China Business Blog and Podcast

Item from today’s Bloomberg – “China’s property market is a bubble that may burst by as early as this year, according to hedge fund manager James Chanos.” According to Chanos, this will put China’s economy, “on a treadmill to hell…” when the real estate bubble bursts later this year or sometime in 2011.

This Bloomberg report on Chanos’ comments is the latest prognostication on China’s property bubble from a respected Wall Street financial guru. The article cites supporting forecasts from Mark Faber and Kenneth Rogoff, also highly respected financial economists who were on the right side regarding the U.S. economic meltdown. We have actually heard this forecast for China before and you will see more items like this in the U.S. business media over the next few months. Even Charles Evans, the unflappable president of the Chicago Fed, raised a question about China’s property bubble when he recently visited Shanghai and Beijing.

It is absolutely true that (1) residential property prices in major urban centers have more than doubled in the last couple of years and (2) the recovery in China was driven by massive bank lending (some US$1.5 trillion in 2009) that was largely soaked up into the property sector. High-end residential real estate prices in Shanghai jumped 60% in 2009 alone. Average residential real estate prices were up 10% year-on-year in February 2010. Furthermore, Chanos is also correct that China’s still hot economic growth is primarily driven by investment, not consumption. Investment is well over 50% of GDP, certainly the highest investment/GDP ratio in the world for major economies. To kick the economy back up to speed, Beijing just slammed the investment pedal to the metal once again, injecting massive liquidity through the State-owned banking system last year, in addition to the $585 billion Chinese stimulus program.

However, I do not buy the forecast that there will be a sudden real estate price deflation, particularly in residential property prices. The government routinely manipulates property price levels, using transaction taxes and access to bank lending to either stimulate or cool the property market. Right now, we are in a cooling phase, with the government raising real estate sales and business taxes, doubling mortgage down payment requirements, and dampening speculative buying dampened with local rules limiting the number of apartments that can be purchased by a single owner. But the government can just as easily reverse these levers, as it did in 2008 when property prices briefly showed negative growth.

Chanos and the other pundits who expect a property market crash in China have missed the invisible elephant in China’s “socialist market economy.” The simple fact of the matter is that there are about 10 million active Communist Party members who control the government, the banks, the State-owned sector, land allocation and development, and many other elements of the economy. Guess what – they are all residential property owners, in many cases of multiple residential properties and in some cases of commercial property! The levers of political and economic power are in the hands of the same relatively small group that benefits from rising, or at least stable, real estate prices. They will continue to pull those levers in a way that maintains the value of their assets. They would lose substantial personal wealth from a sharp decline in the residential property market. Given low bank interest rates and highly volatile domestic stock exchanges, real estate is the primary reservoir of personal wealth.

This is why urban real estate prices in China appear to defy the laws of economic gravity and will probably continue to do so for the foreseeable future. There is more potential volatility in commercial property prices than in residential prices, but this volatility will be largely local in nature and will depend on the supply/demand situation in different urban areas. China has a real estate market that is driven by the lack of other personal investment opportunities and that is controlled within parameters that are set by the same people that own the assets. That is a market reality that will not change later this year or sometime in 2011.

When we started this Blog and Podcast, those words were barely in the English lexicon (I originally thought that “blog” was an Australian word to describe the feeling when you’d had too much football and Foster’s over the weekend).  Heck, I think they were still calling this the “Information Superhighway that Al Gore Built.”  Suffice it to say that we’ve grown along with the blogosphere (notice how carefully I avoided saying “grown up” … we try to avoid that at all costs).  Our mission has been to provide original, thought-provoking and – we hope – well-researched views on China business, adding to the conversation rather than just reciting what others are saying.

So when our research manager, Frank Tsai, came to me and said that he could see some value in a review of the week’s news on China, I admit that I was a bit skeptical. It seemed to me like we were just anthologizing stuff already out there.  But as he kept talking and showing me some material, I came around … there is a TON of good writing on China and, while it is impossible to take it all in, it is important to try.  So we are going to try an experiment … every week, we’ll highlight some of the things that interest us about the news on China, adding comments where we feel we can add something or just setting it out there for you to take in.  We won’t stop the original stuff … that’s our bread and butter (and besides, its cheaper than therapy for us) … but let’s see how this goes.  Drop us a line and let us know what you think and/or clue us in to things that you think we should be paying attention to.

OK, here goes…

Living in a Bubble?

When your Chinese friends are making six figure (USD) salaries, and they say they don’t FEEL rich, even though the cost of living is almost invariably much lower in China, you know something is odd.  They feel that way because housing costs in Shanghai are 20 to 50 times annual income for the typical ($10,000/year) worker, and the better homes that rich Chinese executives want to buy are still 10 to 20 times annual income.   According to the China Daily, real estate prices rose at their fastest rate in two years in February, going up 10.7% year-on-year in 70 major cities, and undoubtedly even faster in major cities like Shanghai and Beijing.  Housing and housing-related purchases, according to the Global Times, now account for 40% of consumer spending, and have accounted for 20% of GDP since 1998.  While the government has recognized the risk that rising asset prices pose for inflation and social stability, and has signaled measures to curb the property market, some investment banks like UBS are, apparently, still bullish on Chinese property.  Needless to say, the continuing boom in housing-related purchases is great news for many foreign companies – from an IKEA, to home appliances, to decoration services, to home water purifiers.  However, we all get the feeling that “something” is out there and, at least among average people who have become “overnight millionaires” just by owning homes in Shanghai, there does seem to be the ominous feeling that values can’t keep rising.

Working for a Living

Years ago, the rallying cry for multinational participation in China was “cheap labor!!”.  Well, while labor costs in China are still much lower than North America or Western Europe, we are seeing some changes here as well.   In recent months, factory wages have risen by about 20 percent, as many migrant workers have gone home for the Chinese New Year and decided to stay home, having found better (and often less arduous) jobs in their hometowns.  According to the China Economic Review, many factories have had to lure back workers with substantial raises and that the average wage for a migrant worker in Shenzhen is now about $200/month.  Despite fears of a labor shortage at the low end, however, college graduates at the higher end are facing dimmer prospects, as detailed in pieces in both the LA Times and the New York Times.  So it seems that demand in the labor market is becoming curiously U-shaped, with factory workers getting raises and the experienced managers seeing their wages double and triple in just a few years, while recent graduates suffer on subsistence pay, even at good companies.

Gloom and Doom

Year-end predictions are lots of fun … you get to talk eloquently about what just happened (and drop a few “I-told-you-so’s” in if you can) and then go all Nostradamus and predict a gloomy future.  If you are right, kudos to you.  If you are wrong, that’s OK because it means the gloom-and-doom didn’t happen and everyone is basically happy.  This could be the case in an article in the New York Times that came out last December that highlighted the three greatest dangers that could derail the Chinese economy are inflation, protectionism, and inequality.  Let’s see how they’ve been doing so far …

• Chinese economists have been sanguine about Febuary’s 2.7 increase in the CPI, and policy shifts are unlikely in the near-term.  However, we’ve seen instances where China moves pretty quickly against inflation should the need arise so that might be the source of their comfort.
• Pressure for protectionism against China could rise, however, in light of China’s 46% export increase in February and slim chances that the government will let the RMB will appreciate.
• Growing inequality is reflected in the growing ranks of Chinese billionaires, and in a sign that the government is concerned about inequality, it recently capped the compensation of bank executives in line with similar measures in the West.

Hmmm … seems they’re doing pretty well so far, but the year is still young.  Stay tuned for more.