China’s hard landing conundrum

A Chinese hard  is not an option, at least while there are other options.

So, I have been asking myself for the past few months how to avoid a hard landing, or to delay it at the very least.  The most popular defence of the bullish camp (or the most popular argument against the bearish camp) is that the government and the People’s Bank of China are able to prevent a hard landing (translation: government and PBOC are omnipotent).  The government may use fiscal stimulus again, and/or the PBOC may have rooms to cut interest rates and reduce reserve requirement ratios.

I don’t disagree that there are things that the government and the PBOC can do, but there is still a dilemma here.  Inflation remains well above the target (although it has probably peaked), making the case for outright monetary easing somewhat difficult.  If the PBOC does ease now, that would simply mean declaring a premature victory on inflation fighting and the real estate bubble.  Of course, I can’t really rule that out, and that would delay the inevitable, and does present an upside risk in the near-term.

If inflation and the real estate bubble is still the top priority, that means policy easing isn’t yet on the table.  If that’s the case, some of the problems that we are seeing right now will likely get worse before getting better.  We are already seeing some strains in terms of funding small and medium sized businesses, and real estate developers are having trouble funding themselves as well.  If the overall tightening stance continues, real estate developers will be forced to cut prices in order to obtain cash, and some will probably go bankrupt.  That will weigh on the real estate market.

A Financial Times report suggested that Beijing officials might be rather happy to see some failures of real estate developers:

“There are some developers who are facing funding pressure or have even been cut off. This is something we are happy to see,” said one of the officials, who asked not to be identified. Developers were like “dragons and fish jumbled together”, he added, referring to a mixture of high and low-quality companies for whom a consolidation process was “very necessary”.

Furthermore, Deutsche Bank is expecting  a 10% correction in home prices because it would be a disaster if prices are allowed to fall by, say, 30%:

Those who understand China’s political economy should know that a 15% decline in average property prices in 35 cities within a few months must be accompanied by a range of economic and social consequences. These will include a sharp decline in real estate transactions, a visible deceleration in real estate investments, rising unemployment in the property construction and agency sectors, a further decline in construction material prices, demand destruction due to inventory destocking, and finally a worrying decline in GDP growth and the resulting concern of social stability. In other words, the government will most likely not tolerate a 30% drop, and probably not even 15% in our view. We expect real estate policies will likely be relaxed way before a 30% price decline is observed.

I hear that!

The next question is, however, can you be happy to allow some property developers to fail miserably while at the same time limit the fall in home prices to within 10% so that you can avoid “a range of economic and social consequences”, in other words, hard landing?

Or, if Deutsche Bank’s judgment is true that policy will be relaxed well before property prices fall significantly, we can question whether that will be enough to save the market if the downturn has passed the point of no return.  We should all understand that once a trend is established, it is not easy to turn around.  Property prices in the US have failed to bottom-out even with ultra easy monetary policy, for example. 

So, the real question is, how do you engineer this landing, which requires the wheels on one side of the aircraft to fall off and a gentle touch down on the other side.

Houses and Holes
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  1. It’s simple. If the prices of apartments falls too much, the Chinese government will start buying them to stablize the price.

  2. Captain Benny will do what he can to engineer a hard landing. Just when the numbers coming from China start looking grim, I’d bet on a whopping QE program to be triggered by the Fed.

    That way, they can tank the dollar virtually overnight, driving inflation through the roof in China, just when they can least afford it, hopefully busting the Yuan peg and forcing a Chinese adjustment from their current Mercantilistic policies.

  3. Ultimately, even the China market must reach saturation point. The authorities have fostered a construction boom for political, social and economic reasons, but clearly there are mismatches between supply prices and volumes on one hand, and buyer capacity on the other.

    For example, friends of mine from Tianjin – a reasonably prosperous city in Eastern China – tell me a new apartments are typically priced around AUD200,000. Their academic salaries, including housing allowances and after tax, total about AUD2,200 per month.

    They consider they are moderately well paid by comparisons with others, though they are not affluent. They do not yet own a car, for example. In their opinion, their income is not enough for them to buy a new apartment.

    This is just one example, but they assure me their circumstances are not unusual. While there is a plentiful supply of new housing in Chinese cities, and most of the old housing stock has been demolished, new housing is expensive in relation to income.

    This is the crush point for Chinese people.

  4. So it’s a possible Poor-kin ,with a side order of Greecey baken and euro source
    with sick old uncle Sam ,eclipsed with
    a Job Hope’s encore trapped in the exits
    of ‘Thanks for the Memories…
    arr, who needs food anyway…Cheers H&H
    Stomachs will Roll…JR

  5. There was some talk that the “social housing” projects were rushed earlier this year to prevent a rapid cooling of the economy. Really, the saturation point has already been reached, and desperate attempts are made to hold this shambolic state of affairs afloat. The question is only how long and how hard. The sad reality is that the longer the shambles are held up, the harder the fall will be.
    Back in 2003/4 when the US economy “roared back” on 1% Fed rate, I knew disaster was coming. The same now applies to China. The “if” is no longer a question. Only “when” is still a question.

  6. A number of the “out of favour” developers will be sacrificed. Trialled for corruption – injustice towards the people – for obtaining land illegally/below market value, selling at obscene prices and corrupting local government officials. A hanging or two is the likely outcome.

    Beijing earns a few gold stars and earns respect of the little people.
    This sends a strong message to the remaining developers. Confidence restored.Prices will come down in a manageable way and not crash.

    This is china!

    • Agreed Booga…but I think the developers would also keep some insurance and ensure if they are going down…they will bring some crooked cronies with them. Throw in the internet and a global economic crisis unfolding…and you have yourself a Chinese Uprising

    • Plus throw in all the angry young men who can’t get a ro*ot due to the one child policy shortage of eligible ladies. Yep uprising on the way, sooner or later.

    • Hi Booga, I have to say you know some about China but donot know much. In China, even if the property’s price drop more than 605 percent, it is still too expensive for normal chinese people. in past 5-years, chinese central governemnt did their best to keep the property price flat but failed. the major reason is vast of the overseas hot money has dived into chinese assets and gambling for “Yuan ” apprecaition. These investors (form USA and Europe) have keep giving chinese governemnt pressure to lift “Yuan” up then they can take profit away. Chinese government now trying to beat the property price down and force these investors back to overseas with huge loss. This is a part of “Currency war”.

  7. Failed Bbaby Boomer

    I returned to China for the first time in eight years after working there for three years. I was very interested in the property bubble and I chatted to all and sundry about it (it is a very popular topic). My impression is that people are aware of the unaffodability and numbers of empty apartments but they believe the developers will have to reduce the prices to a reasonable level, and they are prepared to wait for 5 years or more. When I suggested a property crash scenario with developers and banks going down they thought I was wildly pessimistic – the government would not allow that here . . .

  8. “One of the biggest misperceptions about China in our opinion is a belief that the government is monolithic, and run by “a few wise men in Beijing” whose policies are followed to the letter. In our view this could not be further from the truth (A big misperception about China, 23 Feb 2010). Many policies in China are the result of negotiations and compromises between different interest groups, and the policies are often behind the curve and sometimes bring about unintended consequences.”