A bubble is never known until after the fact. I remember the dotcom madness of the late 90s, when absurdities were occurring like Boo.com burning through $188 million of venture capital in six months, with their TV ads achingly hip, but no doubt fearsomely expensive, and Yahoo! buying the Geocities web hosting site for over $3.5 billion when it never looked like turning a profit, despite then being the third most visited US website. (It was shut down 10 years later: an incredible rate of amortization). Yet while these colossal misjudgments seem self-evident, at the time no doubt intelligent people were urging them on. Hindsight is always perfect, of course, and it’s the easiest thing in the world to criticize the mistakes of others, but only in hindsight can errors like these be known: until then, they are cited as proof of “the new economy”. (The most horrifying phrase in business and finance is surely, “It’s different this time”.)
The question on many people’s minds is whether China is different, and whether it can get through what looks to surely be a deflating property bubble without causing a hard landing (a sudden slowdown). In many respects, of course, China is different. The effects of its economic boom have been unprecedented, transforming the world economy in areas as disparate as raw material markets and the US deficit. But to assess what’s currently happening in the Chinese economy is a difficult task, given its macro scale and unique position of being so large and yet still medium-developing. A wise provincial governor, rather than simply accepting the GDP figures presented to him by statisticians, used to look at the underlying figures, such as electricity demand and shipping volumes. When trying to do similarly, I am struck by some of the stories regarding the Chinese economy, despite it still reaching an annualized growth figure of 9.1% in the Q3 of 2011. Let’s look at the various aspects.
1 Local government debt in 20 provinces is over 100% of GDP. Following the economic crisis of 2008, the central government encouraged banks to lend and local government to borrow, to keep the economy buoyant in the face of a sharp decline in import orders from western nations. This was successful insofar as the economy kept growing above 7% (seen as the essential growth rate, below which the economy may fail to absorb new workers). However, the debts remain to be paid off.
2 As much of the money was issued by banks based upon bureaucratic channels rather than based on credit assessment by banks, the lending and spending too often went into unproductive areas. You may have heard about the “ghost towns”, entire cities constructed with not a solitary soul living there. Consequently, the rate of return on these loans is expected to be poor, leaving banks burdened by bad debts. As Reuters commented on October 10th, “Local governments had amassed 10.7 trillion yuan in debt at the end of 2010. The government expects 2.5 to 3 trillion yuan of that will turn sour, while Standard and Chartered [Bank] reckons as much as 8 to 9 trillion yuan will not be repaid — or about $1.2 trillion to $1.4 trillion.”
3 One of the main sources of funds for local government is land sales. At the moment, developed cities (and not just those in the richer eastern provinces) have astronomical land values (and consequently property prices). For example, Bloomberg (July 13th) cites Loudi, a city of 4 million in Hunan province, which issued 1.2 billion yuan ($185 million) of bonds, guaranteed by land valued at $1.5 million an acre. That’s about the same as prices in Winnetka, a Chicago suburb that is one of the richest U.S. towns, where the average household earns more than $250,000 a year”. Average incomes in Loudi, by contrast, are $2,323.
4 Consequently, property prices, as has long been well known, are extremely expensive, but with interest rates below inflation and few other investment opportunities, most Chinese feel there is no other sound investment. However, for prices to be sustainable, there must be willing buyers. Recent moves by the central government to tame property inflation by diminishing demand look to be increasingly effective; but perhaps there comes a time when people at the bottom can no longer afford to step on the property ladder. The Economist (October 23rd) noted, “the number of residential properties sold during the weeklong national-day holiday earlier this month—usually a brisk period for sales—was down by 72% compared with the holiday in 2007”. Prices in one district are down from CNY15,000 a square metre to CNY9,000, while “in March a company in the southern city of Shenzhen caused a stir after it cut prices by 20%”.
5 One of the most worrying signs comes from Patrick Chovanec, associate professor at Tsinghua University’s School of Economics and Management. He says that “With credit conditions tightening, [property developers] systematically ran through the credit lines available: first the banks, then high-yield bonds in Hong Kong, then the private wealth management vehicles that have been popping up all over China, then the loan sharks. Finally, they ran out of options, and had no choice but to start selling some of their inventory at whatever price they could get.” This perhaps explains why, as the Financial Times reported (October 9th), “the ‘big four’ state banks suffered a net loss in deposits of RMB420bn – more than four times their lending in the same period – as savers fled to high-yielding shadow banks.” Savers, and developers, it would seem.
I am sure there are still many signs of strength in the Chinese economy, too. The fact is still it is still growing at 9.1% a year and doubtless has a great pool of would-be buyers waiting for prices to drop to affordable levels. All the same, it shows the tightrope upon which Beijing is walking. These are very delicate days.
Published in Business Tianjin