Economic, Financial and Political Analysis

China Troubles Ahead

By Monty Pelerin on July 21, 2010 in China, credit, Housing with 0 Comments

Mish has written a disconcerting piece on China’s lending bubble as it relates to real estate.

China’s housing market valuations are much worse than ours were at the peak. In Beijing, housing values are 22 times incomes. A quote from one of Mish’s sources states:

A 90-square-metre (968-square-foot) apartment in Beijing cost 1.6 million yuan (236,000 dollars) last year, the China Daily said, citing an independent report.

That compared to an average household disposable income of around 71,000 yuan in 2009, according to city figures.

Much of the financing comes via “loan sharking.” That is, it is at very high interest rates and independent of the official banking sector. In some regards it is similar to what was described as our “shadow banking system,” albeit much worse, given the interest rates charged. A quote from a source in Mish’s article describes the motivation behind the schemes:

Local officials, [required by] the government to produce double digit GDP growth numbers, give real estate developers permits to build housing projects in return for bribes. They also get bribes in return for allowing the shark loan companies to operate under their jurisdiction. Some of them are active partners in shark loan businesses. Every scheme has a ring leader whose job is to collect money from all the participants in the Ponzi scheme. When some of these Ponzi schemes blow up, the party leaders always get bailed out first.

The real estate situation in China appears unsustainable. Signs of collapse are starting to show up as Mish points out in his article. It is probable that they are facing the same real estate bubble collapse as the U.S. and much of the rest of the developed world experienced. Mathematics is not to be denied. There is no way that housing values can be 22 times income. Either incomes must rise or housing values must drop. It is impossible for real incomes to rise enough in the short term to sustain housing values.

Look for the same housing collapse to hit China. What that will mean for their economy and the rest of the world is not seeable, at least by me. It could mean they sell Treasuries to support whatever stimulus packages they deem necessary. That would be disastrous for the dollar, U.S. interest rates, the U.S. and world economies.

China may or may not be the economic leader of the world some day. It likely has major problems before that day comes, if it ever does. Problems longer term with China are likely to arise as a result of their quasi-system of Central Planning and Capitalism. It is unlikely to work long-term in its current form. For more on this take, see The Daily Bell:

In fact, as we will see sooner or later, the trade-off that China has made is one between a vibrant, growing economy and one that is collapsing in on itself. Austrian economics shows us quite clearly that wealth is created by individuals via human action, not state action. The fundamental argument for state competence is flawed – and investors especially would do well to take care. Statist methodologies do not create dreams but nightmares.