[Otebo]

China's epic hangover begins
China's credit bubble has finally popped. The property market is swinging wildly from boom to bust, the cautionary exhibit of a BRIC's dream that is at last coming down to earth with a thud.

It is hard to obtain good data in China, but something is wrong when the country's Homelink property website can report that new home prices in Beijing fell 35pc in November from the month before. If this is remotely true, the calibrated soft-landing intended by Chinese authorities has gone badly wrong and risks spinning out of control.

The growth of the M2 money supply slumped to 12.7pc in November, the lowest in 10 years. New lending fell 5pc on a month-to-month basis. The central bank has begun to reverse its tightening policy as inflation subsides, cutting the reserve requirement for lenders for the first time since 2008 to ease liquidity strains.

The question is whether the People's Bank can do any better than the US Federal Reserve or Bank of Japan at deflating a credit bubble.

Chinese stocks are flashing warning signs. The Shanghai index has fallen 30pc since May. It is off 60pc from its peak in 2008, almost as much in real terms as Wall Street from 1929 to 1933.

"Investors are massively underestimating the risk of a hard-landing in China, and indeed other BRICS (Brazil, Russia, India, China)... a 'Bloody Ridiculous Investment Concept' in my view," said Albert Edwards at Societe Generale.

"The BRICs are falling like bricks and the crises are home-blown, caused by their own boom-bust credit cycles. Industrial production is already falling in India, and Brazil will soon follow."

"There is so much spare capacity that they will start dumping goods, risking a deflation shock for the rest of the world. It no surpise that China has just imposed tariffs on imports of GM cars. I think it is highly likely that China will devalue the yuan next year, risking a trade war," he said.

China's $3.2 trillion foreign reserves have been falling for three months despite the trade surplus. Hot money is flowing out of the country. "One-way capital inflow or one-way bets on a yuan rise have become history. Our foreign reserves are basically falling every day," said Li Yang, a former central bank rate-setter.

The reserve loss acts as a form of monetary tightening, exactly the opposite of the effect during the boom. The reserves cannot be tapped to prop up China's internal banking system. To do so would mean repatriating the money – now in US Treasuries and European bonds – pushing up the yuan at the worst moment.

The economy is badly out of kilter. Consumption has fallen from 48pc to 36pc of GDP since the late 1990s. Investment has risen to 50pc of GDP. This is off the charts, even by the standards of Japan, Korea or Tawian during their catch-up spurts. Nothing like it has been seen before in modern times.

Fitch Ratings said China is hooked on credit, but deriving ever less punch from each dose. An extra dollar in loans increased GDP by $0.77 in 2007. It is $0.44 in 2011. "The reality is that China's economy today requires significantly more financing to achieve the same level of growth as in the past," said China analyst Charlene Chu.

Ms Chu warned that there had been a "massive build-up in leverage" and fears a "fundamental, structural erosion" in the banking system that differs from past downturns. "For the first time, a large number of Chinese banks are beginning to face cash pressures. The forthcoming wave of asset quality issues has the potential to become uglier than in previous episodes".

Investors had thought China was immune to a property crash because mortgage finance is just 19pc of GDP. Wealthy Chinese often buy two, three or more flats with cash to park money because they cannot invest overseas and bank deposit rates have been minus 3pc in real terms this year.

But with price to income levels reaching nosebleed levels of 18 in East coast cities, it is clear that appartments – often left empty – have themselves become a momentum trade.

Professor Patrick Chovanec from Beijing's Tsinghua School of Economics said China's property downturn began in earnest in August when construction firms reported that unsold inventories had reached $50bn. It has now turned into "a spiral of downward expectations".

A fire-sale is under way in coastal cities, with Shanghai developers slashing prices 25pc in November – much to the fury of earlier buyers, who expect refunds. This is spreading. Property sales have fallen 70pc in the inland city of Changsa. Prices have reportedly dropped 70pc in the "ghost city" of Ordos in Inner Mongolia. China Real Estate Index reports that prices dropped by just 0.3pc in the top 100 cities last month, but this looks like a lagging indicator. Meanwhile, the slowdown is creeping into core industries. Steel output has buckled.

Beijing was able to counter the global crunch in 2008-2009 by unleashing credit, acting as a shock absorber for the whole world. It is doubtful that Beijing can pull off this trick a second time.

"If investors go for growth at all costs again they are likely to find that it works even less than before and inflation returns quickly with a vengeance," said Diana Choyleva from Lombard Street Research.

The International Monetary Fund's Zhu Min says loans have doubled to almost 200pc of GDP over the last five years, including off-books lending.

This is roughly twice the intensity of credit growth in the five years preceeding Japan's Nikkei bubble in the late 1980s or the US housing bubble from 2002 to 2007. Each of these booms saw loan growth of near 50 percentage points of GDP.

The IMF said in November that lenders face a "steady build-up of financial sector vulnerabilities", warning if hit with multiple shocks, "the banking system could be severely impacted".

Mark Williams from Capital Economics said the great hope was that China would use its credit spree after 2008 to buy time, switching from chronic over-investment to consumer-led growth. "It hasn't work out as planned. The next few weeks are likely to reveal how little progress has been made. China may ride out the storm over the next few months, but the dangers of over-capacity and bad debt will only intensify".

In truth, China faces an epic deleveraging hangover, like the rest of us.

I've often thought that the predicted inevitable rise of the BRICs to global economic dominance was slightly hysterical. China (and the others) has a whole host of issues that will either bring it's era of rapid growth to a halt or in the worst case result in a spectacular crash. I doubt we'll see China go bust just yet, however this impression given by some that the BRIC countries are immune the the economic problems facing the rest of the world is nonsense.

[Bramlow]

Don't want to say I told you so, but I told you so.

[Rei Murasame]

Just in time for Igor to see and experience it first-hand!

On the issue of Brazil, Brazil's growth last quarter was 0%, down from its previous 7%. So when the author of that article mentions that Brazil is next, that is already happening.

Good article Otebo, well spotted.

[Soulflytribe]

Just in time for Igor to see and experience it first-hand!

On the issue of Brazil, Brazil's growth last quarter was 0%, down from its previous 7%. So when the author of that article mentions that Brazil is next, that is already happening.

Good article Otebo, well spotted.

Whaaaaaaat??

0% growth compared to the second quarter of the year. +2,1% growth compared to the third quarter of 2010.
Previous 7%? What is that supposed to mean? Brazil's economy didn't grow 7% in the second quarter of the year, it was much lower than that.
http://www.economist.com/node/21541864

[Rei Murasame]

My totally ambiguous writing there may have made it unclear, but this is what I was recalling:

Brazil’s economy stalled in the third quarter of this year, demonstrating the vulnerability of the world’s emerging market growth engines to the eurozone crisis and the slowdown in the developed world.

Gross domestic product contracted 0.04 per cent in the three months ending on September 30 compared with the previous quarter as weakness in the industrial sector spread to Brazil’s once vibrant consumer.

[...]

For Brazil, the fall in annualised growth in the third quarter to 2.1 per cent compared with a year earlier – the lowest quarterly reading since the third quarter of 2009 – is particularly pronounced, coming after 2010 when the economy grew 7.5 per cent.

So to correct myself, it's 2.1% and not 0%. And to clarify, by 'previous 7%' I meant last year. In my previous post I should've specified that I meant 'annualised'.

My bad. But you get the general point.

[U184]

Growing pains hurt and even though China is ancient... she is fairly new at capitalism. It should be much harder to point the finger at the US now, but I am sure they will find a way.

[HoniSoit]

Capitalism is nothing without a good real estate bubble building and busting every couple of decades or so.

It would indeed be a surprise - a huge anomaly - if China doesn't experience one.

[Eauz]

the cautionary exhibit of a BRIC's dream that is at last coming down to earth with a thud.

Wow, someone is jealous or something, considering in the 90's, everyone was talking about the end of boom and busts.

“I am satisfied that the new monetary policy arrangements will deliver long-term price stability, and prevent a return to the cycle of boom and bust”

[Bubba]

What's with people's obsession with China's every fart? Do people really believe the bursting of a housing bubble will destroy China's economy, do they really believe China is destined to always have a GDP/capita 75% lower than America's, even lower than Brazil's, so China will never become the world's biggest economy even though they have 1.3 billion people and are hardly in the stone age?

[Eauz]

I don't think it is so much to do with China, but with the fact that we (and the world) got burnt by the bubbles that developed and if China ever sees a similar burst of its own bubbles, you can pretty much kiss your future good bye.

[U184]

if China ever sees a similar burst of its own bubbles, you can pretty much kiss your future good bye.

... and why would that be?

[Igor Antunov]

This so called crash seems to be a lowering of housing prices with many chinese ready to pounce on cheaper homes because they sit on savings, not debt. This has very little to do with the central government, which is swimming in more wealth than it knows what to do with. People are unwilling to pay $500,000 for a 3x3 meter concrete coffin on the 70th floor, so they wait. Chinese workers are not in debt to their banks, they are not being laid off in their millions, chinese don't stand to lose their homes to foreclosures.

The chinese housing market does not even closely resemble the Us housing market. It has weak ties with the rest of the economy, chinese stock market is tiny, banking system is massively cushioned and centralized and speculators are a novelty.

It is the highrises in the large cities that are stagnating because they are laughably overpriced coffins that far exceed the build price. Think shanghai, hong kong, shenzhen and other coastal cities.

A single high rise will have thousands of apartments, these aren't homes with big backyards and 5 bedrooms like in america, these are 3x3 meter coffins massively overpriced. Whoever built them in shanghai is already building more in the countryside. It's a hit and miss affair. Some tycoons will set off entire communities, others will see their middle of nowhere tenements crumble. But in both instances people are employed and are making money, and don't worry, the investors are still rich and investing in other schemes across the country and of course abroad. There is a reason 50% of the worlds steel and 80% of it's concrete is being eaten up by China every year, the country isn't going broke, it's going nuts.

As the west continues to collapse due to Us and european recklessness, the doom and gloom about china grows louder. It's pretty cute in a sad way. Everybody needs to visit the country at least once. It may alarm you if you hate the concept of china, or just pleasantly surprise you if you don't mind china being the new future hegemon, it's a matter of perspective. Either way these opinion pieces looking outside in and hoping for parallels with western style troubles are bunk. China could see 10 major natural disasters, 50% of it's factories closed, the housing market in shanghai collapse completely, all within 12 months, and still it would continue to expand it's economy, and consume most of the worlds concrete and metals.

Very wasteful indeed, but when you can, you do.

[U184]

It seems as if you are describing the inevitable consumption of a host body from a virus within.

Economics, breeding, migration all of these things, taken singularly or as a whole, are not enough for any Country to have complete world wide control. America and other countries have a niche, for some that niche is bigger than others, but it is still a small portion of the world given as a whole.

Short of a massive war, in the style of Hitler, China would not be able to cast the shadow of its hegemony across the globe. It would be very difficult for them to force that same hegemony even in war and China is not ready for a war of that magnitude and scope.

The only way, as I can fathom, for China to do as you describe... is to breed and wait. Send out migrants to the four corners and breed the other races away. Though even that would fail, as new subcultures sprang up.

So how, exactly, do you see this massive forced change coming to fruition?

[Igor Antunov]

So how, exactly, do you see this massive forced change coming to fruition?

You described it in the paragraph preceeding the quote. Imagine if the economically savvy jews, suddenly had 1.4 billion compatriots. It is happening as we speak.

[U184]

As I said...

Though even that would fail, as new subcultures sprang up.

There is no way to ensure loyalty to a particular regime. The populace will diversify genetically, but the cultural separation will remain. One only need look at the surrounding countries that border China to see this.

The hegemon of China will remain static and though there is little doubt that it will, one day, become the great power of its given region, there is no hope for world domination short of war and re-population.

China will gain control of almost the entire Asian areas, both by economic control and trading sanctions and will become a dominant super power. That will be it's place and one can see that coming within the next 100 years, the type of change you paint would take a millennium, and by then, the very face of the Chinese culture will have been infected just as much as it influences will infect other cultures world wide.

One could argue that America was able to affect such change in less than 500 years, but I would suggest that Americas influence has been minimal.

The real face of change was that of technology and America was just the harbinger.

China has a great population and yet it yearns for western ways, their change has already been started and the infection is deep, even you stated this in regrades to things you observed on your journey.

The west will absorb very little from Chinese culture, China on the other hand, will take on and absorb the ways of the west and that of technology and will undergo a metamorphosis from those influences.

In the greater scheme of things, it has not been that long since China emerged from behind their hidden world and when they did, it was forced on them. Now China is emerging on it's on accord, they do so because they want changes, the need changes.

The lure of technological advancement and the decadence of creature comforts will infect their culture to the core, as it has done to almost every culture on Earth.

What unique aspect of Chinese culture is being kept? What areas are strictly the providence of the Chinese? What areas of their culture is so intriguing and popular that it is sweeping the imagination of the world? What do they find so dear that they will carry it on with them as they advance into the new technological era?

I do not see much of any of those special little gems. In fact, as I see it, China runs the risk of becoming the Asian version of America. They are already well on their way, they spend more than they bring in and they have became wasteful and dependent on technology.

You may see the Chinese people as the future face of the dominate species on the planet, I just see a billion more consumers.

In the end, China will need to learn some lessons from Japan and America or its very weight will crush in on itself, they will need to lead areas instead of follow.

They have the manpower and currently have the ambition and the economics to lead, the question becomes, are they going to do so, or are they so enamored with western ways and this technological era that they lose their way?

[Rei Murasame]

Igor, why are 80% of the rural co-operatives in China effectively bankrupt? Where is all this money, other than being malinvested in places where there is little to no need for it?

The distribution of resources in China is also abysmal, growth in China in 2010 was apparently driven heavily by consumption of furniture, jewellery, and cars. One can only wonder who has actually been making the money there.

[Igor Antunov]

Igor, why are 80% of the rural co-operatives in China effectively bankrupt? Where is all this money, other than being malinvested in places where there is little to no need for it?

Rural cooperatives? What do these do exactly? This sounds like a very small segment of the economy. We came across a manual brown sugar production scheme right next door to a closed down sugar factory (closed down decade ago to curb carbon output). These people if they were bankrupt seemed fairly enthusiastic about their blocks of brown sugar.

Most of these cooperatives are not the lifeblood of the rural folks, most chiefly work in cities or engage in bigger markets with their crops, china still sporting the worlds biggest agricultural sector by value. These sound like side-business schemes built on disposable income that inevitably fail, because most (over 80%) of new small businesses eventually fail, even in Australia. It's called free market competition, bankruptcy is an institution and matter of course. It rarely ever leads to ruin unless you've been seriously unwise with your investments.

Anyway, if you want further details on the construction boom, it's not just new homes being built, it's old homes being improved. The central government covers 75% of the cost of renovations to existing properties. Many rural chinese are taking advantage of this and beautifying old villages and farmhouses. There is no bubble in a better home for yourself and your family.

The distribution of resources in China is also abysmal, growth in China in 2010 was apparently driven heavily by consumption of furniture, jewellery, and cars. One can only wonder who has actually been making the money there.

Various manufacturers, private market stall operators and the government through taxing of income and goods. The populace is clearly making money somehow, otherwise they wouldn't be purchasing luxury goods at an increasing rate.

[ralfy]

Credit crunches due to casino capitalism masking the results of peak oil, made worse by increasing resource demand from BRIC.