Beginning with the dot com Tech bubble in the United States, the 21st century has begun with an ever-increasing concern about economic bubbles. Much of the world looked on in horror as the housing bubble burst in the United States, with consequences from which they have yet to recover. Here in Australia, we watched in disbelief, secure in the knowledge it couldn’t happen here. Similar sentiment pervaded amongst our Canadian cousins, and even to our trading partners in China.
Now we are bombarded with experts warning us of impending doom here in Australia, in Canada, and yes, even in the economic juggernaut of the last three decades, China.
Is there really a property bubble in China? And if there is, why should an Aussie worry about it? After all, we have our own housing bubble to worry about, among other things. Retail sales are down, our banks are getting downgraded, and the RBA continues to tell us not to worry.
Well, maybe we should worry. Maybe this time, she won’t be right. The fact is the Australian economic boom is inextricably intertwined with China and their continuing need for what we have – natural resources.
Countries across the globe marvel at China’s dramatic economic growth over the last several decades. Yet many of us are unaware the cornerstone of growth in China is property development. In a vast and underdeveloped country, building infrastructure drives GDP (Gross Domestic Product.) And all that building drives the demand for more and more iron ore, coal, and liquefied natural gas – imported from us.
If that demand for property and infrastructure in China weakens, they will not need so much of our stuff and we will be in a bit of a pickle. You can search the Internet for hours for facts and figures, but it all boils down to that simple fact. We have the supply and they have the demand.
While all bubbles have a tangled web quality to them, what is going on in China is without parallel in modern times. You will read comparisons of the current situation in China with what happened in Japan in the early 1990’s and with what happened recently in the United States. Many of these comparisons are worthless because they ignore the single fact that makes a China bubble totally unique. Simply put, theirs is a command economy.
In the United States and in Japan, government policy played a major role in the development of their financial bubbles, but when the dilemma became apparent, they were powerless to do all that needed to be done to prevent catastrophe.
The Chinese government created the property bubble to drive GDP. However, they are even now well aware how their creation is running amuck and taking steps to stop the bubble from bursting.
It all began with lower interest rates and increased bank lending to increase demand. Remember, in China, the government controls the banks. Another aspect of the situation in China that makes it unique is property ownership.
In China the government owns the land. Local governments sell the land to developers and fund themselves from the proceeds of those sales. Some experts estimate as much as 50% of local government revenue comes from these land sales, entangling the government directly into the web of the developing property bubble.
As demand for these properties increased, prices went up. Estimates vary, but there is no denying property values in China have exploded. However, much of the demand is coming, not from home buyers, but from real estate speculators.
Wealthier Chinese citizens have limited access to foreign investments. When the Shanghai Stock Market heated up to the point of a meltdown, the government stepped in and took measures to cool it down. In a command economy, the government needs no approval from anyone to take whatever steps it deems necessary.
The result was the stock market was no longer an attractive place for Chinese citizens to invest their new found wealth. With the government also keeping bank interest rates low, these investors turned to an area where price appreciation was sky-rocketing – real estate.
Today, much of the demand for the real estate boom in China is coming from real estate speculators.
When the Great Financial Crisis (GFC) began, the Chinese government responded with a massive stimulus program of additional infrastructure projects. While Western democracies were hampered by political considerations at every turn, China was free to spend as much as it wanted without objection or interference.
Now you read of ghost cities throughout China, because the average citizen cannot afford to buy the residential property that has been developed. Search the Internet and you will find claims of as many as 64 million empty apartments throughout China.
It seems there is no question there is a property bubble in China. The real question is whether or not it will pop or simply slowly deflate. Already the Chinese government is taking steps to ensure a “soft landing.”
They are attacking the problem of speculative investing in several ways. First, they have added additional real estate sales taxes, nationwide.
They have eliminated all mortgage discount programs that were initially designed to promote demand. In addition, they have raised down payment requirements on non-owner occupied homes and second home purchases to as high as 60% of the purchase price.
Will these measures work? With property prices so high and with a purported oversupply of homes, it seems inevitable prices will fall and the web will untangle as the bubble bursts. However, those assumptions apply to traditional economic models, which China certainly does not follow. They have created some kind of hybrid socialist/capitalist economy that no one in the West may really understand.
If you have been investing in the share market for some time you are aware there have been repeated warnings of the coming demise of the Chinese dragon. Perhaps because of their rabid hatred of its Communist past, some financial experts in the United States have been predicting hard landings for China for years. Yet somehow, they manage to fool us all.
Maybe they will fool us yet again. In reality, there is no shortage of demand for housing in China. There is a shortage of people with sufficient income to buy. Perhaps the Chinese government will find some creative way to fill that gap. Australians should hope they do.
>>Back to the newsletter to view other articles - July 16th 2011
