China’s real estate bubble burst could derail the world economy

The Chinese inflated a real estate bubble more than ten times larger than the United States. Bursting this bubble could destabilize the world economy.

House_CrashWhat would happen if the Chinese housing bubble burst? Obviously, a real estate crash would devastate China, but since the Chinese economy is somewhat isolated and export driven, would a Chinese real estate crash plunge the world into recession? Maybe.

Coastal California real estate would suffer from a crash in China. Not only would a Chinese crash remove a hefty component of local demand, it could turn Chinese buyers into desperate sellers. While US lenders can keep distressed properties financed with US debt from the market indefinitely, but they don’t control the entire market. If desperate Chinese sellers put must-sell inventory on the market because they need cash back in China, Coastal California would feel the pain.

The problems in China go beyond our little niche in the real estate world. A deflating housing bubble in China could destabilize their entire financial system and disrupt the world economy.

Why a Chinese Real Estate Bubble Could Bring Down the Global Economy

by Chris Matthews @crobmatthews NOVEMBER 2, 2016going_down

Trouble is brewing in East Asia. …

Analysts are sounding the alarm about growing Chinese debt loads and a potential real estate bubble that threatens to dramatically slow growth in Asia, and which could be a drag on the entire global economy if it bursts.

If China’s real estate market crashed, the Central Bank in China would print a great deal of money to paper over the problem. The currency would devalue, boosting Chinese exports. While the demand for goods imported to China would fall, and industries that rely on this market would suffer, the flood of cheap Chinese goods would be a strong economic offset to external economies around the world.

In September, Ma Jun, the chief economist of the People’s Bank of China’s research bureau, argued that the Chinese government must take action to stamp out real estate speculation. “”Measures should be taken to put a brake on the excessive bubble expansion in the property sector, and we should curb excessive financing into the real estate sector,” Ma said, according to a translation of a Chinese news report by Bloomberg News.

Other Chinese analysts have been even more vehement. “The dangers of overly inflated housing prices are huge,” writes Hu Shuli, chief editor of Caixin Media in Beijing. “Indicators such as the ratio of mortgage payments to a buyer’s income indicate that on a relative basis, China’s current housing prices are now more expensive than those during Japan’s property bubble, and are close to U.S. prices just before the global financial crisis exploded.”

Local governments in China depend on land sales for funding, so the Central Government feels pressure to maintain the housing bubble and increase construction. Even a slowdown in the pace of construction and development would be problematic for local governments, so the Central government encouraged this bubble to inflate to epic proportions, believing they could manage it — and so far, they have.


Chinese policymakers have instituted measures aimed at cooling the overheating housing market, with some cities imposing “local purchase restrictions, raising mortgage down payment ratios, and tightening developers’ financing,” according to Zhiwei Zhang, chief economist with Deutsche Bank Research. He also points out, however, that these measures may have simply led investors to funnel money into property into cities where real estate has been appreciating less quickly.

Zhang recently conducted an analysis of 252 land auctions in 10 Chinese cities. He found that if land values stayed the same, 105 of those deals would end up being money losers, which suggests that developers still believe land values will continue to rise, despite the warning signs. Meanwhile, mortgage loan growth continues to explode, up 88% YTD in September.

Since this is a government-supported Ponzi scheme, the developers rightly believe land values will keep rising. The government support consistently drives prices up. Why would they believe they have any risk?

Of course, this is a case study in moral hazard, and the longer this goes on, the more distorted, corrupt, and inefficient the market becomes. Does it seem like a good use of resources to build entire cities, leave them empty for 10 years, and then bulldoze them?

Many analysts are predicting that these bubbles, especially those in real estate markets, are presaging serious trouble for the Chinese economy and ultimately for the globe. It’s unlikely that the Chinese real estate bubble, however, will create a financial crisis like the recent subprime bubble in America. The roots of that crisis were that banks lent to borrowers who could not repay their loans, and this inability to repay initiated a chain reaction through the financial system. In China, real estate borrowers have the collateral to repay their creditors if they can’t make their debt payments.

In the US, lenders believed their borrowers had the collateral to repay their loans too. Unfortunately, if that collateral is inflated in value by these loans, lenders painfully discover the collateral isn’t as valuable as they thought.

Still, the existence of these bubbles are an indication of the lack of other investments available to Chinese savers, a problem that has troubling global economic implications. The Chinese government has long capped what banks can pay savers, and is also now cracking down on attempts by citizens to move their savings abroad in search of better returns. These policies help the government funnel those savings at low rates to politically important state-owned enterprises, helping to keep unemployment low.


But this strategy also hinders China’s transition to a more consumption-driven economy, and underscores the government’s wariness of enduring any period of significant economic slowdown or unemployment during that transition. Meanwhile, the government and state-owned enterprises continue to crowd out the more dynamic private sector, making inefficient investments for the future. George Mason University economist Tyler Cowen has worried that this habit of papering over slower growth with investments in projects that will not make the country richer in the long term will just make the cost of rebalancing the economy that much larger over time.

This might not matter much if the rest of the world were expanding robustly. But much of the rich world is barely growing at all, so China accounts for nearly half of all global GDP growth. If an inflating real estate bubble—and the unwillingness of China’s leaders to institute genuine reforms—lead to a significant slowdown in East Asia, it could be a problem that infects the global economy as a whole.

No matter how bad it gets, the Chinese Government and the Central Bank will do whatever it takes to keep the Ponzi Scheme going. The problem with moral hazard is so obvious because the necessity for the government to support the Ponzi scheme is just as obvious. The Chinese government will continue to prop up its real estate market is because the bubble is so large, that allowing prices to find a natural equilibrium will lead to a 90% to 95% reduction in home prices — and that’s not an exaggeration.

We built $500,000 houses for a local population making about $40,000 a year in Riverside County, CA. Prices cut in half there despite aggressive government stimulus before an equilibrium was restored. In China, they built $500,000 houses in areas where the local population lives in shanties on $3,180 a year, so take our bubble and multiply the problem by 12. A 90% reduction in prices is necessary just to bring priced down to where they were as inflated as our bubble was during 2006. Cut that in half again, and a 95% decline in Chinese house prices is a very realistic scenario.

There is more evidence of the 10-fold imbalance. The United States averaged a home vacancy rate of about 1.6% since the mid-1950s. During the housing bubble, due to property speculation, investors began trading empty stucco boxes, and the US home vacancy rate increased to 2.7%, a dangerously high level indicative of a housing bubble.

If 2.7% vacancy is dangerous, what do we make of China’s vacancy rate of 20%?

National Homeowner Vacancy Rate, 1986-2007

Many people envision the Great Reset, the ultimate culmination of Hyman Minsky’s vision. So far central banks around the world lowered rates and printed more money to prevent this reset from happening, particularly in China. Right now, the moral hazard in China is so extreme that nobody believes the central bank will allow the Great Reset to occur — even the central bankers believe it; however, when you consider the size of the enormous bubble in real estate in China, it’s hard to believe the central bank can print enough money to save it.

If China prints enough money to paper over its bubble, it will flood the world with its currency, and its value will crash. Ultimately, the value of any currency cannot exceed the value of a countries assets and the value of goods and services produced. If China’s real estate is 90% to 95% overvalued as I demonstrated above, the actual value of property based on the income of Chinese workers will force the Great Reset to occur — and it’s not like China can raise everyone’s income by 2000% to support real estate because such high wages would ruin its export base and further destabilize the economy.

There’s no easy solution.