International | Apr 07 2010
By Greg Peel
RBA governor Glenn Stevens fears an ever expanding property bubble in Australia and is in the process of raising interest rates to slow that expansion down. Chinese premier Wen Jiabao is also very concerned about a property bubble, as well he might. China's current property price explosion puts Australia's steady price rises to shame.
The acceleration of rising property prices in China has quickly encouraged comparisons with Japan in the 1980s. With the post-war Japanese “miracle” of economic growth reaching a crescendo, stock and property prices were scaling dizzy heights. But it all fell apart in 1990. And Japan has never recovered.
Were the same to happen in China, where would that leave the global economic recovery?
The current Chinese property bubble lends itself to the hefty domestic stimulus package provided by the Chinese government in late 2008, intended to reinstate Chinese economic growth and kick-start the global economy through commodity purchases. While the government's intention was to promote domestic infrastructure spending, leading to job creation and greater disposable income, not all of the money found its way to such endeavours. Much of it was hijacked by property speculators.
Wen Jiabao is now hell bent on slowing the property bubble as tightening measures are implemented intended to reduce 12% GDP growth to 8%. Wen is fully aware of Japanese history. At risk is the Chinese economic “miracle” of the twenty-first century.
Much of the world made the mistake in 2008 of assuming the Chinese economy was “decoupled” from the US and other developed economies and as such would not be impacted by the GFC. But China's economic miracle was based on exporting manufactured goods to developed economies and usurping local products via its artificial currency peg. Despite a billion people potentially being ready to buy their first television, fridge or car, the Chinese were still ostensibly savers, and not spenders, due to their austere communist upbringing. Hence there was little in the way of a Chinese domestic economy that could run under its own steam.
So when the developed world went down, so too did China.
Hence the stimulus package, financed with all those surplus export earnings. But while the stimulus package is undoubtedly a cause of the recent property price surge, it has also had its intended effect, as economists at ANZ have discovered.
ANZ had noticed a recent unexpected increase in trade within Emerging Asia. The first conclusion to draw from this was that lesser Asian nations were exporting goods to China to then be on-sold to China's major markets of the US and EU. The developed world had outsourced its manufacturing to China early in the century, and as the Chinese economy picked up steam the Chinese, too, sought outsourced manufacturing among those lesser nations with lower wage costs.
But if other nations were simply selling parts to China to then be assembled into goods for the West, there would have to be an equivalently unexpected increase of exports from China to the West to explain the increase in Asian exports to China. But there hasn't been.
After extensive analysis, ANZ reached a simple solution – the Chinese consumer is on the move. China is actually consuming exported goods domestically. Ergo, the stimulus is working.
Previously, the Chinese economy (one fifth the size of the US or EU economies) featured only about 35% household consumption compared to the 60% of the EU and 70% of the US. For China to truly be “decoupled” from the West, this ratio would have to balance out. Now it appears that is exactly what's happening, and recent Chinese retail sales data increases bear such a conclusion out.
If Chinese spending is on the increase, Chinese incomes must be on the increase, and the data are supportive here as well. Indeed, the analysts at GaveKal believe Chinese incomes are probably higher than current data suggest. And if incomes are higher, then it stands to reason that property prices will also rise.
Nevertheless, Chinese income growth is nowhere near as rapid as house price growth. With average prices running at ten times average income, GaveKal admits “apparent madness”, or at least that prices are “certainly unreasonable by any normal standard”. Yet GaveKal is not yet overly concerned.
GaveKal sees Chinese property prices as irrational, but suggests the irrationality can last a “fair bit longer” than others might think – maybe even three or four more years.
One reason GaveKal does not see imminent danger is the effects of the current subsidy system. China is in the process of replacing all its decrepit old urban apartment blocks with new ones, but owners of old flats cannot necessarily afford the new flats. Hence the government is subsidising such purchases, affecting a capitalisation of inner-city land values. This can go on for some time.
Eventually incomes will rise to make new flats more affordable, and house prices will begin to normalise as subsidies are withdrawn. The ideal scenario is that house prices rise by only 6% while incomes rise by 12%, for example, and average Chinese start buying their dwellings out of savings. However, GaveKal admits that the whole process would be sped up with a house price “crash”.
This is what Wen Jiabao, and the world, is looking to avoid – a bursting of the bubble. But what exactly would be the ramifications?
We know what the ramifications were in the US as house prices began tipping over in 2006 – a GFC. But Americans were mortgaged to the hilt, and their total household debt to income ratio had reached ridiculous levels (as is the case in Australia). Chinese household debt, on the other hand, is minimal. Mortgages represent just 34% of property value, and total household debt last year was only 16.5% of GDP. (Developed world equivalents have reached well over 100%.)
In other words, if Chinese house prices crash, so what? There would certainly not be a devastating impact on consumer spending. Indeed, suggests GaveKal, consumer confidence may even rise given houses would suddenly be a lot more affordable, and savings could be released to enjoy this wonderful new concept of property ownership.
That is not to say there wouldn't be victims. Local governments and state-owned banks have collateralised vast amounts of borrowing with land at inflated values. But as GaveKal points out, Chinese public entities are all part of one big, closed-state system. There is no obligation to mark property values to market. It would actually be in everyone's interest to simply leave the accounting alone until the Chinese government has moved further down the path of liability restructuring.
It is GaveKal's conclusion, therefore, that the Chinese property “bubble”, which is a bubble in anyone else's terms, could happily carry on for a while without causing disruption, and that even if there were a house price crash it would not necessarily be a bad thing.
It would not be another Japan.
On that basis, between ANZ's belief in the emerging Chinese consumer and GaveKal's downplaying of a Chinese property crisis the rest of the world should not really have much to fear.
