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Wednesday, May 7, 2014

POP! Goes the Real Estate Bubble

Soap Bubble

There are more indications that the Chinese real estate bubble has popped. First, and foremost is this article by Ambrose Evans-Pritchard at the Telegraph:
So now we know what China’s biggest property developer really thinks about the Chinese housing boom. 
A leaked recording of dinner speech by Vanke Group’s vice-chairman Mao Daqing more or less confirms what the bears have been saying for months. It is a dangerous bubble, and already deflating.

... Li Junheng from JL Warren Capital has translated his comments, which I pass on for readers.
 
“In 1990, Tokyo’s total land value accounts for 63.3pc of US GDP, while Hong Kong reached 66.3pc in 1997. Now, the total land value in Beijing is 61.6pc of US GDP, a dangerous level,” said Mr Mao. 
“Overall, I believe that China has reached its capacity limit for new construction of residential projects. Only those coastal Tier 3/Tier 4 cities have the potential for capacity expansion.”
Mao cites several factors. One, house production had reached 35 per 1,000 persons in 2011--well above the average of 12 in most industrialized nations.

Two, anti-corruption campaigns have spooked party officials who are quickly trying to offload top-end properties.
The numbers of flats and houses for sale has suddenly doubled. “Many owners are trying to get rid of high-priced houses as soon as possible, even at the cost of deep discounts. As a result, ordinary people who want to sell homes in the secondary market must face deep price cuts,” he said.
Three, “[i]n China’s 27 key cities, transaction volume dropped 13pc, 21pc, 30pc year-on-year in January, February, and March respectively. We expect the trend to continue in April."

Four, “[m]ost cities have seen an increase in the ratio of inventory to sales. Among the 27 key cities we surveyed, more than 21 have inventory exceeding 12 months, among which are 9 greater than 24 months. The supply of residential buildings is rapidly increasing month-on-month.” He also notes that 42 projects in Beijing slated to be completed in 2015 will introduce another 50,000 units.

Fifth, "[a]s for the demographic time-bomb, he said China will have 400m people over the age of 60 by 2033. Half the population will be on welfare by then. 'If China fails to develop technology as a driving force for its economic growth, the country will be in trouble.'” On that note, this article from Quartz Magazine observes: "China’s birth rate peaked in 1987, and since people marry approximately 25 years later, that means demand for 'new household formation' homes maxed out in 2012." The same article states: "Rapid aging of China’s population means that future workers will have less and less disposable income to spend on housing in the next two decades."

Evans-Pritchard goes on to indicate that the problem is even worse in the smaller interior cities--the so-called third and fourth tier cities--where 67 of the construction is taking place.

So what is going to happen? It is not clear. According to Evans-Pritchard, 39% of Chinese tax revenue comes from property transactions. Taking that away, government spending is 10% above GDP. Thus, there will be a temptation to kick the can further down the road.
The question is whether President Xi Jinping wishes to take his lumps now by pricking the speculative bubble and forcing capitulation – hopefully in a controlled deleveraging – or whether he will blink as his predecessor famously did in the summer of 2012 and let rip with another round of stimulus. 
Blinking stores up greater trouble later. Credit has already grown to $25 trillion. Fitch says China has added the equivalent of the entire US and Japanese banking systems combined in five years. 
On balance it is better for China to get the trauma over and done with sooner rather than later. But the rest of the world should be under no illusions as to what it means.
This policy decision – should President Xi stay the course – is equivalent in global scale to the decision by Fed chief Benjamin Strong to pop the US speculative bubble in 1928, causing a commodity slump that was transmitted worldwide through the dollar based currency system (Inter-War Gold Standard) and which later snowballed into something far worse.
 
The US was then the world’s rising creditor power, with foreign reserves above 6pc of global GDP, almost exactly the same as China’s holdings today. When China sneezes … you will catch a cold, wherever you are.
Read both the articles cited above.

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