something about a place 7000 miles away.

Dilluminati's picture

Chicoms have perfected the act of "yes but."

In asian languages the word no is rarely used, it is "yes but."

Yes China has a housing bubble, "yes but" be running thin.

the NPL's are accumulating and it is the PRA (peoples republican army) who is accruing the bad debts


no do like da Chicoms

ds's picture

When debt is growing faster than GDP, it is a Ponzi. there should be no dispute on this as they (the Chinese Leadership) officially recognize the imbalance and want to curb it. The vested interests are stonewalling the deleverage. More importantly, the leaders have overporomised the People on hockey stick growth and at the minimal they can do now is to keep zombies alive so that there is no unempolyment. This trade-off with the debt porblem being kicked down the road is imminent this year when there is an important leadership change. President Xi has to look good to staff the top echelon with his People. (He is lkely to get what he wants).

Actions are here to play the downtrends unless you believe that markets are benign and owe them a living to actualize their dream of a long soft landing. They have arrogantly ignore global market force imagining that markets must pay obeisance to them. This will help them a lot.

Cheer them on in their other vanities in ther global shopping to buy influence and power. This will drain them further. They need more than any major power to have global peace and stable economic conditions for their soft landing. So call their bluffs on territorial aggressions. 

Honest Sam's picture

China subscibes, as so many do, to the irrefutable economic reality:  There is only so much land, it is finite, and the gods have told us that they ain't gonna give us any more, in fact, they are going to place more and more land underwater where human beans can't live and reproduce, to live and reproduce, to live and reproduce. 

So buying land is a sure thing. Some day there will be a shortage of that housing because of the Law of Truthiness. 

This is a bubble that ignores the cold hard fac that they ain't making any more of it.  

We just need to get world population up to 14 billion.


DelusionsCrowded's picture

Chinese also love to gamble , it seems to be a part of testing ones auspicious luck , pandering for signs of favour from the gods . I would guess that it is the ambition of every Chinaman to get enough money to immigrate to Australia or New Zealand and by a 'Mansion' . This is a sort of 'I've  made it ' statement . Who wants to live in corrupt expolititive polluted overpopulated China ?