Bonfire of the vanities

It’s time to balance the view about China and look at the clay feet of the world’s new economic giant. Having discussed some things that China is doing well in recent weeks, there are clouds on the horizon.

One of the most prominent is the real estate bubble, which has already reached the hysterical stage that the U.S. property market was living on prior to the economic meltdown.

China’s economic growth does not mean a person who earns 40,000 to 50,000 RMB ($6,000 to $7,500 U.S.) a year can afford a 1 million RMB ($150,000 U.S.) house.
Understand 40,000 to 50,000 RMB is the median family income for a two-earner professional family in Beijing, and your 1 million RMB gets you a starter home, with less than 1,000 square feet in an outlying area where your commute to work could be a couple of hours.
While Beijing is probably the worst example in terms of the disparity between incomes and residential property prices, it is the undeniable trend that is afflicting all Chinese urban areas.
Of course, there are those who see things differently; in their Shanghai Property Market 2009 Review and 2010 Outlook, Colliers Halifax wrote:
“The economic backdrop will see little downside risk on China’s property market in 2010 as cyclical tailwind prevails, coupling with the government’s continuation of the proactive fiscal policy and “moderately loose” monetary policy to support growth. This helps mitigate negative impacts inherent in the uncertainties on the external front amidst withdrawal of government stimulus in the advanced economies. Policy adjustments on the real estate market will accentuate on supply side, while demand side measures will focus on curbing speculation and warding off financial risk of the banking sector. No adverse tightening is expected for fear of excessive dampening on market vigour.”
Contrast that with the view presented in a Jan. 12, 2010 Xinhua article (Xinhua is the official Chinese news agency, think Reuters/AP for China):
“HARBIN: Looking up at a new building for sale, Jin Jian, a fitness trainer in Harbin, turned and left with a sigh. ‘There’s no way I can afford it.’ The 28-year-old has been dating for sometime but his relationships have gone nowhere. They often failed because the women wanted a man with a decent apartment, said Jin. ‘Frankly speaking, I can’t afford to marry if that means I have to buy an apartment,’ he said. Like Jin, many Chinese born in the eighties, at a time when China began its market reforms, are struggling as a consequence of the country’s bullish property market. With half of his 4,000-yuan monthly income spent on rent and living expenses, Jin needed to save at least for 20 years to own a 60-square-meter apartment in Harbin, the capital of northeast China’s Heilongjiang Province. Decades ago, the newly employed could always make do with dormitories first and later would move into rented apartments after getting married. They were happy because they knew an apartment or house would be given to them eventually by the government. But it is a different story today as home ownership has become an elusive dream for many.”
You can judge for yourself which one reflects reality.
Note, the effect of a real estate downturn in China will be different than what happened in the United States, because the Chinese prefer to buy outright, or put down substantial down payments, meaning they use less leverage and are therefore in a better position to weather a fall in property prices. Banks, on the other hand, could be left holding the bag on loans to developers as high-priced inventory remains unsold.
How to head this off is another matter. Part of the problem is that the economic pistons which have been providing the energy for China’s economic success, the cities, derive a lot of their income from land leases and development activities. While there are many issues which affect the property market, lessening the calamity will depend on the Chinese government’s ability to change the system which currently rewards local government officials for pushing real estate development.
The same cabal of greed and stupidity which precipitated the economic meltdown in the West is present in China; it is the pyrrhic rhythm of human nature. There is a real estate bubble, it will burst (if I knew precisely when, I would be pricing large yachts and small countries) causing many of the same issues faced by the West, but the end result will probably not be as severe because they use less leverage. As always, the poor will be hit hardest, the wealthy will complain the most and although everything will be different, in time it will be more of the same.
Look at us. Despite the S&L crisis of the 80s and 90s, the Japanese real estate meltdown and the countless historical examples of property bubbles, we followed the siren song of avarice when we invested in concepts which were neither real nor rational.
The only thing that we can be sure of is that we will do it again.

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