Category Archives: Economics

SOEs: Buy High. Sell Higher?

Ignoring the Dubai Crisis and Bubble Concerns, Chinese SOEs Continue Playing “Land King”

Another 19 real estate companies also showed interest in the land bought by Sino Ocean, among them Gemdale Group, a private real estate company. It didn’t bother to bid, though, as prices were too high and a huge challenge for a private company. In the current environment, SOEs are able to take significantly greater risks than private enterprises.

My closest friend in Shanghai is also a land developer (房地产开发商) and I’ve heard the exact same story from him. Every time they try to bid on a project, some SOE backed business comes in at a higher price. No matter how much you are willing to offer, the SOE backed group raise the bid until they get the property.

Do SOE’s have a secret for generating better ROI than experienced, well managed, privately held developers? If they do, they should start a training academy teaching their “post-market economics efficiency”. Most likely this will be a lesson in buying high and selling low.

Zhang Shuguang, chairman of Unirule Institute of Economics, says, “Real estate policy next year is a choice among contradictions and big changes may not take place. Tightening policies will cause the real estate bubble to burst, resulting in economic problems, while excessive stimulus will bring a bigger bubble and greater risks.”

You’ve got a bubble on your hands. Choices I’m aware of are a) soft landing or b) hard landing. Sounds like the Chinese plan is to “manage the bubble”. Good luck with that.

The dilemma is more obvious for local governments. Zhang Shuguang says that half of local government income is real estate-related, and local real estate policies will not see big changes. Preferential policies may be fine-tuned instead of cancelled.

In case you want to know “why” the bureaucrats what to “manage the bubble” instead of fixing the economy? Because the bubble is putting money in their budgets. The bigger the budget, the bigger the kickback.

Can we bring Zhu Rongji back the way Deng Xiaoping was brought back? He’s ceased to exist as a public figure since 2003 – just about the time the economy started going way off track.

Zhu tackled the problems of an excessive money supply, rising prices, and a chaotic financial market stemming, in large measure, from runaway investments in fixed assets. After four years of successful macro-economic controls with curbing inflation as the primary task, an overheated Chinese economy cooled down to a “soft landing”.

Unfortunately, he’s not likely to be restored because:

Zhu has a reputation for being a strong, strict administrator, intolerant of flunkeyism, nepotism, and a dilatory style of work. For his hard work ethic and general truthful and transparent attitude, he is generally considered one of the most popular Communist officials in mainland China.

NY Times: SOEs Pushing Out Entrepreneurs

The New York Times put together an excellent story about the struggle against chinese real-estate speculation here in Beijing. The article is called “Chinese Businesses Resist Eviction by Developers“.

The company that bought the land that included her restaurant for $700 million — a huge parcel a few minutes from the Olympic stadium — was already busily clearing the block for another glittering mega-development. The sooner it broke ground, the sooner it could capitalize on property values that spiked more than 30 percent this year in Beijing and a handful of other cities.

The only thing in the company’s way was a squat row of buildings that included the Fish Castle Restaurant, a decidedly modest Sichuan-style seafood joint that Ms. Qin and her boyfriend opened just before the 2008 Summer Olympics. The couple, the very picture of modern Chinese entrepreneurial bravado, had signed a three-year lease, poured their extended families’ life savings into fixing up the space, and then learned in August that they had only two months to get out.

Chinese newspapers are filled with stories of battles involving so-called nail houses, the properties whose owners and occupants are like deeply embedded spikes that refuse to give way to redevelopment juggernauts. As an unceasing real-estate boom has swept the nation, much of it orchestrated by the local governments that benefit from soaring land values, property owners and occupants often protest unfair compensation.

SOEs are becoming an ever larger portion of the Chinese economy, bidding up prices and pushing out private entrepreneurs. Long term, I have zero faith that the “central planners” in any country can create long term growth better than innovative entrepreneurs.

Bloomberg Picks up on China Real Estate Bubble

Bloomberg published: “China Property Bubble May Lead to U.S.-Style Real Estate Slump

Although parallels with other bubble markets, the China bubble is not quite so easy to understand. In some places, demand for upper middle class housing is so hot it can’t be satisfied. In others, speculators keep driving up prices for land, luxury apartments, and villas even though local rents are actually dropping because tenants are scarce. What’s clear is that the bubble is inflating at the rich end, while little low- cost housing gets built for middle and low-income Chinese.

Koyo Ozeki, an analyst at U.S. investment manager Pimco, estimates that only 10 percent of residential sales in China are for the mass market. Developers find the margins in high-end housing much fatter than returns from building ordinary homes.

The central government now faces two dangers. One is the anger of ordinary Chinese. In a recent survey by the People’s Bank of China, two-thirds of respondents said real estate prices were too high.

The second danger is that Beijing will try, and fail, to let the air out of the bubble. Pulling off a soft landing means slowly calming the markets, stabilizing prices, and building more affordable housing.

One difficulty in handicapping the likelihood of a nasty pullback is the opacity of the data. As long as property prices stay high, the balance sheets of the developers look strong.

The China Bubble: Beijing Luxury Hotels

The 234-room Pangu Plaza, which opened in December, charges as much as $17,750 a night for a suite. The sushi bar, where the cheapest lunch special is $265, cooks its rice in mineral water flown in from Japan.

Confidence, however, is belied by the cavernous, empty lobby where the only sound is the tapping of the high heels of the crisply attired staff. No paying customers were evident during a weekday afternoon visit, although Seng said that occupancy has reached “up to 30%.”

This is an extreme example, but this sort of scene is EVERYWHERE in China. Weather you’re in the showcase cities of Shanghai and Beijing, in the 2nd tier provincial capitals, or any of the smaller cities. EVERYWHERE you go there is construction and everywhere you go the buildings are UNUSED.

Glad to see the western media is finally opening their eyes to this one. Nice job to the LA Times for this article “Global financial crisis hits Beijing luxury hotels hard“.

CASS: 85% of Chinese families can’t afford houses

Reported in the People’s Daily on Dec 8th: 85% of Chinese families can’t afford houses.

According to Chinese Academy of Social Sciences (CASS), 85 percent of Chinese families can not afford housing expenditure, and house prices are much higher than their incomes. The situation was pointed out in the Blue Paper on Analysis and Prediction of Chinese Economics in 2010 issued by CASS Dec. 7, 2009. The Blue Paper says that house prices are 3 to 6 times greater than people’s incomes; therefore it will be very difficult to buy a house for citizens. Furthermore, the average ratio of house prices to incomes in China, 2009 will be 8.3, well beyond the scope of reasonable affordability. In fact, it will be 22.08 for migrant workers and 29.44 for farmers in 2009. Because of this, 85 percent of Chinese families do not have the ability to buy their own future houses.

This is a very important fact. Chinese real-estate runs a big spectrum. Of the 15% of people that actually can afford a “house”, this means a 40 sqm condo in an hour commute from the city.

So, how many people can afford the huge inventory of 150-300 sqm luxury condos that are being stock piled like bricks of gold? Beyond the people that own them already, my guess is pretty close to nobody.

Real Estate Bubble – Exit Strategy

Following comments are from Professor Pettis at Guanghua Univ, Beijing’s article: “China: The Pace of Change“.

The so-called “Anglo-Saxon” model would involve a rapid liquidation of loans, the seizing and selling of collateral, and bankruptcies. The advantage of this model is that assets are quickly re-priced and allocated to their most profitable or efficient uses.

Pure creative destruction. Socially painful, but the imbalance is quickly corrected.

The second way, broadly speaking, that the break in the housing bubble might occur, and without the brutal social adjustments, is what has sometimes been called the “Japanese” model. Rather than force bankruptcies and rapid liquidation, borrowers would be permitted easily to roll over their loans, financing costs would be kept low (at savers’ expense of course), and excess inventory taken off the market.

Preservation of the status quo. Competitively painful, because imbalances are slowly corrected and continue to create distortions in the economy.

China´s financial sector issues are different [than the US]. China´s systematic misallocation of capital is its biggest financial problem. China needs serious governance reform and interest rate liberalization so that capital can flow to the most dynamic parts of the economy and be made available to risk-taking entrepreneurs in a way the fosters productivity growth. It needs capital to be correctly valued so that it is not wasted on creating overcapacity, asset market bubbles, and trophy projects, all of which detract from future consumption growth.

Agreed 100%. It’s important to remember that the politicians aren’t the source of the growth, they are the providers of infrastructure. The platform. The framework. The politicians give us the roads, the bridges, the electricity, and the law that ties everything together. China’s success so far has been in removing the restrictions that prevented entrepreneurship.

China Radio International (CRI): Real Estate

Real estate prices have risen dramatically in recent years – especially in the major centers of Beijing and Shanghai. But is there an asset bubble forming? Today we’ll ask the experts.

  • Patrick Chovanec, Associate Professor at Tsinghua University
  • Wang Lina (汪利娜), Research Professor, Institute of Economics, Chinese Academy of Social Sciences
  • Yongheng Deng,Director, National University of Singapore

Summary of points discussed, as documented by Professor Chovanec.

The main driver of mounting housing prices in China isn’t short-term speculation (“flipping”) but longer-term stockpiling of empty apartments as a “store of value,” like gold.

  • If “flipping” were the main problem, we’d see a much more active secondary market. In fact, China’s secondary market is quite weak, suggesting that new housing is being stockpiled off-market and not being priced.
  • This phenomenon is partly due to a limited range of other investment options, and partly due to low holding costs, particularly the absence of an annual property holding tax. Other holding costs, such as maintenance fees, can often be minimized or avoided entirely.
  • Because it addresses the wrong problem, the government’s new tax on speculative “flipping” is unlikely to have much impact, and may actually make things worse by increasing the incentive to holder vacant property longer.
  • Local governments in China depend on land sales for as much as 40% of their revenue, so have a keen interest in keeping prices high — in effect, a kind of “hidden tax.” The point of an annual property holding tax is not to increase the overall tax burden, but replace this revenue stream with a more rational and sustainable structure that rewards productivity.
  • The so-called “affordability ratio” in China is sky-high. As a result, the unaffordable price of housing is already becoming a hot social issue in China. See: “Desperate Owners
  • Even though many people are spending cash to stockpile vacant apartments, there is plenty of hidden leverage in the market. The commercial real estate sector is highly leveraged, and most business loans in China have been issued based on high-priced real estate as collateral. The exposure is not the same as in the U.S., but is serious nonetheless.

Check out the complete interview (1st hour) online at:

Original post on Professor Chovanec’s blog.

How to know if you’re in a bubble

A bubble is when assets are screaming to new highs everyday, everyone is talking about them, and everyone owns them. Right now, virtually no one owns commodities. So for Mr. Roubini to talk about a bubble in commodities defies comprehension. It proves he does not understand markets.

I am flabbergasted at Mr. Roubini’s comment about bubbles because there is not a single market in the world making all-time highs except Gold, US Government Bonds, Cocoa, and the Sri Lankan stock market. That’s hardly reason to call for a bubble. So, I am most perplexed about this alleged bubble which is out there.

If an asset rises 100% in one year, that’s a great year, but not necessarily a bubble. Look at oil. It’s up huge off the bottom but nowhere near it’s old highs. Look at Citigroup. The stock is up 3 or so times off the bottom …

-Jim Rogers (2009, Wall Street Cheat Sheet)

China: Trade of the Century

Long term (40+ Years) I am an absolute bull on China. It’s a big country and it’s going to get bigger. If you can close your eyes and wait 40 years to look at your investments, don’t read this. Just buy China.

However, if you’re concerned about rate of return over the next 10 years or so, I would bet on the downtrodden USA market. When everyone already agrees on something (whether positive or negative), that is usually the time to ask if the traditional wisdom has finally gone too far and we’re ready for a correction.

When thinking about current asset valuations, remember that the “Rise of China” was the biggest online story of the DECADE, outpacing the number two story (Iraq War) by 400%. See the full list.

Burton Malkiel, professor of economics at Princeton did an interview on FOX Business TV called “Betting on China”. Malkiel is a leading proponent of the efficient market hypothesis. If this guy is bullish, that might be reason enough to short. Reasons for bullishness include:

Large Labor Force: With a population exceeding 1.3 billion people, China has plenty of labor available to expand GDP (Gross Domestic Product).

However, China’s had a big population for a long time, but it’s been poor for a long time. India has a large population (1100M) but per capita numbers are still low. Russia has 140M people and the workforce is highly educated, but they’re only exporting natural resources. Japan has around 130M with GDP per Capita of $33K. The USA has over 300M with a GDP per Capita over $47K., and Singapore slightly above the USA average with $51K, though only 4M people.

No Nonsense Government: An authoritarian government has its advantages. While pornography and unrest may be problems, infrastructure projects are not.

Thoreau first said that”The Government That Governs Least is the Government That Governs Best”. How did the Central Planers in the USSR perform? What happened to the magic of METI (Ministry of Economy Trade & Industry) in Japan? How would we expect central planners in a bureaucracy even larger to do a superior job?

Both Markets and Planners allocate resources. Do you trust the few or the many?

Education: Chinese culture values education. As a result, China is slowly moving away from its roots as the globe’s manufacturing and piracy capital. Intellectual property is appreciated more now that China is becoming a leader in emerging technology areas, such as solar power.

Most of the Profit in exports from China is derived from Design, Process Management, Quality Production Standards and Marketing managed by firms from developed nations. With the exception of a few State Owned Enterprises, purely Chinese products marketed to Chinese people are typically very poor quality and not ready for competition on international markets.

Trade Surplus & Currency Reserves: Must be nice to have trade surpluses and massive currency reserves (~$2.3 trillion). This is what happens when you are in a position to export more than you import.

Manageable Debt: China’s Debt/GDP ratio is less than 25%. You can compare that to the U.S. approaching 100% and Japan at over 200%. Disciplined fiscal management provides the Chinese government with more options in dealing with the global slowdown (e.g., stimulus).

This is the big hidden issue with China. The numbers we read are that there’s only 25% Debit/GDP ratio, but there is way too much infrastructure investment in glamourous conference centers, hotel high rises, vacant luxury apartments and bridges to nowhere for this number to be real. The real number is likely 75-150% of GDP.

Long Runway of Growth: China’s long runway of growth has allowed it, and should continue to allow it, to grow at above average growth rates – in the 3rd quarter of 2009 the Chinese economy grew at a very healthy +8.9% rate.

Interesting that consumption numbers for China are down. Sales of gasoline are down. People everywhere are spending significantly less money, and yet GDP will grow at 9%. Growth numbers during the Great Leap Forward looked great too! However, 2005-2009 will likely prove to be China’s Great Leap Backward.

Newsweek’s Why China Won’t Rule the World ended with the apt:

Of course, the Chinese are thrilled that everyone thinks they’re the biggest winner. The truth, however, is that they’re more like the least-bad losers—and they know it.

Fallows – Clear Headed Look at US/China Relations

Definitely have a lot of sympathy for Jim Fallows fending off phone calls from angry Americans on a Tuesday morning.

C-SPAN Update after presidential visit, November 17, 2009

During the 2009 call in discussion, Fallows has to fight off many angry phone calls about lost jobs and a “Rising China”. Overall, the discussion is much more grim than during the 2007 presidential visit to China.

C-SPAN Update after presidential visit, October 21 2007

In 2007, there were some discussions about the size of China’s foreign currency reservers, some concerns about job losses, and questions about teaching english in China. Overall, the conversation was far more upbeat in 2007 than in 2009.

Interestingly, Fallows has a total of 55 C-SPAN appearances over the years. Take a look.

Fallows also has some books that are well worth reading. Personally can’t wait until Apple’s new mobile book device is released so that I can sign up for The Atlantic and The Economist directly in a mobile print edition. Would also be great to have mobile versions of Vogue and GQ for easy reading.



  • Postcards from Tomorrow Square: Reports from China December 2008
  • Looking at the Sun: The Rise of the New East Asian Economic and Political System April 1994
  • More Like Us: Making America Great Again March 1989
  • Goldman Sachs: Would you trust them?

    Goldman Sachs Research just completed a visit to China where they’ve concluded that their bullish thesis on the country was justified, China commodity demand would drive prices higher and they feel increasingly confident about their current $94 crude oil price target.

    More here.

    Prices of oil will surely go up because their being measured in worthless currencies.
    The China real-estate market has been in bubble mode since the credit bubble started in 2001.
    Shanghai real-estate prices per sq ft are comparable with Los Angeles, yet these are 70-year land leases, not purchases.

    Shouldn’t we know by now that if Goldman says to buy, it probably means that Goldman insiders are already selling.

    Jim Rogers: Clean out the system

    • Why are there banks on every corner?
    • What are the functions that banks provide that can’t be managed more efficiently online?
    • Why do we have ATMs when “Cash Cards” (like the Hong Kong Octopus) work so well for small transactions and “Bank Cards” like Visa or Wall Mart’s own credit card processing system are so much more efficient than cash?
    • Once we get rid of the paper (money) trail and make everything electronic, then we can also radically simplify and improve the efficiency of tax collection.

    If we had let the archaic, over leveraged banking system fail the way it was designed to, there would have been more pain that we’re seeing now, but some truly innovative, highly efficient institutions would have emerged and banking could have had a renaissance.

    Instead, special interests were allowed to take over…

    Jim Rogers has a great interview that he did as part of a 2 hours special on CNBC:

    “Banks have been going bankrupt for a few hundreds of years. The world has not come to an end. And Ross, the way the system is supposed to work is that when somebody fails, you let him fail. You let competent people take over the assets. Reorganize the assets and start over again. What we’re doing now is we’re taking the assets away from the competent people and giving them to the incompetent people and saying ‘now you can compete with the competent people with their money!’. This is just propping up the system. This is not going to solve the problem. Do you remember zombie banks from the 1990s in Japan? This is not going to solve our problems at all, we’re going to carry it over and over and over and over again. We’re going to be reporting on this for several more years.”

    Looking Forward, 2010

    There are a lot of things going on right now.

    • Chinese Gov’t driving in wrong direction. China Bubble is getting ready to Pop!
    • Broadcast Media, Physical Media and Middle men are being creatively destroyed!
    • Global labor force is doubling (China, India and Brazil) so labor supply far outstrips demand for labor.

    First, I expect that the Chinese economy is now in full “bubble mode” and will be popping sometime soon.

    • Caijing Magazine, through government support has exposed some of the largest corruption cases in the country is going to stop covering corruption – so now who is watching?
    • Urban China Real Estate prices have been increasing 20%/year for at least 5 years and even the new Shanghai World Financial Center is 70% empty.
    • Wen Jiabao just went to the World Economic Forum summit in Dalian and announced that China’s GDP growth target “appears to be achievable“, which the US press will read as “9% AGAIN!” Perhaps they should read How China Cooks Its Books.
    • Meanwhile, everywhere I go Taxi rides are down, the reported rail freight numbers for 2009 are 30% below last year, night clubs are empty, KTVs are closed. People are not consuming. Retail sales are down 12%.
    • Factories in the south that closed have not yet reopened – perhaps 50,000,000 people are out of work, and the last 2 years worth of college graduates have been unable to find jobs.
    • Yue Yuen, the Shoe Factory I visited here on my first trip to China has reported it’s biggest loss ever.
    • The largest rail line in China reports freight loads down by 12%.
    • Banks call my WOFE registered phone number on a regular basis explaining how it would be beneficial to take out a loan.
    • When asking people “how’s the economy”, everyone says it’s doing great.

    Second, What will happen next? I’ve set myself up to be a middle man, an intermediary between US producers and Chinese consumers. This is what I’ve been doing for movie cameras and this is what I can provide value doing long term. My value is largest for products that are more complicated (specialized technology products) since these are more difficult for local providers to support.

    • MEDIA: Physical Media (Newspapers, Magazines, CDs, DVDs) and Broadcast Media (TV, Radio) is finally being “creatively destroyed” – being replaced by a more efficient (low distribution cost, large selection) medium – the Internet.
    • DISTRIBUTION: Middle Men will become less and less relevant.
    • POLITICS: The Internet makes voting extremely efficient. Not only can we reshape the way we elect our representatives, but we can reshape the purpose and power of our representatives, returning the power to the people.
    • BANKING: We all bank online. We no longer need a bank branch on every corner. Banks can lease space in the Grocery Market and put their ATMs there. Remember, ATM is “Automated Teller Machine” – if the Teller can do it, we can surely make a machine that can do it.
    • MOVIES: Movie Theatre (in terms of the box office) is a Retail Service (atmosphere, seating, timing, snacks) and not likely to be affected, however changing media consumption habits will impact the requirements for future feature films.
    • RETAIL: The 25 and under generation downloads everything over the Internet. The iTunes Music Store is the largest Music Store on the planet (in annual revenue)
    • MOBILE: The iPhone is the only smartphone that meets the definition of “a computer in your pocket”, but Apple is not going to be able to lock MSFT, DELL, etc out of this market. Google will try hard to get in too.
    • COMPUTING: 10 years from now, the AVERAGE person will only use a desktop computer for the times that lots of research of lots of text input is required, but notebook/laptop computes will be like desktop computers. Laptop (R&D, Professional Content Creation, Finance & Accounting). Desktop (High End Media Creation. “Time Clock” office workers who shouldn’t bring devices home)

    Third, in terms of creating products or services, be aware that long term the consumption market will not grow significantly, but the supply of labor for all forms of production markets will grow, driving labor prices down in nearly every sector. Going forward, anyone who is directly trading labor for income could find themselves in trouble, especially if their labor was at a premium due to their location.

    Selling in China… How to do it?

    Depending on your product or service, you’ll need to alter this list, but this can help you get started:

    1. Create a Chinese Company name and Chinese names for your key Products/Product lines
      (in modern mainland China phonetic translations rather than translated meaning is optimal. In Taiwan and Hong Kong, better to simply use the English names. for example, Chinese people can’t pronounce “Nike” so they say “nàikè”. In Mainland China it’s typically an operating flaw to use english for anything important)
    2. Chinese Language operational/interaction instructions
    3. For Business to Business products, Chinese can often accept USD pricing
    4. EMAIL is not a good lead generation tool for Chinese clients – but it is a good way to transfer attachments. Instead:
      • Exchange Business cards at Trade Shows
      • Engage in online communities
        (However, beware most active online community members lack the ability to buy)
      • Establish your own promotional seminars
      • Chinese language website with: Address, Phone Number and MSN information
        (Chinese people want to stop by or talk to a human about it, now)
      • Create service center to handle Phone/MSN/Walk In inquiries. Operating hours vary by product category. Staying open later in China is typically more useful than opening earlier.
      • Learn how to quickly identify customers who have the financial ability to purchase your products,
    5. China Customs is a very slow (typically delays shipments 3-5 days) so all efforts should be made to repair product in country
    6. Import Tariffs are very high, so don’t let product diverted from Hong Kong (0% VAT, 0% Tariff) compete with your Mainland China sales (17% VAT, 10+% Tariffs) and distribution plans.
    7. Be Careful: in Chinese culture “tricking” someone for your personal gain only proves that you are smarter than they are, and if a Chinese person has a good opportunity to make money that they don’t take (even if it is “wrong” in western eyes) then their friends and family would accuse them of being dumb.
    8. Be Aware: that the more that someone speaks a language, the better they get at it, and the less they speak one, the worse they get at it. When you meet the Chinese guy that speaks really great english and claims to protect you and “unlock a market of 1.3 billion customers” for you, most likely this guy is not connected at all and only knows how to trick western people out of their money.
    9. Legal system is unlikely to grant proper recourse, especially in native vs/ foreigner cases. You should always sign proper contracts, but if you are taking any risk on the part of your partner, YOU MUST REQUIRE A DEPOSIT (押金) in exchange for that risk. If the Chinese partner can save 1¢ by pretending the contract does not exist, then they will try it.
    10. Chinese customers are EXTREMELY PRICE SENSITIVE, and are particularly unwilling to pay for services.
    11. Long term, the Middle Men in China will be out of work, but in the short term, for most sales you are far better figuring out a way to with multiple resellers (avoid letting one crook control your destiny). Depending on volume and cash flow requirements, working with large stocking distributors is probably not the optimal way to operate because they have very fat margins, and with a fat margin it’s too easy for them to divert product back into your other markets. On the plus side, Agents can also keep you insulated from the darker side of Chinese business practices.
    12. Keep costs down. If you operate like a traditional international company while in China, it could be very difficult to make a profit, but all of your suppliers will take profits.
    13. Chinese customers want to hold the product in their hand and are particularly weary of Internet sales.