Wednesday, January 11, 2012

If you think our real estate bubble was bad, just wait for China to implode

Thomas Friedman, please take note.  China’s lack of political wrangling is not an asset, it’s what will drag it down.  Friedman’s and other liberals’ utopian dream of a benevolent dictator has never worked.  It fails because unrestrained dictators, with the best of intentions, make mistakes – often grandiose mistakes.  And when they are criticized and challenged, they fight to hold on to power.  And then they become the Stalins, the Pol Pots and the Kim Jong Ils of the world.

And China’s single party autocracy has made a grandiose mistake.  It has embarked on a building spree that according to Australia’s Special Broadcasting Service (SBS) has resulted in 64 million unoccupied housing units.  Entire cities, designed to house millions, stand empty or nearly empty.  Video here  Yet the madness continues with construction continuing unabated, because China’s command economy demands it to sustain GDP growth.  Why do they sit empty?  Because most Chinese simply can’t afford them.  
Unoccupied development in Ordos.  Note the lack of cars


Speculators own many but it is unclear how many and how they can afford to sit on empty properties with no income.  The value of the unsold property is staggering.  Based on 64 million units at an estimated $50,000 each, the total is $3.2 trillion worth of unsold properties.  It is likely local and provincial governments, which do the actual building, are taking much of the hit.

Newspapers in China are reporting provincial government borrowers are being squeezed.   China Daily is reporting many of them are deferring loan payments and it goes far beyond just the real estate market.

China's biggest provincial borrowers are deferring payment on their loans just two months after the country's regulator said some local government companies would be allowed to do so.

Hunan Provincial Expressway Construction Group is delaying payment on 3.11 billion yuan ($490.5 million) in interest, documents governing the securities show this month. Guangdong Provincial Communications Group Co, the second-largest debtor, is following suit. So are two others among the biggest 11 debtors, for a total of 30.16 billion yuan ($4.757 billion – Ed.), according to bond prospectuses from 55 local authorities that have raised money in capital markets since the beginning of November.

As local governments delay payments for projects commissioned as part of the stimulus to ward off recession in 2009, less money is available for bank lending even as China is taking steps to inject more into the economy. The central bank has held interest rates at 6.56 percent since July to boost the economy, while the US Federal Reserve and the Bank of Japan have kept benchmark rates near zero since 2008.

"When companies start to roll over debt they're not retiring debt, and banks aren't retrieving their capital, so you're crowding out new lending," Patrick Chovanec, a professor at Tsinghua University in Beijing, said in a Dec 13 interview. "This is a problem that's going to start to bite next year."

Local governments had 10.7 trillion yuan ($1.7 trillion – Ed.) in debt at the end of last year, 79 percent due to banks, according to the country's first audit released in June. So-called local financing vehicles that meet collateral requirements can have a one-time extension on their loans, Zhou Mubing, vice-chairman of the China Banking Regulatory Commission, said at a conference on Oct 24 organized by the Internet portal Sina.com.cn, according to a transcript of his comments on the website.

Guangdong Provincial Communications Group, Hunan Provincial Expressway Construction Group, Gansu Provincial Highway Aviation Tourism Investment Group Co and Sichuan Railway Investment Group Co owe more than 200 billion yuan ($31.5billion –Ed.)to banks, the data show. They plan to defer 34.4 billion yuan ($5.43 billion –Ed.) in interest payments, according to their bond prospectus.

At the heart of China’s problems is the central government’s emphasis on exports.  With the stagnation of Europe’s economy,  imports from China are in decline and that is slowing China’s growth threatening the nation’s highly leveraged economy.  Robert Samuelson in a recent article in Real Clear Politics addresses the problem:

There are warning signs. Economist Nicholas Lardy of the Peterson Institute cites three. First, Europe's slump has weakened China's trade; Europe buys about a fifth of its exports. Second, housing is showing signs of a bubble and is deflating. Finally, China's government will have a harder time deploying a stimulus than during the 2008-09 financial crisis. Government debt rose from 26 percent of gross domestic product in 2007 to 43 percent of GDP in 2010.

He goes on:

Unfortunately, booms breed busts. Buyers ultimately recognize that rising prices reflect artificial demand. Purchases slow. Prices fall. New building declines. The process feeds on itself. With modest imbalances, the result is a correction. Otherwise, there's a crash.

…A popped real estate bubble could exert a big drag. Housing construction exceeds 10 percent of GDP. That's historically high, says Lardy. At a similar stage of economic development, Taiwan's housing investment was 4.3 percent of GDP. In the recent U.S. real estate boom, housing peaked at 6 percent of GDP. In China, housing stimulates much consumer spending (furniture, appliances) and accounts for 40 percent of steel production, notes Lardy. Land sales are also a big revenue source for local governments. All would suffer from a housing bust.

What does all of this mean for the US?  First it will mean a reluctance for China to purchase US debt, to better use its resources for itself.  That may be the reason for Treasury Secretary Geithner’s current trip to China.  With a reluctant China, interest rates to finance our debt will rise harming our efforts to keep rates low. 

But it could go beyond that. Just as the US was in denial that its overheated real estate market was in danger just before it collapsed, China’s could do so also.  An implosion in China would send shockwaves through all developed countries.  While its $3 trillion in foreign debt holdings ($1 trillion US) could be sold and used, any such attempt would ruin its value. 

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