Economics by walking around…

By Monday, May 26, 2014 No tags 0

Lady Bell and I were walking home from the gym one fine Saturday afternoon; the same 1,200 metres as always. Suddenly, Bell had her camera out and was pulling me across the road and then having me pose on some abandoned sofas. She snapped the shots of undersigned you see below.

“Bell, isn’t this where we got noodles last week?”

This is the result of a few weeks worth of wrecking ball crews – this entire area used to be populated by hundreds of families. Gone. Overnight. Can you glimpse the highrise apartments in the background? That’s the future of this area.

Welcome to the Five Step Plan for Creating a Property Bubble! Has your teacher explained what happened in the US in 2008? N0? Tell him/her there is now a good chance for a reprise but this time in Chinese. Here is what I see happening on a daily basis:

1. Property developers (often with strong ties to local government) see that property prices are rising by 10 – 20% in certain areas so they get planning permission to build apartment blocks and/or malls. This commonly involves a goodly sum of money (“fragrant grease”) from the developer to government officials to speed the process up. It also involves easy credit – though, admittedly, the Chinese government has tightened the monetary strings over the past year! Tenants are evicted or relocated – this is quite easily done since in fact private individuals cannot “own” land but lease from government on 99 year contracts. Think Hong Kong.

2. Easy soft loans and a booming housing market in Shanghai fed by increasing numbers of upper-middle income Chinese and expatriates guarantee that there will be speculation. Or, rather, in the case of Chinese owners; saving! You see, Chinese are big savers – some 30% of disposable income compared to around 5% in the UK – so buying an apartment is considered a fail-safe way to postpone consumption (= saving). In addition to this, Chinese buyers do not borrow as much of the purchase price of housing as in the US or EU; around 30% of the purchase price has been previously saved by the buyer.

3. The classical bubble starts to build; higher incomes fuel demand for housing…and higher housing prices mean that owners feel wealthier so they can spend more now and defer (= put off ) saving to the future…and building is strongly linked to driving AD in China where some 50% of AD is driven by investment…which in turn creates jobs and drives up incomes…etc. Now there is a self-reinforcing feedback loop.

4. The additional “spice” here in China is the strong element of command economics in the building sector; governments saw the resulting demonstrations and violence during the onset of the US financial crisis with horror since just a slight fall in growth figures means millions of jobless workers. What the Chinese government immediately started to do was build. Build bridges. Build skyscrapers. Build roads. Build government buildings. Build theme parks. Build…everything. Some trillion dollars of public debt piled up within five years leading to an overall debt-to-GDP ratio of 2 (e.g. private and public debt is now some 200% of total income) and this:

“Is there anybody out there?” (From “The Wall”, Pink Floyd, 1979)

You think I’m making this up?! Google “ghost town China” and click on ‘Images’. There are so many brand new buildings and towns/townships that Ghost Town has become an accepted term here. It is now estimated that housing overcapacity is some 15% – i.e. that there is an excess supply far outstripping available demand.

5. “When there’s blood on the streets – buy property!” This is a quote attributed to the Baron Rothschild in the early 1800’s after Napoleon’s defeat at Waterloo. He had a point and it is still valid; sell high before the chaos and buy low during/after the chaos.We are heading towards this crisis right now.

The Chinese government is caught between the proverbial rock and hard place. If they do not continue to fund government infrastructure and building then we can foresee a serious hit to AD and thus increasing unemployment and ensuing civil unrest. If they continue to fund the building (via easy money or government spending) then they are simply delaying the inevitable adjustment when somebody – i.e. one of the buyers of an apartment used as a pension fund – decides to sell and run. That will set the spark off and suddenly property owners will see that the emperor is indeed buck naked and rush to sell off properties previously thought of as “safe bets”. Falling demand…increasing supply; go figure!

At the time of writing there is not ONE SINGLE EXPAT at my school or amongst some very high-powered parents that is unaware of the impending collapse of the housing market! No economics is necessary (but…as always, it helps!) since we see the eerily empty malls, deserted high rises, darkened neighborhoods and skateboard friendly pedestrian zones on a daily basis. So, while I indeed warn you of that most irritating myth that some form of “Consensus amongst scientists” is stronger than a single solitary scientist being correct (shades of the global warming debate and the IPCC here!), there is indeed some strength in consensus when the actors themselves are involved and can influence the market. We have such a situation.

Oh, and being me, I did some checking. There has NEVER, in the history of mankind, been a situation where property prices have risen this fast (literally doubling in the past five years!) and overall debt levels have been 200% of GDP without resulting in a financial crisis. Never.

  • Constantine
    May 26, 2014

    Hi Matt,

    I understand that every government has a duty to keep the economic wheels in motion, but at what cost?

    The world we live in is stuck in a viscous cycle, it’s a shame that we haven’t learnt from our past mistakes and we are moving into the future sinking further into despair. I really dread what the future will bring for generations to come.

    • Matt McGee
      May 30, 2014

      Ah, but then that is the underlying point isn’t it?! I cannot be ‘political’ here but the fact is simply this; the Chinese government *must* keep at least 7.5% growth (latest figures downgrade predictions to 7.4%) to keep status quo in labour markets. There is a marked simmering of discontent in this country where I see arrogant parvenu (= new rich) drivers in Mercedes cars honk and cut off a local noodle saleswoman on a trike! I keep waiting for the explosion a la 1949…or, indeed, your very own Greece 1973 (I lived there at the time). Power from the barrel of a gun can go on as long as bellies are full and living standards rise. My students’ parents tell me about 2008 when about 10 million Chinese labourers became redundant overnight and returned to their villages en masse – and the subsequent thousands (literally) of demonstrations that were violently quelled in the towns outside the major cities. Little of this made the news.

      My take on the issue is that power based on commanding the heights rather than on democratic, free-market, equity-based ideology is power based on wielding a big stick. It works as long as the subjects (people) do not do a serious re-calculation of the opportunity costs of fighting back. This country has 1.3 *billion* people and has refused to publish Gini figures since 2001! Do the math on 1% of the poorest arriving at the conclusion that the squalor of their unemployment means they have nothing to lose in burning a few cars…

  • Nick
    November 17, 2014

    You mention a “democratic, free-market, equity-based ideology.” Sounds like there might be a few contradictions in there….

    • Matt McGee
      November 30, 2014

      Well, possibly. Yet most of us Scandinavians (I’m Swedish) would be inclined to at least accept the *intention* of the above list.

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