Chinese Real-Estate Bust Is Morphing Into a Slow Leak: Andy Xie
It’s Shanghai hairy-crab season.
To cook them, you put them in a container with cold water. They feel like they’re back in a lake and get comfortable. You then cover it with a heavy top and light a fire below. You can hear scratching sounds. They start faintly, then furiously, then faintly again, then nothing. When it’s quiet for a few minutes, you lift the top and see the crabs all golden brown. Dip them in vinegar and ginger for a delicious meal.
China’s property speculators are like crabs in cold water already. They feel good, kicking their legs once in a while. They don’t see any danger. Little do they know the heavy top has been lowered over their heads and a fire is lit below. They will be cooked, but they just don’t know it yet.
In April, I told readers I would let them know when China’s property bubble was about to burst. The market has now peaked. It will trend down gradually for the rest of the year. When expectations of a yuan revaluation reverse and capital outflows ensue, probably in 2012, the market will deflate faster.
China has entered a property bear market that will last for five years. The average prices in larger cities are likely to decline by half or more. Land values will fall by much more. In the biggest and craziest bubble in Zhejiang Province, they may drop 80 percent or more.
Incomes Versus Returns
Why so much? When a bubble deflates, the price must fall to where incomes and returns can support each other. In the case of China’s property market, it means rental yields -- now less than 3 percent -- must rise to 5 percent or more, and the price per square meter should be no more than two months’ average salary.
In a bubble, calling the tipping point is an art. Animal spirits, always the fuel in a bubble, are the last thing to dissipate. Receding liquidity is usually the trigger for a bubble to burst. Sometimes oversupply surpasses speculative demand, which scares off speculators. Most bubbles burst in one big pop. Some leak air bit by bit, day by day.
Hong Kong’s bubble burst in 1997 when the withdrawal of foreign liquidity pushed up interest rates and sucked all the oxygen out of the gambling room at once. The Internet bubble caused a crash in 2000 when the lockups of big shareholders in companies that made initial public offerings expired and the looming supply woke up all the speculators. The U.S. property bubble burst in 2007 as the teasers in the subprime mortgages expired and speculators couldn’t cough up the required cash.
Property bubbles can deflate over many years. Japan’s expanded for two years after the Nikkei-225 Stock Average crashed in the 1990s. Instead of bursting, it fell about 8 percent every year for two decades. Taiwan’s paralleled Japan’s and declined gradually until the China hype revived the market.
In 1998, China’s little-noticed property bubble burst, too. Shanghai real-estate prices dropped by two-thirds over the ensuing three years. Unfinished buildings dotted the landscape in Guangdong and Hainan. More recently, Shanghai’s property prices fell by a third from May 2005 to the end of 2006. Many developments downtown fell by half.
I thought the current bubble, fueled by rapid monetary expansion and expectations of a stronger yuan since the beginning of 2007, would go the same way. Recent developments have changed my mind. This bubble may not end suddenly, but with a slow leak. Previously, I thought the government would relax its credit-tightening policies in the fourth quarter, leading to another surge in property prices. The bubble would pop with a big bang in the second half of 2011 or in 2012.
The government isn’t relaxing the credit restrictions on second and third mortgages. As most potential buyers fall into the restricted categories and depend on credit -- not everyone has sacks of cash -- the market can’t go up another level to release all the animal spirits.
In addition to credit policy, liquidity is tightening. The yuan story has been sort of like a striptease show. After waiting for years without seeing the real thing, the hedge funds are fed up and don’t want to hang around anymore. Even though U.S. Treasury Secretary Timothy Geithner is howling again about China’s undervalued currency, the market isn’t paying much attention. The yuan non-deliverable forward market isn’t expecting significant appreciation for the next year.
That is having a big impact on hot money flow into China. The competition for deposits is heating up. Banks are offering products that are like deposits and with much higher interest rates than the policy rates.
As Chinese real-estate prices deflate slowly now, and faster in 2012, the economy will hold up. Exports, consumption and infrastructure should sustain a 7 percent to 8 percent growth rate for the next decade. That seems low compared with recent years, but it will be much better for lifting wages, household living standards and corporate profits.
China has no home-equity loans for consumption. Those who hold more than 20 million empty flats will become poorer or bankrupt. The sales of Mercedes cars may shrink. But the middle class will be able to consume more as they pay less to buy flats from speculators.
To stop the property deflation from affecting other investments, the government must recapitalize the banks quickly. It has the balance sheet and the wisdom to do so. China has had a strong property market and weak consumption for the past decade. The reverse may be true for the next 10 years.
Like crabs in cold water, property speculators are getting cooked, but the smart ones still have time to escape the slow hot-pot treatment.
(Andy Xie is an independent economist based in Shanghai and was formerly Morgan Stanley’s chief economist for the Asia- Pacific region. The opinions expressed are his own.)
To contact the writer of this column: Andy Xie at firstname.lastname@example.org
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