The Chinese Super-Bubble

Jim Chanos, founder of investment company Kynikos Associates, said that, “China’s on an economic treadmill to hell… They may very well become Dubai times 1000.” As I reported in a previous entry, Dubai is in the midst of its own real estate crisis, one that makes ours look relatively small. $263 billion worth of projects have been cancelled or put on hold; and property values have fallen more than 60%. Some of you may be asking yourself: compared to Dubai, can the situation in China actually be worse? The fact of the matter is that China’s real estate bubble makes Dubai’s look trivial. As if that’s not bead enough, the Asian super-bubble is still growing. Its explosion will likely lead to a massive economic meltdown.

The Chinese bubble’s rapid growth can be attributed to several things. The first reason boils down to poor lending practices. For years, the government kept interest rates unusually low— at around 5.3%. This stimulated the economy and made GDP go up. Little did finance officials know that their efforts to improve the economy would lead to its likely demise. According to Jim Quinn, the author of an article titled Why the China Miracle is Really a Debt- Financed Bubble, “bubbles can only form when monetary policy and/or fiscal policy is extremely loose”. A great example of this— and its consequences— is the American subprime mortgage crisis. Here in the U.S, many people criticize Alan Greenspan for precipitating the U.S. real estate crash “with his 1% interest rates in the early 2000’s”. Now imagine implementing Greenspan’s tactic on an exponentially larger scale— Chinese banks got into this predicament by giving out huge loans with very low interest rates to people who cannot pay them back. Sound familiar? If the outcome of the situation in China even slightly resembles what happened here in America, a massive market crash is almost inevitable!   

Another cause of the Chinese real estate bubble is shady lending. Although government- regulated, most banks gave out many more loans than they were legally permitted. Recent estimates by Fitch Ratings on The Market Oracle suggest that banks lent out about 30% more money— informally of course— in 2010 than the government limit of 7.5 trillion Yuan. A substantial amount of this money was invested in real estate, making the bubble grow. Just like in the U.S, getting a loan in China was far too easy. Common sense and logical thinking were superseded by greed. Amazingly, this all occurred while the government was trying to put such lending practices to an end.

An additional explanation for the Chinese real estate bubble is unsustainable market growth. It’s impossible for the market to grow at such a rapid pace and it’s just a matter of time before it begins to nosedive. The statistics are mind- boggling. According to an article titled “China’s Housing Bubble”, six years ago home prices averaged just 500 Yuan per square meter. That number has skyrocketed to roughly 8000 Yuan. That’s an increase of 1600%! Compare this to the United States where prices only increased about 120% (and look at the chaos that ensued). Such a drastic difference in growth rates puts things into perspective— China is an economic time bomb. Since the market for real estate is cyclical, it’s obvious that such a rapid level of growth will be short lived.    

The main cause of the real estate bubble is a huge oversupply of expensive homes. Government investment in real estate spurred a construction boom in 2007— and it still hasn’t stopped. The Chinese skyline is dotted with what seems like hundreds of cranes.

This dramatic oversupply can be explained by a few things. One is overbuilding. Even in a country this large, the supply of homes drastically exceeds the demand. According to The Market Oracle, there are sixty- four million vacant homes and apartments in China— enough to house 15% of the country’s entire population or 200 million people! As I stated in one of my previous blog entries, there are 18.3 million vacancies in the United States— yes, that’s a huge number— but compared to the Asian Superpower it’s drop-in-the-bucket. Overbuilding isn’t even confined to large cities. Ghost towns have sprung up all across the country, the most famous of which is Kangbashi— 90% of homes there are empty.

Considering this, some of you may be wondering why developers continue building— the answer: speculation. Rich speculators buy these units and, in hopes of future profit keep them in great condition, but refuse to rent them out. These investors are convinced that the government won’t allow prices to fall; so they keep buying homes at an alarming rate, creating a demand that’s at best artificial. This explains why even though vacancies are rising, prices are still falling.

One last reason for this oversupply of homes is market distortion. This mainly stems from speculative investors’ greedy tactics. One reason why vacancies are still rising is because— at today's prices— the majority of the Chinese population cant afford a home. A study conducted last year by The Chinese Academy of Social Sciences found that a typical property costs 8.8 times the average national income. According to The Beijing University of Technology, this figure can be as high as twenty two times the average income in cities such as Beijing. Compare this to five times the average American’s income of around $52,000. Keep in mind, the daily wage of many Chinese citizens is roughly a single dollar. In a country where so many people are poor, demand for such expensive homes is practically nonexistent. Unless prices drop to acceptable levels, vacancies will continue to go up.

Luckily, the Chinese government finally realized that they have a major problem on their hands—sixty-four million vacancies must have been an eye- opener! In an article titled Be Afraid— Very Afraid: China’s Bubble is Set to Blow, Alain Sherter states that Chinese leaders have started to “tighten lending standards and raise interest rates to cool the real estate market”. I don’t think this will be anywhere near enough. It’s too late for the Chinese economy to be rescued; it’s in too deep of a hole. Also, this country’s complicated banking system makes it very difficult for soon-to-go-bankrupt companies and lending institutions to be bailed out. Sherter agrees since he thinks real estate bubbles, especially one this large, can’t be popped so easily. As of April 14 2011, Moody’s Investors Service (a very reputable financial research agency) even reduced China’s “property sector rating from stable to negative”. Most people, including myself, are convinced that the market for real estate in China is on a dangerous path. I think this country its way to an unparalleled economic disaster.

A ghost town in mainland China