More warnings about China’s bubble economy

Following on from Yesterday’s post on Jim Chanos’ crusade against China, another two reports have come to light sounding the alarm bell on China’s bubble economy.

The first article from Bloomberg quotes Richard Duncan from Blackhorse Asset Management, who claims that China’s economy is the biggest bubble in history that may be headed for collapse.

A more than 50% surge in China’s money supply since 2008 helped fuel economic growth in excess of 9% per year, even as trading partners sank into recession. The expansion also saddled the country with factories that produce three times more goods than can be bought by China’s workers, 80% of whom make less than $5 a day, said Duncan.

“China has the greatest economic bubble in history…There’s a real risk it’s going to collapse in a Great Depression-style scenario.”

The pin that may prick China’s bubble, Duncan said, is a backlash against free trade among voters in the U.S., where unemployment last month rose to the highest since April. The U.S. House of Representatives in September enacted legislation that would let U.S. companies petition for duties on Chinese imports to compensate for the effect of an undervalued yuan. Protectionist sentiment could gather steam in the next two to three congressional election cycles, Duncan said.  

Meanwhile, The Telegraph ran an article on a recently released report from the Chinese Academy of Social Sciences (CASS), which claims that China’s housing bubble has grown so large that 85% of Chinese living in cities can no longer afford to purchase a home.

The Chinese Academy of Social Sciences (CASS) said in its annual Economic Blue Paper that a typical Chinese property now costs 8.8 years of average earnings.

In addition, CASS said that house prices are still rising far in excess of wages, putting property more and more beyond the reach of average Chinese.

CASS estimated that Chinese property prices had risen by 15% this year, although the rises in some cities have been far steeper.

By contrast, the UK’s typical house costs five years of wages to buy, according to the Nationwide Building Society, and the UK’s long-term average is four years of earnings.

“House prices have risen steadily for years,” said Zhou Linhua, the co-author of the CASS report. “This has inflated investor expectations of a high return, which has brought more money flooding into the market, and fed the bubble”…

“Property prices are likely to remain high for a while,” predicted Matthew Fang, an analyst at Guosen Securities, adding that demand was still strong and that inflation was rising.

Negative real interest rates have helped to persuade many Chinese to invest in bricks and mortar rather than leaving their money in the bank, and there is a continuing requirement for Chinese men to own their own property before they can get married.

Attempting to quantify the size of the property bubble, CASS calculated what it believed was a “real” house price in 35 large and medium-sized cities in September, using an index of eleven statistics, including per capita disposable income, saving deposits, number of doctors and university students, retail sales volumes and local capital investment levels.

According to its figures, new homes in seven out of the 35 cities were more than 50% over their fair value. Property prices in Fuzhou are 70% too expensive, while those in Hangzhou are 66% overpriced. New homes in Shanghai are 37% overpriced and those in Beijing are almost 50% overpriced.

The CASS’ findings are similar to those of my China’s Colossal Housing Bubble article from August 2010. And my conclusion then is just as relevant now:

A key reason why Australia was able to ride-out the GFC of 2008/09 was because of continued strong demand for commodities by China. China is Australia’s number one export destination, accounting for 22% of our exports. As such, Australia benefited directly from the massive building boom that emerged following the Chinese Government’s 4 trillion yuan ($US590 billion) stimulus package, which led to sharp rises in the prices of commodities, including iron ore, aluminium and copper.

However, if a significant slowdown emerges, evident by a fall in China’s infrastructure construction and/or apartment and home building, then demand for Australian commodities will fall sharply, leading to both lower commodity prices and decreased volumes being exported into China. The economic consequences for Australia from a sharp slowdown in China could, therefore, be enormous and would manifest itself through significantly lower economic growth, higher unemployment and falling asset prices.

What deeply concerns me is that while most of Australia’s mainstream commentators are alive to the opportunities that stem from Australia’s heavy exposure to China, they are completely unaware of the significant potential risks to China’s (and by extension Australia’s) economic outlook.

I hate to always be the bearer of bad news. But a slowdown of the Chinese economy is, in my view, the biggest threat to Australia’s ‘miracle’ economy. Those banking on continuing record high commodity prices and perpetual economic sunshine could be in for a rude shock. Forewarned is forearmed…

Cheers Leith

Leith van Onselen

Leith van Onselen is Chief Economist at the MB Fund and MB Super. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.

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  1. "a slowdown of the Chinese economy is, in my view, the biggest threat to Australia's 'miracle' economy"

    Exactly correct. It has only been resource sector activity that has cushioned the economy – we have little else. And even then, the government wanted to tax the sh*t out of it…

  2. The government should have been allowed to "tax the sh*t out of it" so that the economy doesn't continue to expand on false fundamentals. When it all turns to poo the explosion working migrants will turn into an explosion of unemployed migrants on welfare.

  3. Great article and I entirely agree. What worries me is that Australian consumers have already hit Peak Debt – if China slows and inflated Australian asset prices fall, we are in real trouble. The value of debt will remain the same yet the value of our collateral on that debt will vanish.

    The Chinese and Australian bubble economies only need one catalyst, and that could be Chinese inflation – average factories and restaurants are so stretched that they cannot afford to increase wages in line with other costs.

  4. China has an even bigger problem ahead to deal with – their ageing population. Maybe the State is preparing for this with the massive expansion – apparently 66% of its assets are in construction?? They might just be one step ahead in preparing? However … and let's face it, the state will want to teach the peasants that capitalism does not work. Those speculating on property now will be cremated shortly, serving that lesson, of course the State will get through as they have the big dough and the resources to survive (the way the system works – are you aware of the red phone system and how roughly 300 people run the country?).
    The biggest challenge China has is the inevitable effect of the ONE CHILD POLICY – introduced 1974. Forward projecting peak spending by 42 to 44 years, maybe less (in the western world it is 46/47), add those figures and you get the middle of this decade, perhaps earlier. They will be in for the biggest implosion we have ever seen as deflation is unavoidable. Imagine a young couple's responsibility to look after a number of other generations under the same roof as they grow old … what disposable income?
    Right now inflation is driving up everything, including "household wealth" – it is like a drug. When demand for goods and services drops due to the ageing population, deflation will turn up, the bubble pricked, leaving people with massive debt and little to show for it – plus the burden of supporting their ageing population.
    When the bubble in China bursts is the question, we all need to be ready for it, cash will be king, ironically as it happened in GFC1, the USD is the likely place to put cash. The AUD will be belted back to 55 cents I suspect and the lofty days of perceived wealth in Australia will be over for 15+ years before we see asset prices at current levels.
    It is time for this little black duck to fix and sell his home. We have allocated these holidays to do just that. Oh, did I mention the tax benefits of selling out your home … TAX FREE. Perhaps not for much longer?
    We will wait for the tsunami to go through and rent for 3 to 5 years – housing prices in Australia ought to get back to where the bubble started, overshoot the runway a bit (proven by PhD thesis that booms and busts always go too far) and buy twice the property to ride the capital gain (tax free) once again.
    I'm thinking a 50% fall in our housing prices as our population ages and the demand for everything falls off the cliff – just like the rest of the western world (all due to that pill that stopped the birth rate – sent it backwards for 13 years = X Gen … 1962 to 1975).
    Unfortunately nothing can stop this from unfolding – you can invent people with wealth to pour new money into this golden period of growth (asset inflation)!!
    Cheers, Phil

  5. The signs are really as plain as a train going downhill without brakes, and saying that I am trying to get prepared. Problem is, I'm having trouble is finding an asset class to shift funds into (From cash in the bank $3-$4M) (Got rid of property portfolio) that will save erosion. Cash in banks or under mattress/shares/property, all wont do any good. Basically leaves physical commodities only. Does anybody have any idea's where U would be moving towards, in the event of meltdown?

  6. @anon 1:00 – "The government should have been allowed to "tax the sh*t out of it" so that the economy doesn't continue to expand on false fundamentals." Meaning what, out of interest? That the economy not expand at all (what other than resources/commodities do we have)? And what false fundamentals (seem real enough to me at the moment? And the tax be used for….mmmm I know – funding to small bank/non bank lenders in order to extend the life of the property bubble!

  7. Interesting that the hedge fund managers are being heard more and more in the US and UK. Hugh Hendry in London is echoing Chanos's sentiments about China and has constructed a portfolio of Japanese options that would deliver a tidy sum, should China implode. Like Chanos, he’s talking his book, but you have to respect that these guys are putting their money where their mouths are.

    Leith, congrats on the blog. It’s pleasure to read some Australian economics and market commentary that doesn’t have a jingoistic theme pumping up the strong dollar and the All Ords running through it.

  8. Pardon me, but I have a question for the Anon poster who signs as Phil:

    you said: {just like the rest of the western world (all due to that pill that stopped the birth rate – sent it backwards for 13 years = X Gen … 1962 to 1975).}

    I'm uncertain what your premise was in writing this. Are you for instance suggesting we made a mistake in slowing population growth?