Dumping hundreds of billions of yuan into illiquid, mostly luxury dwellings is a catastrophic misallocation of capital in a country with an average per capita income of $3,000 per year. But that gross misallocation of capital is only part of the problem: since the vast overhang of luxury flats is illiquid and cannot be sold, these "investment properties as savings" are a black-hole capital trap: the invested capital cannot be turned back into cash.
Once the cash has been dumped into the black hole of illiquid real estate, it cannot escape; as with physical black holes in space, there is an event horizon beyond which the capital cannot be recovered. In China's real estate market, that is the moment when the buyer's funds are transferred to the developer.
This trapping of China's vast private capital in illiquid, rapidly depreciating investment properties will have far-reaching negative consequences going forward. When the time comes to transfer their "savings" back into cash, owners will find that their flats are worthless due to deterioration and/or the inability to find a buyer at any price.
All these luxury flats are speculative; many are empty and will never be inhabited. When the citizenry finally understand that the Central Government cannot stop prices from falling, or provide a deep, liquid market for re-sales, then panic will take hold, just as it does in the collapse of every bubble.
Unfortunately, investors in China will discover too late that luxury flats are not equivalent to cash in savings accounts, for the money only flows one way near a black hole: over the event horizon and into an inescapable capital trap.
I completely agree.
July 1, 2010
Jim Chanos: The Power Of Negative Thinking
The following was what Chanos said on May 18, 2010.
Q: How to Short China?
A: Obvious is the land development companies and I'll let you figure out which ones. But we also short the derivative plays. There was a dramatic increase in commodities, specifically in Iron Ore, in 2005. It went from $30-$40 up to $160. I expect that it will mean revert when China stops building.
I offer a chart showing where the inflation adjusted mean is on nearly a century's worth of iron ore prices.
July 15, 2010
Iron ore tumbles on steel cutbacks
Investors searching for signs of a double-dip recession could do worse than look at iron ore. Prices have tumbled by more than a third in three months, as Chinese steelmakers have scaled down production.
...
Steel Market Intelligence, a market research company, said the Chinese steel industry had brought its troubles upon itself by “producing high-cost steel at a breakneck pace”.
“We are stunned by the lack of financial good sense by China’s high-cost steelmakers who continue to turn gold into straw,” it says.
I remain deflationary. I continue to be extremely bearish on China's unsustainable economic "miracle" story, just as I was back in 2007 heading into their stock market collapse. I also have no desire to hoard any rocks right now, shiny or otherwise.
Source Data:
USGS: Historical Mineral Prices
BLS: Historical CPI
"Prices have tumbled by more than a third in three months,"
ReplyDeleteMark,
After reading this I went and checked on copper prices, they were down only 2.72% compared to iron ore's 1/3 drop in the same time period.
Why isn't copper following suit on iron's demise?
Any thoughts?
China may have a mean income of $3000, but it still has a 38% savings rate.
ReplyDeleteMy version of economics sez that until this untapped purchasing power is eliminated, real estate is . . . undervalued!
The fair value of real estate is between the amount that BKs you and the amount that BKs the 2nd highest bidder.
Yes, I am a "jealous bitter renter" since the 80s. At least I have my mom's Prop-13 protected house to inherit.
watchtower,
ReplyDeleteCopper May Decline
“The Chinese data shows a clear slowdown,” said Jesper Dannesboe, a strategist at Societe Generale SA in London. “But we would expect the Chinese government to prevent the slowdown” from continuing in the second half, he said.
There is way too much faith in the Chinese government in my opinion. It was the Chinese government that was supposed to stop the Chinese stock market from falling too.
Troy,
ReplyDeleteYou can't be serious. What's 38% of $3,000?
That "untapped purchasing power" represents roughly 1 gallon of gasoline per day. That's it.
Further, since there is no Social Security safety net in China, that money must be saved. It cannot be wasted on gasoline. If you can't afford a gallon of gasoline per day then you most certainly cannot afford a $150,000 condo. That's true even if it is given to you as a gift and there are no property taxes.
As a general rule of thumb, I would estimate that a house/condo requires at least 1% of its price in insurance, maintenance, and upkeep. A $150,000 condo would therefore eat $1,500 per year. If you don't believe me, picture buying a house and ignoring it for 100 years.
What's 38% of $3,000?
ReplyDeleteChina's averages are skewed by 600,000,000 people who don't have a pot to piss in. These people are not in this market, they need pasture for their cows and goats.
The OTHER 738,000,000+ people have something approximating US wages, albeit scaled down 10X.
Among these are the 3% Inner Party people that have the big bucks. That's over 20,000,000 dudes, plus the remainder of the top 10%, 60,000,000 upwardly-obile wanna-bes.
I don't know the first thing about China but I do think it's possible they'll be seeing a discontinuity event, like how RE here in the states got repriced between 1970 and 2000 or Japan 1960-1990.
Granted, there are all the hallmarks of an irrational bubble, but I just think it's a big mistake to judge from 10,000 miles away.
"Forget it Jake, it's China."
I met a young Chinese Singaporean recently. He was back from only his second ever business trip to Beijing and Shanghai. "How's the Chinese economy?" I asked. First he rolled his eyes. Then he gathered his thoughts and said "frightening".
ReplyDeleteSupposedly, China / Chinese speculators have been buying raw materials instead of US treasuries...maybe copper has the support there, but not iron ore?
ReplyDeleteMan, when they try to sell off their copper hoard (if it exists) it will be nasty.
Thank God, steel prices are not going up - I sell a lot of steel products and 2007-2010 has been a frickin' nightmare of constantly adjusting prices.
coba
BTW, I think one reason the Chinese go big on real estate is face. "I won 3 homes" says that you are rich - its like sailing for rich people here...check out my boat...Also, they have seen stupendous returns on real estate and greedy people who want to get rich fast keep the fire going.
Now, Taiwan also has crazy home prices and crappy rental returns. I have been waiting for a fall there for decades...has not happened. My Taiwanese vendor sold off his Chinese empty apartments and then bought empty apartments in Taiwan for speculation. (Seriously, I don't know who makes enough money to buy US$ 1 million dollar apartments in a city you never heard of...)
He then complains that he cannot get a decent rent from his other apartment in Taiwan...so he will sell that off...you'd think eventually everyone would figure this out, that the low rents are because there is an oversupply and the price would fall. nope.
coba
Troy,
ReplyDeleteThe OTHER 738,000,000+ people have something approximating US wages, albeit scaled down 10X.
I just don't even know where to go with this. You seem to really want to believe that they can afford the real estate.
dearieme,
ReplyDeleteFrightening is certainly what I see when I look at it, but then again I could say the same thing about the US economy or the European economy. It's just one big global frightmare.
coba,
ReplyDeleteSupposedly, China / Chinese speculators have been buying raw materials instead of US treasuries...maybe copper has the support there, but not iron ore?
I was thinking the same thing last night. Copper hoards better than iron. I don't know much about iron ore, but iron definitely rusts.
He then complains that he cannot get a decent rent from his other apartment in Taiwan...so he will sell that off...you'd think eventually everyone would figure this out, that the low rents are because there is an oversupply and the price would fall. nope.
There is probably some support if the price of an apartment isn't that much higher than the price to create an apartment. Any idea if that is the case? Otherwise, they'll just continue to be built until the prices eventually collapse one would think.
You seem to really want to believe that they can afford the real estate.
ReplyDeleteReal estate, in retrospect, was cheep in Palo Alto in the 1960s, 70s, 80s, 90s, and even as recently as 2003.
But it was still very expensive at the time.
My only argument is that wage inflation may be coming to China. The supply of young people falling 30% over the next 10 years will pressure wages, also, their LOW wages have nowhere to go but up.
Currency adjustments will also make construction costs lower, and also inject more purchasing power into their system, which will eventually harbor in rents and land values.
Everybody would like to have an actual house, another bedroom, live in a nicer part of town, or a nicer town entirely. And there's 700M+ people who've been denying themselves the luxuries of space since the 11th century or whatever.
The competition for land literally knows no bounds.
I thought real estate in Los Altos was overpriced in 2001, but I was severely, severely wrong. I wasn't counting on the Google and Apple infusions, nor the current 3.88% interest rates.
Troy,
ReplyDeleteThis isn't a case of Chinese real estate being a bit expensive relative to wages, as real estate was here at some points in our country's history. The typical Chinese worker has no chance of affording the real estate at these prices.
...their LOW wages have nowhere to go but up.
The poor have been sold that theory for centuries, and what exactly has it gotten them?
Why Factories Are Leaving China
"Chinese don't want to work in factories anymore."
So Fan is expanding his factory in Vietnam, where wages are $100 a month, one-third what he pays in China.
Fan seems to think that LOW wages can be even lower elsewhere.
Bogus wage rises fuel anger among Chinese workers
At Foxconn, the wage rises were part of a carefully orchestrated public relations exercise, not only aimed at placating workers. It also reassured major international companies such as Apple, Nokia and Sony that their corporate image was not going to tarnished by the exposure of the inhumane, sweatshop conditions where their products were manufactured.
Not everyone seems convinced that the wage hikes are even real in the first place. I'm not sure what to believe but I am certainly willing to entertain the "carefully orchestrated public relations excercise" theory.
And there's 700M+ people who've been denying themselves the luxuries of space since the 11th century or whatever.
The poor have been denying themselves the luxuries for centuries? Are you suggesting they could have been eating cake instead?
My quasi-thesis incorporates the Japan model for China.
ReplyDeleteI lived and bicycled all around Tokyo so I got to see the surviving housing and what the standard of living was as indicated by this housing.
In the pre-war, both China and Japan had a similar, overcrowded standard of living.
the "economic miracle" of the 1950s and 1960s resulted in more modern, but substantially shoddy construction by modern standards (and non-ghetto US postwar standards for that matter).
Then the 80s hit and the architecture actually started getting more deluxe than ours. It got REALLY nice in the late 80s.
I just see 300 to 700 million middle-class Chinese, crammed into their coastal settle zones, increasingly shift into the Japanese pattern of higher wages and becoming less poor, just as Palo Alto and Los Altos have become less poor since the 1960s.
As for factories leaving China, there's a limit on that, and at any rate it's not the factory work that is pushing up home values, it's the white collar service sector. We've hollowed out our manufacturing and outside of former factory towns home values are still pretty high compared to the 70s.
Troy,
ReplyDeleteI just see 300 to 700 million middle-class Chinese...
And that is once again why we differ and will continue to differ on this topic.
Indeed : )
ReplyDeleteOne of the key things about a service economy is that it can spread the wealth around a lot more before this wealth is consumed or otherwise lost.
It's utterly fascinating to me, the interrelation between money, wealth (the state of having one's wants and needs met), and the creation of the stuff that we call wealth which actually provides the services of utility.
I think as China's economies moves into the grooves the US, Euros, and Japan have cut, they too will see an increasing interchange of services and thus a widening middle class.
Perhaps the strengthening yuan will help them increase their food and energy surpluses, too.
I'm not invested in this alternate model, it's just something I think is possible given the general course of economic development from poverty to prosperity.
I don't have any great faith that the Chinese technocracy can pull this off, though they seem to be kicking our asses since the 90s, so there's that.
Mark,
ReplyDeletewith so many music posts I wonder if you are hearing music, maybe like Wedding Bells in your head????
Any news??
I could give you away if that is the case, HA!
ReplyDeleteTroy,
ReplyDeleteI don't have any great faith that the Chinese technocracy can pull this off, though they seem to be kicking our asses since the 90s, so there's that.
I get the feeling that they are kicking their own asses too though. Check this out.
Another New City In China Bites The Dust
GYSC,
ReplyDeleteHells Bells is about the best I can do these days, lol.
”Another New City In China Bites The Dust”
ReplyDeleteyes, things will get crazy at the margins and I expect this kind of mass misinvestment can be found much nearer to Beijing too.
The amount of the investment flows involved here are perhaps unknowable.
Like oil-state sovereign wealth, capital can be too strong some time. . .
The development in question is 2 hours south of Hohhot:
http://maps.google.com/maps?f=d&source=s_d&saddr=Huhhot+Railway+Station,+Station+West+Street,+Hohhot,+Nei+Mongol,+China&daddr=Qingshuihe,+Huhehaote,+Inner+Mongolia,+China&hl=en&geocode=&mra=ls&sll=40.359103,111.887512&sspn=0.967954,1.638336&ie=UTF8&ll=40.644178,111.876526&spn=0.96385,1.638336&t=h&z=10
itself quite a hardscrabble location, the capital of Inner Mongolia.
http://en.wikipedia.org/wiki/Hohhot
Reminds me of Fresno, actually, but it apparently has
twice the pop.
Dunno what the 1-child policy is going to do for China's periphery, whether there will be any continuance of the centrifugal settlements of the Chicom development policy.
Looking at the google street photos of Hohhot, one can see the wealth accretion proceeding.
Yes, well, but exactly what is the price of tea in China?
ReplyDeleteThis is not real estate, in the sense that it's not building a real estate. Empty cities, empty homes, empty buildings, empty malls, that's not development. It's lunacy.
This will all come to an inglorious end in the not too near future. Probably with the advent of World War III.
GawainsGhost,
ReplyDeleteEmpty cities, empty homes, empty buildings, empty malls, that's not development. It's lunacy.
Empty stores of value?
Pun intended.
An Outspoken Fund Manager With Contrarian Views
ReplyDeleteHis latest obsession is China. He likens the country to Starbucks: good at growing quickly but not so good at creating wealth.
I know the feeling!
“The idea is that things would happen today that are commonly thought of as impossible, most notably a significant reversal of China,” Mr. Hendry said.
We live in the era of turning impossible ideas into painful realities.
Maps cover the walls of his office. On one, blue magnetic pins plot his recent trip through China. He filmed himself there in front of huge, empty office buildings and giant new bridges in the middle of nowhere — signs, he said, of a credit bubble.
I'm not that far along, but my blog is certainly filled with several years worth of Chinese "miracle" story heckling. For what it is worth, very few thought the Chinese stock market would fall apart but I likened it to ours just before our Great Depression. I did so pretty much right at the peak too.
The real estate market is much more dangerous though. First we had our dotcom bubble and its collapse, then we had our real estate market follow. It is my belief that China is playing from our very same economic miracle playbook.
Not that I am an expert, but the difference is that our 2003-2006 period featured cash COMING OUT of the housing sector, while in China it appears cash is GOING INTO the housing sector.
ReplyDeleteTroy,
ReplyDeleteCash first must go into a bubble before it can come out.