First, let me say that the term bubble could be the most overused term of 2009.  We now are calling anything excessive a bubble; it's become stale.  Of course some things are developing bubbles, but not every asset class as some would have you believe.  Second, much of what I am reading about China today reminds me of the things I was reading in the US in 2005-2006.  With the caveat that knowing what information to believe out of China, and how accurate it all is - is many times harder.  That said, just as one could of raised the red flag in the US property market in 2006 (when it really struck me what was happening), you'd of been wrong to be worried for almost 2 more years.  In fact, you missed much of the party as the last part of a parabolic move is usually the strongest.  [Aug 13, 2009: WSJ - In China, Land Prices Fan Bubble Fears] [July 28, 2009: FT.com - China Warns Banks Over Asset Bubbles]

While China has a huge surplus to pay for its sins, versus America who deficit spends to solve everything, I am still keeping an eye out for the damage that surely will occur from the massive loan expansion in China in 1st half 2009.  [Feb 16 2009: Is China Pulling an Alan Greenspan?] Just as Greenspan's solutions in the early part of the decade were lauded, just as Bernanke's solutions of today are lauded, so are China's solutions from early 2009.  Which essentially was the largest banking expansion relative to GDP in recorded history.  Can anyone say massive misallocation of resources?  [Nov 13, 2009: Ordos - China's Empty City] [Jun 29, 2009: China Business News - $170B of Bank Loans Funneled into Stock Market]  But for now, the world lives awash in a world of liquidity and the damage from these solutions is festering under the surface.  When the music stops - we just never know.  We simply have to remember to always dance near the emergency exit..... and stay as far away as possible from that mind altering Kool Aid.

But to give the Chinese credit, at least they realize they are blowing bubbles [July 28, 2009: FT.com - China Warns Banks Over Asset Bubbles], unlike our central banker (Person of the Year) who claims it's difficult to even see a bubble.... 

Via BusinessWeek:  [click to enlarge graphic to the right]

  • Li Nan has real estate fever. A 27- year-old steel trader at China Minmetals, a state-owned commodities company, Li lives with his parents in a cramped 700- square-foot apartment in west Beijing.  Li originally planned to buy his own place when he got married, but after watching Beijing real estate prices soar, he has been spending all his free time searching for an apartment. If he finds the right place -- preferably a two-bedroom in the historic Dongcheng quarter, near the city center -- he hopes to buy immediately. Act now, he figures, or live with Mom and Dad forever. In the last 12 months such apartments have doubled or tripled in price, to about $400 per square foot.
  • Millions of Chinese are pursuing property with a zeal once typical of house-happy Americans. Some Chinese are plunking down wads of cash for homes. Others are taking out mortgages at record levels. Developers are snapping up land for luxury high- rises and villas, and the banks are eagerly funding them.
  • Some local officials are even building towns from scratch in the desert, certain that demand won’t flag.
  • And if families can swing it, they buy two apartments: one to live in, one to flip when prices jump further. (hello, Miami, Las Vegas, and Phoenix - circa 2006!)
  • In Shanghai, prices for high-end real estate were up 54% through September, to $500 per square foot. In November alone, housing prices in 70 major cities rose 5.7%, while housing starts nationwide rose a staggering 194%.
  • The real estate rush is fueling fears of a bubble that could burst later in 2010, devastating homeowners, banks, developers, stock markets, and local governments. Once the bubble pops, our economic growth will stop, warns Yi Xianrong, a researcher at the Chinese Academy of Social Sciences' Finance Research Center. On Dec. 27, China Premier Wen Jiabao told news agency Xinhua that property prices have risen too quickly. He pledged a crackdown on speculators.
  • Despite parallels with other bubble markets, the China bubble is not quite so easy to understand. In some places, demand for upper middle class housing is so hot it can't be satisfied. In others, speculators keep driving up prices for land, luxury apartments, and villas even though local rents are actually dropping because tenants are scarce. What's clear is that the bubble is inflating at the rich end, while little low-cost housing gets built for middle and low-income Chinese.
  • In Beijing's Chaoyang district—which represents a third of all residential property deals in the capital—homes now sell for an average of nearly $300 per square foot. That means a typical 1,000-sq.-ft. apartment costs about 80 times the average annual income of the city's residents. Koyo Ozeki, an analyst at U.S. investment manager Pimco, estimates that only 10% of residential sales in China are for the mass market. Developers find the margins in high-end housing much fatter than returns from building ordinary homes.
  • How did this bubble get going? Low interest rates, official encouragement of bank lending, and then Beijing's half-trillion-dollar stimulus plan all made funds readily available. (sounds vaguely familiar - where I have heard of these policies before?) City and provincial governments have been gladly cooperating with developers:
  • Economists estimate that half of all local government revenue comes from selling state-owned land. Chinese consumers, fearing inflation will return and outstrip the tiny interest they earn on their savings, have pursued property ever more aggressively.

So back in 2007 when the blog had a small audience, and Chinese stocks were the biggest fad (think fall 2007), I wrote some pieces on how many Chinese companies were taking their cash and speculating in the stock market.  Hence much of their profits were from stock speculating, rather than operations.  It's just 2 years later and we're already on the same path - only this time, it's not just stocks - its' property baby.

  • Companies in the chemical, steel, textile, and shoe industries have started up property divisions too: The chance of a quick return is much higher than in their primary business. When you sit down with a table of businessmen, the story is usually how they got lucky from a piece of land, says Andy Xie, an independent economist who once worked in Hong Kong as Morgan Stanley's (MS) top Asia analyst. No one talks about their factories making money these days.

I am sure this will end well...

  • The central government now faces two dangers. One is the anger of ordinary Chinese. In a recent survey by the People's Bank of China, two-thirds of respondents said real estate prices were too high. A serial drama with the ironic name The Romance of Housing, featuring the travails of families unable to afford apartments, was one of the most popular shows on Beijing Television until broadcasting authorities pulled it off the airwaves in November.
  • The second danger is that Beijing will try, and fail, to let the air out of the bubble. Pulling off a soft landing means slowly calming the markets, stabilizing prices, and building more affordable housing. To discourage speculation, the State Council, China's cabinet, is extending, from two years to five, the period during which a tax is levied on the resale of apartments. Tighter rules on mortgages may follow. Beijing also plans to build apartments for 15 million poor families.
  • The government is reluctant to crack down too hard because construction, steel, cement, furniture, and other sectors are directly tied to growth in real estate; in November, for example, retail sales of furniture and construction materials jumped more than 40%.

Deja vu.

  • The worst scenario is that the central authorities let the party go on too long, then suddenly ramp up interest rates to stop the inflationary spiral. Without cheap credit, developers won't be able to refinance their loans, consumers will no longer take out mortgages, local banks' property portfolios will sour, and industrial companies that relied on real estate for a chunk of profits will suffer. It's not encouraging that the Chinese have been ham-handed about stopping previous real estate frenzies. In the 1990s the government brutally ended a bubble in Shanghai and Beijing by cutting off credit to developers and hiking rates sharply. The measures worked, but property prices plunged and economic growth slowed.
  • Analysts are divided over the probabilities of such a crash, but even real estate executives are getting nervous. Wang Shi, chairman of top developer Vanke, has warned repeatedly in recent weeks about the risk of a bubble. In his most recent comments he expressed fear that the bubble might spread far beyond Beijing, Shanghai, and Shenzhen.
  • One difficulty in handicapping the likelihood of a nasty pullback is the opacity of the data. As long as property prices stay high, the balance sheets of the developers look strong. (again... this should sound strikingly familiar for Americans) And no one knows for sure how much of the more than $1.3 trillion in last year's bank loans funded real estate ventures. Analysts figure a substantial portion of that sum went into property, much of it indirectly. Banks often lend to state-owned companies for industrial purposes. But the state companies can then divert the funds to their own real estate businesses—or relend the money to an outside developer.

Conclusion?

  • For now, the party continues.

As speculators, as long as those wonderful Chinese economic reports keep coming in overnight, our job is to clap like seals, buy stocks in a very earnest manner, and whistle as we saunter past that graveyard. 

Nothing to see here. ;)