Macquarie bursts the China bubble

The pressure is growing for China to open up its capital markets as a way to solve its internal bubbles. The question is: how will that affect the rest of the world? The greatest impact of China – its massive scale – is so far largely confined to trade and global production chains. What happens if it spreads into global finance? A report by Macquarie Equities sheds some light on what is happening in China’s property market, which looks extremely familiar (report below). Yes, it’s a developers’ rort.

The Macquarie report notes that the property boom is a major headache for policy makers. Serious, crippling migraine might be a better description. Policies, including bank tightening, are aimed at slowing the price rises. It says that the government is assuming it is a “normal” market.

Trouble is, it is not – or rather, it is distorted and manipulated in the normal way. That is, it is not a free market (in the same way that Australia’s property market is manipulated by developers) The report says the central government tried to release more land to affect the supply demand balance. In Chongqing land almost doubled, but in Changsha it hardly changed and in Zhengzhou land availability actually fell.

Surprise, surprise, it is “the doing of the developers as they hold back releasing new properties on to the market.” They are doing this to maintain margins of about 30%.

The government is moving to restrict financing. But here the true problem emerges – China’s massive levels of re-investment. Investment, as many are noting, is an unnaturally high proportion of China’s GDP, about four times the usual level for developed economies.

The Macquarie report notes a startling fact. In recent years, bank loans have accounted for only 20% of developer funding. Self raised funds have been bigger. Offshore debt market issuance is denominated in foreign exchange, with interest rates of 10-14% – expensive money. Interest on onshore sources of non-bank funding are probably even worse: about 18%.

This bubble has partly occurred because of China’s being closed on the capital account. The money has nowhere to go (it can’t go overseas) so it is being recycled into property or over building of factories. And because it is China, the scale is enormous.

The solution is to provide more places for investment to go, which means allowing overseas investment. There is no doubt that the authorities are preparing for floating the yuan. This will cause massive funds to flow out of the country (and will mean most likely a weaker currency, at least in the short term – so forget the cries of its being “undervalued”).

This might fit nicely with neo-classical economic theory. But what will it mean when they start exporting their scale and attendant problems (such as not really having a  cost of capital)? The 1998 Asian financial crisis was just a problem with Thailand that spread a bit (mainly because Japan brought its production back home and stopped using South East Asia as a springboard into the American economy). When China starts opening up the potential volatility will be far greater.



  1. Er, China is not a ‘developed economy’ by a long shot, so the rate of investment is not abnormal. Any report on China tends to be more ‘humbug’ than fact due to the lack of reliable data. Even the Chinese government admits they have no idea.

    This is the ‘typical’ way a Chinese real-estate development is funded. Company A is an exporter, and borrow money from the bank. Company A then lend the money to Developer B to bypass the government restriction on real estate loans. That’s why the 20% figure is meaningless.

    The Chinese Communist Party is a control freak, and the idea that the Chinese government will open up their capital market is a pipe dream. Whoever wrote that is either trolling or have never set foot in China.

  2. “In Chongqing land almost doubled, but in Changsha it hardly changed and in Zhengzhou land availability actually fell.”

    I’m not sure I would read too much in to that.

    Chongqing is essentially an island in the middle of a river so there are natural constraints to expansion. Not so much the case with the other two. To stretch the analogy to extremes it’s somewhat like comparing Hong Kong island with Urumqi.

    Would be nice to see a more detailed break-down of the figures though. Fully agree with the thrust of the article though. A large part of the explanation for high prices is that government is in bed with the developers. Anger is palpable in China about this. Spark let me introduce you to prairie.

  3. Well i see China M2 is coming down nicely at 15.7% for Feb so all seems to be going to plan. I don’t know why there are so many nervous investors.

  4. PLease Explain why you say “This bubble has partly occurred because of China’s being closed on the capital account. The money has nowhere to go (it can’t go overseas)” when I’ve heard about the Chinese investors who fly in and out on the same day to buy properties in Australia and London???