Beijing's ability and eagerness, to create and roll from one bubble, whether it is in housing, equities, commodities, cars, bitcoin and so on, into the next has been extensively documented, however, of all recurring bubbles to impact the Chinese economy, housing is by far the most important. The reason for that is that housing provides Chinese society with a dramatic wealth effect, far greater than the stock market, and as Deutsche Bank calculated in March, in 2016 the rise of property prices boosted household wealth in 37 tier 1 and tier 2 cities by CNY 24 trillion, almost twice their total disposable income of RMB12.9 trillion (fig.11).
Which is why it is understandable why after some feeble efforts to rein in China's latest housing bubble at the end of 2016 and early 2017 when things got really out of control, Beijing once again let loose some time in March, as the latest Chinese housing price data revealed.
But how far will prices soar this time?
That is the question Bloomberg asked China's "property bubble prophet." The answer was troubling: "China’s home prices could rise by another 50 percent in the nation’s biggest cities, as the latest measures to rein them in are likely to be eased by policy makers seeking to support the broader economy." This is hardly a bold statement: in February even China's housing minister admitted there is a housing bubble.
According to Zhu Ning, deputy director of the National Institute of Financial Research at Tsinghua University and author of "China’s Guaranteed Bubble: How Implicit Government Support Has Propelled China’s Economy While Creating Systemic Risk" as measures to curb housing prices drag on growth in the second half and early next year, the government will resort to its old playbook of dialing them back again to shore up expansion.
"We’re living through a bubble," Zhu said. "If we don’t engage in more meaningful reform, which we haven’t, we’re very likely to have a financial crisis or a burst of the bubble. It’s a matter of sooner or later." As a result, while he didn't specify a time, Zhu said he expects real estate prices in major cities to surge "by another 50 percent or so" after measures to rein them in are eased. And because policy makers have previously imposed curbs only to ease them again, people see them as a bluff.
Call it the ultimate "housing put."
Zhu said he reached the 50% estimate based on the average price appreciation after past curbs were lifted, an ever-stronger belief among buyers that housing prices will rise, China’s humongous supply of credit, and tighter controls on capital outflows. In short, everything that is broken about China's financial system will catalyze the next - and biggest yet - housing bubble.
Still, perhaps conventional finance does not apply to China? Over the past year Zhu - who earned his doctorate in finance at Yale - told Bloomberg he’s had more doubts over whether the thinking of western-trained economists applies to a nation that’s proven naysayers wrong "with its might and its determination" for three decades. "Over the past 12 months my confidence has really been shaken," he said, adding that a crisis remains probable. "Could China be the black swan that we’ve never seen before?"
He concludes that he hopes his crisis outlook is wrong. Here are excerpts of the interview, courtesy of Bloomberg:
- Question: Is China heading for a crisis?
Answer: Housing prices were allowed to rise so much in the past 12 months and there’s still no tangible long-term mechanism to shape the proper expectations for the housing market or for the economic transition. People still want the economy to grow at 6.5 percent to 7 percent, people still have “the-higher-the-better” mentality. We’re kicking the can down the road by buying time not to keep things in check, but to blow the bubble into an even bigger one. What’s happened over the past two years has made any new reforms even more difficult to roll out.
- Question: Can China nonetheless muddle through for a number of years?
Answer: Maybe three to five. I thought people would take a more careful approach to the housing market and keep things in check. Things are a whole lot harder to manage now than they were a year ago. Two years ago there was a lot of low-hanging fruit to be plucked and a lot of easy reforms to push forward and we don’t have to even talk about a crisis.
If debt is allowed to grow at this pace we’ll be seeing 400 percent of GDP by 2020 and that’s probably putting China on a par with Japan by then. That’s something we haven’t seen before, but China is something we’ve not seen before. The simple math for that is that 300 percent GDP of debt at 5 percentage point of interest translates into 15 percent of GDP, so whatever we’re making, that’s not enough in terms of simple cash-flow calculation to pay the interest coverage.
- Question: What might trigger a crisis?
Answer: In another three years we might see foreign reserves dipping down to $2.5 trillion and maybe even lower. That’s where the real test comes. Now you can still argue that if foreign speculators are trying to short the yuan we still have enough ammunition in our arsenal, so we still have this credible threat. But hypothetically, if reserves dropped to $2 trillion -- and deep down in everybody’s mind China’s optimal or maybe minimal foreign reserves size should be somewhere between $1.5 trillion to $2 trillion -- that’s when all the sharks in the water will smell blood. That’s the real test. China may be different. But we haven’t seen a country can put up a meaningful fight once it’s running out of reserves.
- Question: Why are home prices so hard to contain?
Answer: It’s really difficult at this point to stabilize expectations. People aren’t paying attention to policy any more. They understand the government would have to lift policy curbs sooner or later, and once that happens, housing prices will rebound again. So they’ll try to do everything to circumvent the policy and try to invest or speculate. Whenever there’s a slight shift in the policy orientation the policy makers will realize the market has no appetite for that. That’s why they try to gradually increase interest rates through open market operations and through the interbank lending market, but once interest rates gradually rise, they realize the real economy can’t afford it.