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China's Fragile Economy, Its Housing Bubble, and What It Means To Us: Download

As promised, here is the complete article, China’s Fragile Economy, Its Housing Bubble, and What It Means To Us, in a downloadable PDF. You can download it, print it out, and read the entire piece at your leisure. The conclusions aren’t encouraging.

China's Fragile Economy, Its Housing Bubble, and What It Means To Us: Part II

We think that China is an indestructible economic juggernaut but its economy is very fragile and it is sitting on a property bubble which will burst. What China does in response has major implications for their economy and the rest of the world. This is the second part of a three-part series on this topic.

China’s Government Tightens Credit

The government is very worried about this bubble and in November they announced new rules to reign in developers:

The new rules … include a minimum down payment of 50% on land purchases from the government. Local-level governments previously asked developers to put down 20%-30% of the value of the land in such deals, analysts said.

The new policy also requires developers to completely pay off land purchases from the government within one year of a sale agreement, with a one-year extension allowed for certain “special projects.”

Developers won’t be permitted to buy new land if they fail to pay off a land purchase in time, according to the statement, which was jointly issued by the Ministry of Finance, the People’s Bank of China, the Ministry of Land and Resources, the National Audit Office, and the Ministry of Supervision.

The new rules also require local governments to fully reflect the proceeds of land sales in their budgets and forbid them from giving discounts to developers or allowing developers to delay payments. …

“Land auctions by local governments will be conducted in a more strict manner than before to meet the central government’s new rules,” said Johnson Hu, an analyst at UOB Kay Hian. “It may not have a direct impact on housing prices, but it sets a tone that shows the government wants to rein in the property market to deter speculation.”

And these moves will hit the economy hard, especially developers:

At the end of August [2009], liabilities exceeded 90 percent of assets at more than 160 developers that have borrowed at least 50 million yuan ($7.3 million) each from banks, the person said. New loans for real-estate development surged 121 percent from a year earlier in the first half to 403.9 billion yuan, according to the People’s Bank of China’s latest quarterly report.

The housing market is starting to cool, but in Chinese proportions:

… Continue reading China’s Fragile Economy, Its Housing Bubble, and What It Means To Us: Part II

China's Fragile Economy, Its Housing Bubble, and What It Means To Us: Part I

We think that China is an indestructible economic juggernaut but its economy is very fragile and it is sitting on a property bubble which will burst. What China does in response has major implications for their economy and the rest of the world. This is the first part of a three-part series on this topic.

We are told that China has huge housing needs, that demand will continue for decades, and that prices have nowhere to go but up. But that’s not how economics works for housing or for any other product. It may be true for China’s long term, but the short run can kill you.

Having been in that business, we were told here that America’s long term growth potential was almost limitless, that new family formations, immigration, and abundant financing would continue to drive the housing market higher. And remember, they said housing prices had never declined on a national basis in the last 60 years.

“They” were wrong as it has now been painfully revealed to us. There are many factors affecting the supply of and demand for housing. And prices do go down, dramatically. So, when you hear that China’s housing market will grow in a linear direction and that its economy will not be impacted by a housing bubble, you can evaluate that statement in light of recent history.

4 Important Things to Know About China

Before I go into the details of what is happening in China right now, there are four things about China to consider.

First, most economic statistics from China are inaccurate. This is the result of state, top-down driven economic planning. The nice thing about a planned economy is that they can pretty well dictate what GDP will be because of the way they calculate it. What they mean by “GDP” is very different than what other countries mean by GDP.

China counts the funds that are distributed from Beijing to local governments and entities as spent when distributed. Retail goods are calculated as sold when factories ship goods, not when they are purchased by consumers. This is an artifact of communist central planning that brought them the ruinous Five Year Plans and the Great Leap Forward (Backward) of Mao Zedong.

Local or regional bureaucrats responsible for allocating resources or implementing policies are often corrupt, inept, and lie about the results of their efforts. What comes to mind is the school in Sichuan province (the so-called “tofu-dregs schoolhouse”) that collapsed during the earthquake in 2008 because local officials were bribed, paid off, colluded, whatever, by the contractor who was responsible for the shoddy product. You can multiply that ten thousand times. No one knows what is really spent and what goes into the pockets of corrupt officials.

Second, local and regional governments and state-run enterprises are in serious financial trouble because of the real estate bubble. A big revenue source for local and regional governments is from land sales to developers. We’ve all heard the stories of landowners and tenants getting kicked off their land to make way for a new block of homes or condos. Their compensation is small, and you can guess where a lot of the money goes. The local entities borrowed lots of money to finance developers. Beijing is so worried about the financial solvency of local governments that Premier Wen Jiabao announced at the National People’s Congress last week that it will issue 200 billion yuan worth of bonds on behalf of local governments.

In a “worst-case scenario,” the non-performing loans of local-government investment vehicles could climb to 2.4 trillion yuan ($350 billion) by 2011, Shen Minggao, Citigroup’s Hong Kong-based chief economist for greater China, said yesterday.

“The most likely case is that the Chinese government will engineer a massive financial bailout of the financial sector,” said [Northwestern University Professor Victor Shih] who spent months researching borrowing by about 8,000 local government entities. …

Su Ning, a deputy governor at China’s central bank, said March 8 that a “fairly high proportion” of total lending last year went to the funding vehicles. Chinese banks extended a record 9.59 trillion yuan of new loans in 2009. Su sees “a big risk” from local-government guarantees for money borrowed to fund infrastructure projects that may not generate returns, he said in Beijing.

… Continue reading China’s Fragile Economy, Its Housing Bubble, and What It Means To Us: Part I

China's Housing Bubble

China has created a new housing bubble. Here are some excellent reports on what the bubble looks like and some ominous glimpses on how it may end. Like all bubbles it will burst and the economic fallout will impact China’s economy and the U.S.’s. The frenzy indicates that the blow-up will [...]