Jul302014

The Chinese housing bubble deniers are wrong

The housing bubble deniers in China use poor reasoning and macroeconomic arguments to ignore their massive Ponzi scheme.

denialHere in America, the bubble deniers — and Never forget the bulls and bubble deniers were completely and totally wrong — the bubble deniers succumb to their optimism bias and comforted themselves with fallacies and wishful thinking, even past the point where denying the obvious was no longer operative.

The same is true in China.

China’s Property Market Is No Bubble

A correction is coming, but not a crash.

By YUKON HUANG, July 24, 2014 12:44 p.m. ET

Will China’s property bubble trigger a financial crisis? Concern is high this year thanks to deteriorating sales figures and reports of large price cuts.

(See: The deflating Chinese real estate bubble could destabilize the world economy)

But China really is different.

ROFLMAO! He really wrote that!

different_this_time

Though a correction is coming, the consequences will be more manageable than common sense might suggest.

I’ll go with common sense on this one. A deflating housing bubble in China could destabilize their entire financial system and disrupt the world economy.

No real property market existed in China until housing was privatized more than a decade ago. Then came the 2008 global financial crisis and Beijing’s credit expansion, after which Chinese land prices surged five-fold, triggering commensurate increases in property prices and other asset values. In other words, the market was trying to establish appropriate prices for an asset whose value was previously hidden by socialist fiat (a pattern also seen a decade ago in Russia).

No, the market was inflated five-fold by a massive lending Ponzi scheme that completely detached values from any basis in cashflow.

Instead of a bubble, therefore, China’s sharp property-price increases could represent the real value of land in a densely populated country.bad_situation

It could also represent a massive Ponzi scheme allowed to go unchecked by a country with no experience in capitalism’s dark side.

If so, they would signal the Chinese economy’s financial deepening, not the imminent onset of a financial collapse.

A main concern is that China has allowed housing construction to outpace requirements, especially in second- and third-tier cities, so prices will fall.

China has inflated a bubble 12 times as large as the bubble in the United States, a bubble resulting in a 30% to 50% decline in real estate values before endless and unprecedented market manipulation stopped what should have been an even deeper correction.

But the correction may not be destabilizing because long-term trends in Chinese property prices don’t fit the typical pattern of a bubble.

permanent_bubbleIt fits every typical pattern of a bubble: excessive debt creation with no relation to cashflow, an unfounded faith in ever-increasing prices, frenzied buying by investors who keep properties empty, and constant denials from people who should know better (“But China really is different.” — Yukon Huang).

China’s property market has seen cyclical downturns followed by rebounds, most recently when housing prices started falling in late 2011 and then turned upward again in the second half of 2012. It is hard to find past bubbles that experienced such significant and persistent price declines before reversing and continuing to inflate.

Great Britain has reflated four housing bubbles, and California has reflated three of them.

When prices start falling in a bubble situation, investors typically rush for the door and cause a collapse.

That China’s property market saw no such collapse in 2012 suggests that its high prices were supported by more than “irrational exuberance” and may be a reasonable floor—

Investors in China felt there was nowhere else to put their money, and the correction didn’t cause lenders to call their bad loans; in fact, they extended even more credit to further their Ponzi scheme.

implying, in turn, that today’s prices may fall by about 20% over the coming year but not more than 30%.

Thirty percent is still a large correction. Prices need to fall 95% in order to reach values supported by cashflow.bankers_denial

These kind of minimal-damage predictions are also characteristic of a bubble. At first, everyone claims prices can only go up. When they don’t, they retreat to prices may soften slightly. When prices crash, the market apologists claim the crash won’t be so bad. At every step along the way, they underestimate the final impact.

The China Household Finance Survey (published by Chengdu’s Southwestern University of Finance and Economics) indicates that even after a 30% decline in prices, only 3% of households would be underwater thanks to high down payments and accumulated equity. The strength of household balance sheets has led the Bank of China to estimate that a 30% drop would have a negligible impact on bank ratios of non-performing loans and thus would have only modest spillover effects.

Wiping out that much equity — assuming we believe their numbers — would certainly cause more than modest spillover effects, particularly in the US where Chinese investors support pockets of our housing market. I speculate it could turn Chinese buyers into desperate sellers.

Still, scaling back property construction will have a negative impact on growth. Construction and real estate have been gradually rising as a share of economic activity for three decades and today account for 13% of GDP. Contraction there will slow growth and have ripple effects on related industries.

chinese_boom

The US economy has been weak for 7 years now because our construction industry, which accounts for a smaller percentage of GDP, has been sidelined.

But China’s construction and real-estate boom, like its property market, does not fit the pattern common to bubble countries. As the nearby chart shows, the 1997 Asian financial crisis saw construction and real-estate activity in other Asian counries collapse after sharply increasing in previous years.

Estimates of China’s excess property stock suggest that construction volume will fall by roughly 10%, subtracting two to three percentage points from GDP growth. Yet the full impact of the correction on GDP growth is likely to be spread out over several years. If uncompensated by other infrastructure investments, it could cause growth to fall toward 6% in the next year or two—but darker scenarios, in which growth collapses to 5% or less, are highly improbable.

Given the impact on the US economy, I think the darker scenarios are very likely.

Many China bears are nevertheless convinced that the only thing that has kept China’s growth so high in recent years is the even faster growth of credit, and that eventually a credit curb will cause a sharp economic contraction.

Yes, it’s called a Ponzi scheme, and eventually, they all collapse.

all_ponzi_schemes_are_unsustainable

That pessimism isn’t warranted given the link between credit expansion, property-price increases and GDP growth.

This is where he really jumps the shark. The link between credit expansion, property-price increases and GDP growth is only sustained by Ponzi lending. This analyst’s macroeconomic models overlook this basic feature of unregulated capitalist markets.

The credit expansion that has supported increases in property prices doesn’t contribute to GDP growth but is reflected in China’s increased fixed asset investment—which is why China’s debt-to-GDP ratio has surged in recent years.

This is compelling evidence of a building Ponzi scheme.

But this increase is only a problem if rising asset values aren’t sustainable.

Since these values are completely unsupported by the cashflow on these properties, it is clearly unsustainable.vacant_hinterlands

Rising debt-to-GDP isn’t a problem if, despite whatever credit was wasted, the bulk of it was used productively and unlocked real value in land-related assets.

Take a moment and look over the post showing entire cities that are completely unoccupied, and ask yourself if you believe any value was created.

As such, most of the surge in Chinese credit since the global financial crisis can be considered healthy financial progress toward more market-based asset values.

Complete and utter bullshit.

China’s debt-to-GDP ratio is about what one should expect—lower than that of most developed countries but higher than that of most developing countries. In this context, China’s property-related debt problem needs to be managed, but it isn’t the catastrophe that some are warning about.

Sorry, Mr. Huang, it is the disaster people are warning about.

Mr. Huang is a senior associate at the Carnegie Endowment for International Peace and a former country director for the World Bank in China.

Apparently, Mr. Huang was a former director for the World Bank in China, one of the architects of the Ponzi scheme. Is anyone surprised to see him deny the problem?

This is going to end badly. I am more convinced than ever that the Chinese real estate market is going to implode into one of the most devastating financial disasters ever recorded.

chinese-rehypothocation

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