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Out of Control Policy Blog

Why There Is a Bubble in China

Anthony Randazzo
July 2, 2010, 9:54am

While I am pretty bearish on the U.S. economy, one hope for staving of a double-dip recession is, ironically, a bearish view of China. There is a growing likelihood that the Chinese economy could see a significant slow down in its economy in the coming years, which means one less place to invest. Capital investments area great source for economic growth and can mean more jobs for the nation's businesses receiving the invested funds. With the European markets reeling, and emerging markets viewed as severely unstable, America could wind up as the only real option for investing capital. Only so much capital will wind up in Brazil, Russia, and India (and that is assuming stability in those nation's economies as well).

So why the bearish view of China? It is, admittedly, an incredibly complex nation that outsiders are fools to assume complete knowledge of. However, there are a number of trends that are pointing pretty strongly towards some serious disruptions in the coming months and years. Marc "Dr. Doom" Faber, as recently as September 2009, was cautiously optimistic about China's future. But developments over the past nine months have given him a different outlook. "China's economy will slow and possibly 'crash' within a year as declines in stock and commodity prices signal the nation's property bubble is set to burst," he said in May.

Dr. Doom isn't alone in his concerns. "House prices in Beijing, Shanghai and many other Chinese cities have risen rapidly in the course of the past few quarters," reads the most recent research report from Deutsche Bank. Citing concerns about property bubbles bursting in industrialized nations around the world, the German bank warns, "our set of valuation indicators suggests that these markets are currently overvalued. This also holds for Hong Kong and Singapore." While there remain a handful of skeptics the evidence for a real estate bubble in China is simply overwhelming.

First, property prices have been on a steady climb upwards since 2002 with just a brief dip at the end of 2008 when the world economy was in full panic mode. June 2010 data released by the National Bureau of Statistics of China (NBS) reported an annual growth rate of 12.4 percent in property prices, a near-record clip.

These prices have been boosted by expansionary monetary policy providing cheap credit. China joined the rest of the world's economies in the wake of the financial crisis in using monetary policy to stimulate growth. In 2008, Beijing announced a 4 trillion renminbi ($568 billion) stimulus that state-owned banks used to fund a host of infrastructure and development projects. By the end of 2009, state banks had 9.4 trillion renminbi ($1.4 trillion) in outstanding debt, double the previous year. Since this stimulus was not funded by cash raised in capital markets, as the U.S.'s $787 billion stimulus was, it represents a literal expansion of the money supply in the PRC.

In addition to boosting China's GDP and allowing it to meet a growth target of about 8 percent annually, the monetary stimulus helped keep the nation's real estate bubble inflated. Not only did the cheap credit enable increased speculation in housing-often times by local governments on behalf of themselves-but also by making more credit available for mortgages. The Chinese central bank, The People's Bank of China (PBC), reported that new residential mortgages quadrupled in 2009 relative to 2008. According to NBS Director Ma Jiantang, housing prices dipped 16 percent in early 2009, but rebounded 18 percent by the end of the year to continue the bubble's growth. It is unlikely that the sustained growth pattern would have been possible without the government stimulus, but it remains to be seen if the People's Bank will be able to rein in the monetary expansion to avoid troubles with inflation.

Second, the demand for housing, also boosting prices, is coming from unconventional sources. Across China, massive apartment complexes and high-rises stand empty, but largely owned. Not only wealthy investors and speculators, but millions in China's emerging middle class have bought up many of these available units to hold as a long-term investment. They are owned, but unoccupied.

Owning property is seen by most like owning gold or having money in a savings account-super safe. With a volatile, unproven stock market, restrictions on investing pretty much anywhere else in China or abroad, and poor rate of return from bank or government debt, housing stands out as the most lucrative and stable place to invest. Even the low-end middle class families likely own one to three units, bought with cash, planning to use their increased value for retirement. The very low holding costs in China-there are no property tax-make this an even more attractive investment. And there is widespread belief that prices will continue to rise and yield substantial returns.

Third, there is a growing gap between rent and housing prices in many of the major cities, a universal indicator that a bubble is forming. In February, Hong Kong real estate research group Midland Realty found price-to-rent ratios of an astonishing 546 to 1 in Beijing, and over 400 to 1 in Shenzhen. Shanghai Municipal Bureau of Statistics officials are reporting a similar 500 to 1 ratio, which is well above the 300 to 1 international alarm level. All of this is a growing indication that homeownership is getting far out of range for hundreds of millions of Chinese on the lower end of the income scale.

Finally, the Chinese government is worried about a bubble. In April, the State Council increased the minimum down payment for homes over 90 sq. meters from 20 percent to 30 percent in order to try and decrease demand and put downward pressure on prices. The government also jacked the minimum cash requirement on second homes to 50 percent of the purchase price to reign in speculators.

All totaled, rising prices supported by the government, a host of empty residential housing, and slumping rents equal a supply glut that is nothing less than a Chinese dragon about to pounce.


Anthony Randazzo is Director of Economic Research


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