View to China

I had lunch today in a stylish, modern restaurant.  From where I sat, I could gaze upon parklands, with elegant bamboo trees strewn beside a serene, calming canal.  The clientele appeared well-heeled, a mix of office workers from the nearby business parks out on their lunch hour and housewives catching up with each other. 

As an ex-expat, this, as it happens, is the China I know best.  Shanghai, to be exact.

In the neighbourhood around this restaurant, prices for apartments can still sometimes match the highs that they soared to in around 2006. Real estate prices, even those in less tonier parts of town, are beyond the reach of most of the population here in Shanghai, which is why apparently a TV programme about “house slaves” became such a topic of discussion, simply because it hit a collective raw nerve among the younger generation of urban Shanghainese saving to buy their first home in seemingly economically impossible circumstances.

I confess to having only half-paid attention to the noise about China’s real estate affordability crisis in the past few months, since I have continued to hear personal stories of ordinary wage-earners who are still able to afford apartments in Shanghai, even if these properties are not in these so-called “chic” districts.

Yet, that real estate prices have stubbornly remained high as a multiple of wages is the reason why the other news that continually does the rounds is the China “bubble”, including the latest from “contrarian investor” James Chanos. 

Now, I have been hearing about the China bubble for many years (yes, including Gordon Chang’s The Coming Collapse of China, which, respectfully, has yet to come), and every now and again the talk about it buzzes a little louder than usual.   In 2005, while I worked – like so many other foreign lawyers in China – on direct foreign investment into the domestic Chinese market, things did indeed feel like a bubble.  Since bubbles are largely about investor overconfidence and irrational exuberance, I have decided – and you can accuse me of being simplistic – that foretelling a bubble is just as well done through recognising a “feeling” than relying on statistics and economic indicators. (In a previous incarnation as a lawyer in Australia, about ten years ago now, I worked on a number of deals advising media corporations investing in dot-com start-ups.  That frothy feeling was unmistakeable.)

Anyway, in 2005, there was simply way too much liquidity sloshing around and a lot of it found its way to China.  I remember thinking that foreigners seemed to be banging on China’s door with fistfuls of cash in their hands.  And I was right, in a way, but actually wrong about the scale of the problem.  It was not merely a “China bubble”.

Since then, I have read of a number of looming asset bubbles in China, especially stock exchange bubbles, in part due to the staggering liquidity tap that was turned on by Chinese banks in the first half of last year.  In that astounding first half of 2009, Chinese banks pumped RMB 7.4 trillion into the economy through new lending.  One estimate is that some 20% of this went into the stock market rather than investment in capital projects (I wish I could tell you where these statistics come from, but my rather dated notes do not say. I believe they were cited in The Economist.)

But the way Chinese banks heartily followed the directive of the Central government to increase their lending still did not – if you will excuse me – “feel” like a bubble.  The Shanghai Stock Exchange has become something of a rodeo show in the last few years, but still has not in my view become irrationally overpriced.  Even the complaints that the RMB 4 trillion stimulus plan has ended up unevenly stimulating investment, rather than consumption, demand does not mean that the gains in economic growth are unsustainable (although it does create a separate problem of income gaps if wages do not catch up with corporate profits).

However, here is where I have to admit that even I have begun to turn pessimistic and started listening to the “bubble-talk”.

On my most recent visit to Shanghai, I found that the landscape on the trip from Pudong International Airport to my hotel had changed dramatically and very quickly in the space of six months.  This immense transformation was unsettling and it consisted of block upon block of new apartment housing.  When I visited another Chinese city in the North, there were similarly many more apartment blocks recently built, lying fallow, waiting for occupation.  People have invested in these properties in one form or another, probably banking on continuingly high prices to be realised.  But with so many of these apartments out there, simple supply-and-demand economics tells us that price equilibrium will be achieved at a much lower point.  Plus, the “house slaves” have been stretched to the breakpoint of their affordability, and something naturally will have to give.

And that looks like a glut to me. Even in China’s never-ending, ever-growing consumer market, this looks and smells and feels like a glut.

What does that mean for China?

I watched a recent BBC special, which many of you may have caught, which featured two teams debating the proposition that “Dubai was a bad idea”.  Simon Jenkins of The Guardian newspaper, whom I respect very much, was for the proposition and he had this to say about the Emirate, and I paraphrase:

There is nothing intrinsically wrong with capitalism or expansion built on capitalism.  There is however a difference between rapid expansion on the terms of your own markets (in Dubai’s case, oil) and rapid expansion based on something that is not market-based (in Dubai’s case, Sheikh al-Maktoum’s vision of a grand international city, replete with the tallest structure in the world).  And this was Dubai’s “downfall”.

I accept Simon Jenkins’s view (his team lost, for the record) and think that herein lies the difference between Dubai and Shanghai.  China’s real estate expansion has occurred as a result of runaway market forces.  The glut, I believe, will play itself out ultimately through the natural interaction of those same market forces.  Pain will come to many real estate investors, and many of them will become insolvent as the over-supply of residential real estate translates into far lower realisations than they had thought.   I do not expect the government to intervene in any significant way.

In other words, the bubble will burst.  The real estate bubble, that is.

However, this will not spell the end of China’s boom.  It will mean a serious correction in real estate prices and the real estate market will turn sour for many, for a while (perhaps for a long while). 

But it will not be a China bubble.  China’s economic fundamentals i.e. a vast local consumer market that has yet to reach its potential, an ongoing competitive advantage in labour costs, a relatively cheap currency (a debate for another post!!) and significant currency reserves, will ensure this.  So, I doubt it will even mean a recession for China, let alone a collapse (recalling that China’s main economic players are – for the moment – not its consumers). 

China has so many cards to play and its growth comes from so many engines, that it will ultimately be a blip (yes, and I really do mean a blip!) that will be viewed as a necessary, and who knows, even a welcome, correction.