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from Financial Times:
Is China ‘the mother of all bubbles’?
By Arthur Kroeber, managing director of Dragonomics Research & Advisory
Published: March 9 2010 04:00 | Last updated: March 9 2010 04:00
Is China a bubble? External market sentiment has gyrated wildly from one extreme, thinly supported opinion to another over the past year.
A year ago consensus held that China faced feeble growth and social revolt by an army of millions of laid-off workers. That turned out to be wrong. By mid-year consensus believed China’s spectacular growth would continue to accelerate. That is turning out wrong, too.
Now the flavour of the month, introduced by legendary short-seller Jim Chanos, is that China is “the mother of all bubbles”. Wrong again.
To the short-sellers, a cursory inspection of various indicators makes it “obvious” that China is a giant bubble. We agree that China’s economy suffers from many distortions and systemic mispricing of capital.
But the problem is that a lot of what goes on in China’s economy is non-obvious, especially to people who have not bothered to educate themselves on the unusual structure of China’s political economy.
The easiest way to understand this is to look at the property market. Pessimists note that China’s commercial and office markets are wildly overbuilt, and that house prices are far too high relative to household incomes. Therefore, prices must crash dramatically, with dire consequences for the economy.
The premises are true: the commercial and office markets are overbuilt, and house prices are too high relative to income. But the conclusions do not follow so straightforwardly.
In macroeconomic impact, the commercial and office markets are of marginal relevance since they account for only 20 per cent of real estate construction volume. They could collapse and remain in the doldrums for years without having a material impact on heavy industrial demand. Housing is the key driver.
But here a variety of hidden subsidies enable people to buy much pricier flats than their income alone would allow, and with little leverage. This helps to sustain rising house prices while reducing the chances of a leverage-fuelled banking collapse.
Roughly 80 per cent of China’s urban residents own their homes – an astonishing number for a country that only began to privatise its housing stock in 1998. In most Western countries, by comparison, average home-ownership rates are around 60 per cent.
The biggest driver of home ownership has been implicit government subsidies. One-third of home owners purchased their homes at subsidised rates from their work units during the initial housing reform programme.
So long as these hidden subsidies continue to have a market impact – and many Chinese urbanites flipping luxury homes today started with a small, government-subsidised apartment – house prices can continue to look strangely high.
Eventually – meaning over the next five years or so – prices will have to normalise, and new housing construction will need to reflect underlying demand from new, low-income urbanites, rather than the desire of the existing urban middle class to store their wealth.
Government policy should anticipate and encourage this shift, by taxing property values and encouraging the development of more low-cost housing. A property tax would help bring down prices and provide local governments with a sustainable revenue stream.
Private developers, meanwhile, have little incentive to build affordable housing while margins on luxury homes are so much higher. Unlike Singapore or Hong Kong, China has no national or municipal housing authorities responsible for building cheap apartments.
Nobody is arguing that the imbalances and inequities in China’s housing market are not great. But we have a hunch that this is a market that can stay irrational longer than those betting against it can remain solvent.
Is China ‘the mother of all bubbles’?
By Arthur Kroeber, managing director of Dragonomics Research & Advisory
Published: March 9 2010 04:00 | Last updated: March 9 2010 04:00
Is China a bubble? External market sentiment has gyrated wildly from one extreme, thinly supported opinion to another over the past year.
A year ago consensus held that China faced feeble growth and social revolt by an army of millions of laid-off workers. That turned out to be wrong. By mid-year consensus believed China’s spectacular growth would continue to accelerate. That is turning out wrong, too.
Now the flavour of the month, introduced by legendary short-seller Jim Chanos, is that China is “the mother of all bubbles”. Wrong again.
To the short-sellers, a cursory inspection of various indicators makes it “obvious” that China is a giant bubble. We agree that China’s economy suffers from many distortions and systemic mispricing of capital.
But the problem is that a lot of what goes on in China’s economy is non-obvious, especially to people who have not bothered to educate themselves on the unusual structure of China’s political economy.
The easiest way to understand this is to look at the property market. Pessimists note that China’s commercial and office markets are wildly overbuilt, and that house prices are far too high relative to household incomes. Therefore, prices must crash dramatically, with dire consequences for the economy.
The premises are true: the commercial and office markets are overbuilt, and house prices are too high relative to income. But the conclusions do not follow so straightforwardly.
In macroeconomic impact, the commercial and office markets are of marginal relevance since they account for only 20 per cent of real estate construction volume. They could collapse and remain in the doldrums for years without having a material impact on heavy industrial demand. Housing is the key driver.
But here a variety of hidden subsidies enable people to buy much pricier flats than their income alone would allow, and with little leverage. This helps to sustain rising house prices while reducing the chances of a leverage-fuelled banking collapse.
Roughly 80 per cent of China’s urban residents own their homes – an astonishing number for a country that only began to privatise its housing stock in 1998. In most Western countries, by comparison, average home-ownership rates are around 60 per cent.
The biggest driver of home ownership has been implicit government subsidies. One-third of home owners purchased their homes at subsidised rates from their work units during the initial housing reform programme.
So long as these hidden subsidies continue to have a market impact – and many Chinese urbanites flipping luxury homes today started with a small, government-subsidised apartment – house prices can continue to look strangely high.
Eventually – meaning over the next five years or so – prices will have to normalise, and new housing construction will need to reflect underlying demand from new, low-income urbanites, rather than the desire of the existing urban middle class to store their wealth.
Government policy should anticipate and encourage this shift, by taxing property values and encouraging the development of more low-cost housing. A property tax would help bring down prices and provide local governments with a sustainable revenue stream.
Private developers, meanwhile, have little incentive to build affordable housing while margins on luxury homes are so much higher. Unlike Singapore or Hong Kong, China has no national or municipal housing authorities responsible for building cheap apartments.
Nobody is arguing that the imbalances and inequities in China’s housing market are not great. But we have a hunch that this is a market that can stay irrational longer than those betting against it can remain solvent.
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