Analyzing China's real estate bubble

                                                        and why China will let it burst

                                                                     By Ike Baldwin

Empty roads in Zhengzhou, China

      The photo above is a rather strange sight for many. Lifeless structures and roads fill the entire field of view without a person in sight. What's perhaps more strange is that, in China, 12 to 24 of these "ghost cities" pop up each year. The reason: a banking system with low interest rates that leaves the middle class looking for other avenues of investment. The overwhelming majority of them have sought out apartments, not to live in, but to invest in. The demand has caused China to build large apartment complexes and housing as fast as they can, each structure serving as a physical representation of an urban middle class members' life savings. The rapid and unnatural development rate has created a real estate bubble of immense proportions that, if popped, could lead to an economic disaster. The CCP has the ability to fix the bubble, but president Xi Jinping is too focused on a crackdown on corruption to address the true cause of the bubble: China's flawed banking system.

The Problem

     China’s real estate bubble continues to grow as China creates massive debt to support the demand from the urban middle class. At the end of 2014, Bloomberg reported that China's state owned banks," lost 950 billion yuan ($154 billion) of deposits in the three months through September," and that," new deposits were 23 percent lower than in the same period last year" (Chinese Banks Offer Goodies for Cash). This shouldn't be a surprise as the real estate bubble's existence alone proves that the urban middle class doesn't have much faith in the state owned banks. Therefore, many turn to real estate as a better investment opportunity. Demand for property has caused construction rate to speed to an artificially fast rate. Entire cities are being raised from the ground as fast as possible just to keep the supply and demand balanced. A big problem is created. Since nobody uses these structures, there are almost zero investment returns, and consequently no money to back the huge loans companies took out to build the cities. The banks are constantly being bailed out by the government (more on that later), and the result is a national debt that soars past China’s GDP output. This is the state of the real estate bubble, but further analysis is needed to show why there is just so little trust in the state owned banks.

         

Business insider's private sector debt chart

               The Corruption within the banking system is responsible for fueling the expansion of China’s real estate bubble. In an attempt to make banking investments seem more lucrative, Chinese banks have instilled luxurious incentives for those who make deposits and keep them in the bank for a certain period of time. Such prizes include iphone’s, jewelry, a Mercedes, and more. These incentives haven’t helped; in fact, the banks’ adjustments have only made matters worse and, per Bloomberg," will only push up the costs" (Chinese Banks Offer Goodies for Cash). The incentives plan has only made banks an even less attractive investment option than in years past, but the banking corruption doesn't stop there. Even private banks are being exposed for corruption, as former CEO of Minsheng bank Mao Xiaofeng was arrested for,” having dozens of shareholders below the age of 18” (Probe into China). In addition, Wealth Daily's Briton Ryle reported that China's government has encouraged banks to give out loans even when it doesn't seem the company can repay them. As Briton put it," China is actually giving money away" (China’s Great Money Experiment). When the loans are unable to be repaid, the CCP simply pays the bank what they are owed. A cycle of debt is created by these massive loans and China has dug themselves in a 3.5 trillion dollar hole. The flaws in China's banking system are obvious, so one would think that there would be enough investment by the urban middle class to at least keep the market afloat, but the data says otherwise.

Bloomberg's mock up of a state owned banks sales pitch to potential investors

          Despite the urban middle class’ lack of investment options, demand for property is dropping rapidly. Business Insider's Tomas Hirst discusses the sudden drop in real estate sales in his article "The Scale Of The Chinese Real Estate Crash Is Terrifying", where he states that," chronic over investment in the property market for more than a decade has left a huge overhang of stock leading to a sharp downturn in the sector," which resulted in," sales [falling] by 10.8% over the first nine months of 2014" (The Scale of the Chinese). The chart below shows the drastic decline in the real estate market's sales in the last 6 years. It's clear that the backbone of China's meteoric economic rise isn't so stable anymore as many investors have chosen to invest their money in foreign markets. China could potentially eradicate this issue by fixing their banking situation, but they're too focused on corruption.

China's "solution"

       Xi Jinping is too busy trying to erase government corruption to fix China’s real estate bubble. In a transcribed interview, Anne Steven Yang summarizes Xi Jinping’s agenda when she explains that Xi’s plans,” [have] nothing to do with opening up the economy or social reform,” and that he’s all about,” [tamping] down the cynicism about the system that is increasing in China” (Why Beijing’s troubles). If Xi isn’t focusing on fixing the banking system, then he’s not addressing the real estate bubble. The two are just that connected. James Laurenceson of East Asia Forum shares a similar view about Xi’s governing strategy, saying that,” putting a finger on Xi’s economic reform achievements has been harder,” and specifically that,” there haven’t been any big announcements on privatizing state owned enterprises and banks” (Competition the True). China’s reluctance to address the true source of their economic problems will be their downfall, as the real estate bubble will continue to look frailer and frailer by the day. Some would argue that the bubble will actually stabilize over time, but upon a thorough analysis, that opinion is disproven.

Will it actually burst?

            Some believe that the lowering of housing prices in the ghost cities will stabilize the real estate bubble. The idea makes sense upon a first look. Eventually, the prices will drop to a point where people will actually move in and thus finally give China a return on their investment. The problem is that during all that time when the prices are dropping, the urban middle class’s nest egg’s are evaporating. From there the masses could potentially turn their backs to domestic investment all together, buying apartments in foreign markets instead. That’s why those investing in Chinese business,” [hope] that China would rebalance its economy towards domestic demand” (The Scale of the Chinese). The investors know that letting the real estate bubble work itself out would certainly not be a “stable” situation. In addition, once the prices are low enough to accommodate the general population, there will still no be no jobs in the ghost cities. Since there are no jobs, nobody will move in, and since nobody will move in, there will be no businesses. Clearly, it’s harder to just move everyone into a deserted city than it sounds. So by not addressing the banking issues and letting the prices race down, China’s agenda will allow for the real estate bubble to burst in fantastic fashion.

Comment Stream