Bust Looms As China Booms
Part 1 of 2
It’s an eerily familiar story. Shortly before the American housing bubble burst, pundits across the globe argued that the world had reached a new plateau of economic growth, where the old rules of economics no longer applied—"this time it’s different."
The same has been said about the current boom in China, specifically with regard to its large degree of top-down state control over the economy, which somehow enables it to ignore the laws of economics.
Indeed, this notion seems plausible, according to traditional Keynesian aggregates. After all, China’s GDP growth recovered in record time and at record pace from the global slowdown in 2008, hitting a staggering 10.7 percent toward the end of 2010.
While some of this growth certainly comes from true economic development, a substantial portion is driven by monetary expansion, government “stimulus," and a massive, unsustainable real estate bubble.
In 2008, in order to get back to post-crisis growth levels, the Chinese government prescribed a favorite statist remedy for times of economic hardship: monetary expansion. This was “necessary" in order to increase domestic investment and consumption, as well as to compensate for the slowing down in exports. In November 2008 the government also announced $586 billion worth of “investment" with the very same purpose.
However, when governments claim to be “investing" in something, one should always substitute it for “spending" or “printing money." As governments rarely spend money with the hope of reaping a profit, there’s no way of knowing whether it was put to productive use or not. Even when profit-and-loss calculations guide these “investments," the capital still comes from forced taxation or inflation rather than voluntary savings.
Hello, Anybody Home?
Well-known Austrian investor Jim Rogers has long played down speculations about a major Chinese bubble. He argues that while real estate prices in some coastal cities are overheated, a cool-down of these would leave a slight dent on Chinese growth rather than result in a major slump. The rest of the country, he says, is “hardly in a bubble."
Another well-known investor, Doug Casey, is a lot more pessimistic, arguing that China “is in an unbelievable real estate bubble," which will cause “millions of Chinese—and the banks that lent them money—[to] lose everything."
There is certainly good reason to be concerned about China. A study conducted last summer by the Beijing University of Technology reported that a typical Beijing flat costs a staggering 22 times the average income in the city, while The Telegraph reported in December that the same figure for the city of Shenzhen is 18. On a national level, the Chinese Academy of Social Sciences (CASS) concluded last year that a typical Chinese property costs 8.8 times the average income. Compare this to just 5.5 in the United Kingdom in 2007 and 4 in 2009. In the United States, home prices peaked at a little over five times average income during its housing bubble, according to the S&P Case-Shiller Index.
A Housing Development in Ordos
As in the United States, the Chinese real estate market is plagued by over-construction, and not just in megacities like Shanghai, Beijing, and Shenzhen. Brand new ghost towns have sprung up all across China in recent years, the most famous of which is perhaps Kangbashi in Ordos, Inner Mongolia.
That city’s housing capacity can currently accommodate well over 300,000 residents, yet only one-tenth of that number actually live there. Numerous other, lesser-known cities also boast swaths of high-rise apartments and majestic public buildings while appearing to be entirely devoid of residents.
Jim Chanos of Kynikos Associates claims that the new office space currently being constructed in China is enough to provide a five square-foot cubicle for every single citizen in the country. And that’s just corporate real estate. Finance Asia reports that some 64 million homes and apartments across China have sat empty for the past six months, enough to house 200 million people—15 percent of the country’s entire population. Along the same lines, a study conducted in 2007 by the Beijing Union University found that 27 percent of all newly sold apartments in over 50 different residential areas in Beijing remained unoccupied.
Why, then, is this mad overproduction continuing? After all, such massive discrepancies between units produced and units actually inhabited should result in falling prices.
However, most new real estate developments are actually snapped up before they’re even built. The buyers are usually speculators who refrain from even renting out the properties, hoping instead that they will yield even higher profits once flipped in pristine condition in the future. Bill Powell of Fortune recalls a neighbor in Shanghai who has bought a staggering 43 homes in just three years for this exact reason.
This absurd demand is in turn enabled by the aforementioned credit expansion. Officially, Chinese M2 (a broad measure of money supply) grew by 58 percent between November 2008 and December 2010, while total bank lending (including informal lending) is said to have doubled in 2009 compared to 2008.
A contributing factor to the real estate mania is that, to most Chinese, real estate is the most lucrative and (seemingly) the safestinvestment option available compared to the alternatives; bank deposit rates are below CPI inflation, domestic stocks and other equity have performed poorly in recent years (to say the least), and capital controls still prevent citizens frominvesting overseas.
Markus Bergström is a student in cognitive science at Umeå University, Sweden, and an associate with the Swedish Mises Institute.