Alarm over China’s bubble economy continues to grow.
First, Western commentators, led by Jim Chanos and Vitaliy Katsenelson, warned that China’s economy is over-dependent on fixed asset investment – i.e. building infrastructure, real estate and manufacturing plants. This over-investment in fixed assets, which now comprises a whopping 60% of China’s annual GDP, has caused China to build far too many things (apartments, factories, etc) that are not needed, resulting in significant over-capacity and malinvestment that will ultimately lead to a pile of non-performingloans and destruction of wealth. One only has to view footage of China’s empty cities to understand the extent of this fixed asset malinvestment.
Then, as reported last week, Yu Yongding – a prominent economist from within the Chinese establishment – published a scathing attack on China’s economic model in the state-run China Daily. This article supported the concerns voiced by external commentators over the Chinese economy.
Now the Shanghai Daily has published an explosive article entitled: It’s only a matter of time before China’s housing bubble bursts. Here is an extract of the best parts:
…Property developers everywhere are competing to break records for the highest land-bidding prices, hence, we see a series of “kings of the land,” referring to lots acquired at the highest bid.
What’s more, the fever for land acquisition is spreading from the major cities, mostly coastal ones, to medium and small cities.
…Frustrated people are even beginning to doubt that authorities have silver bullets, and scrambling to buy before prices rise further. This is a vicious cycle, making it more difficult to control prices.
The People’s Daily has been bashing tudi caizheng, or “land revenue,” meaning taxes and fees local governments levy on developers and other land users.
Almost everyone knows that tudi caizheng is at least partly responsible for the ever-inflating bubble.
National data shows, during 2001-2003, the total land-sales revenue was over 0.91 trillion yuan (US$137 billion), accounting for 35 per cent of total fiscal revenue. The figure for 2009 rose to 1.5 trillion yuan, equivalent to 46 per cent of the total.
This year’s figure is expected to surpass 2 trillion yuan, an astronomical one.
In the breakdown, the combined land revenues for Beijing, Tianjin and Shanghai – whose housing prices are among the nation’s highest – are expected to hit 400 billion yuan, 20 percent of the expected national total of 2 trillion yuan. In contrast, the combined GDP of these three cities accounts for only 11 percent of the national total.
Many other cash-strapped cities and counties are virtually running on land sales.
…The adoption of the “revenue-sharing-scheme” in 1994 gave governments great incentive to sell as much land as possible at top prices.
While the ingenious model did spur economic development, it sowed seeds of risks.
With farm land disappearing around cities, vegetables and other food are more expensive; conflicts – many bloody and even deadly – are escalating between demolition teams and home owners.
…Despite wide concern over rising risks, few seriously think the bubble is likely to burst here, as it did in Japan, Ireland and now in Spain.
The latest buzzword is “rigid demand” for homes, meaning demand is endless considering the huge population and booming economy.
There seems to be a “China Myth.” Is that true?
A study of the Japanese property bubble may be helpful.
In the heyday of Japanese prosperity, the land value of Tokyo alone exceeded that of the entire US. Japanese tycoons were considering buying up America. What happened later is history.
Wandering around newly completed residential areas near my home in Shenzhen – stacked with gleaming apartments, I find 80 per cent of the units are still unoccupied one year after completion. The same is true in Beijing.
Prices have made ownership impossible for most buyers. So, it’s a matter of time before the bubble bursts…
This article illustrates just how much of a bind China’s Government is in. Although it wants to reign-in the property market, it has to keep the bubble going in order to preserve local government finances. But by perpetuating the bubble, the Government is on a collision course with ordinary Chinese who are being squeezed by rising costs of living. Not only have housing costs gone through the roof, but food prices are rising due in part because farm land is disappearing to make way for new development.
And although the Chinese believe they are different, the fact remains that China’s housing bubble is approaching Japanese proportions. Whereas Japan’s residential housing values reached a stratospheric 3.8 times GDP at the peak of its bubble, China’s housing values were 3.5 times GDP as at February 2010 (see below chart from my Battle of the Bubbles article).
Implications for Australia:
Instead, I will point you to an excellent article by fellow blogger, Financial Follies, entitled Australia’s unhealthy dependence on China. It’s a brilliant discussion of the devastating impact that a China slowdown could have on the Australian economy. I highly recommend that you read the entire article. Here is a sample:
…Like it or not, our economic future is now inextricably linked to that of China. China now accounts for an astounding two-thirds of world iron ore demand, around one-third of aluminium ore demand and more than 45% of global demand for coal.
…Michael Pettis of Peking University has been arguing for some time that China is running up against the limits of it’s investment and export-led growth model, and that the days of double digit growth rates will soon be a thing of the past….”It seems to me that consumption growth of 8-9% will be very hard to maintain, so I would argue that we should be prepared for even lower average growth numbers, perhaps in the 3-5% range… Non-food commodity exporters will be badly hurt”.
…What would the implications be of such a drop in China’s growth rate? Fitch Ratings recently performed a “stress test” of what would happen if Chinese growth slowed to 5% in 2011…Fitch expects that such a growth slowdown would cause a major crash in Asian stockmarkets, and a 20% fall in commodities prices.
…Fitch identifies iron ore exporters as amongst the biggest potential losers…But perhaps the most interesting section of the report is Fitch’s expectations of what would happen to banking systems and financial markets in the event of a sharp slowdown in Chinese growth….
…Fitch anticipates that a material slowdown in the Chinese economy would have a negative effect on the willingness of global banking systems to continue providing credit… Those countries with the heaviest reliance on China as a destination for exports (Hong Kong SAR, Taiwan, Japan, Korea, Singapore, Malaysia, Australia, Brazil, Chile, Peru and Russia) could potentially see a retrenchment of their banking systems, with credit availability reducing…
This impact could be exacerbated by negative developments in the real estate markets of those countries with strong trade links to China, particularly those where property prices have risen strongly over the past 12–18 months, such as Singapore, Hong Kong, Taiwan and Australia.
…So let’s summarize the implications for Australia of a sharp growth slowdown in China. Firstly, our miners will be heavily hit as Chinese demand contracts and commodity prices drop significantly. The Australian dollar will probably fall sharply. International investors will become risk averse, and may be unwilling to refinance the massive external liabilities of Australian banks without demanding a large risk premium. As credit dries up, Australian property prices will inevitably fall. This is an ugly scenario all round.
The risks articulated by Financial Follies are similar to the doomsday scenario described in my 6 December post. That is, where China’s economy slows considerably causing: (1) Australia’s Terms-of-trade to crash; (2) increased unemployment; (3) severe worsening of the Budget bottom-line; (4) credit rationing and severe bank stress; and (5) a house price crash.
Batten down the hatches, Australia. Things could get ugly.