Category Archives: China

Shanghai Daily on “So Called Internet Freedom”

China whines about “Internet Freedom”

The first lines of the story really say it all.

CHINA hit back at US criticism of Internet control yesterday, warning that relations between the two countries were hurt by the unreasonable accusations in the name of so-called Internet freedom.

Yet another reminder that the CCP is their own worst enemy. It’s sad that the official mouthpiece of a nation with so many bright and talented people responds to intellectual challenge with “your wrong” and “that hurts”. Come on central comittee, you can do better than that.

It was as if the government had hired The Onion as its image consultant.

Seems that the CCP leaders believe they are the ones with the guns and they money and everybody wants to be their friend. However the turning point in Chinese foreign relations seems to have arrived. Their foreign business friends are getting ready to turn their backs just as the real estate bubble litters the landscape with empty luxury apartments and empty office towers.

Of course, the CCP response also included some hard hitting “facts” like:

China’s Internet is open

The Chinese constitution protects the citizens’ freedom of speech

There are a lot of Chinese folks that would sure like to see that new “free speech” version of the Chinese constution… Tank Boy vindicated? We all dream. Come on CCP, this isn’t gradeschool. There are thousands o expatriots and western educated Chinese out here that are here to help, just call before publishing this sort of thing.

Who has a “finger on the pulse” of China

Prof Chovanec on Chongqing

I think when you live in a place like Chongqing; you get a much better finger on the pulse than if you live in an expat community in Beijing. What’s happening in Chongqing is very typical of what’s happening throughout the rest of China.

This is an excellent point that is not made often enough. How much would you expect someone in Washington DC’s Chinatown to know about the intent of the president or the future policies to impact the nation? Yet too many of our int’l correspondents in China are not nearly local enough.

Obviously China’s opaque political system, relatively poorly educated average citizen, flexible (unpredictable?) government policy, restrictions on political speech and “state secrets” and lack of a long track record make accurate forward looking analysis difficult to produce.

The Biggest Peg: Chinese Yuan and Sterilization Bonds

Jeffrey Frankel, of Harvard University wrote “On the Renminbi”, concerning the RMB/USD peg as the view looked from 2005, just after the first minor devaluation (2.1%) of the RMB. When one currency is pegged to another, the value will typically be pegged too high, or too low. If pegged too high, there will be a run on the currency, just like an old fashioned bank run, but in this case it’s the nations central bank. If pegged too low, the currency will be undervalued. Hot money will arrive in anticipation of the eventual revaluation. Central Bankers must try to get the excess cash out of the system, primarily through Sterilization Bonds.

We have already mentioned that a balance of payments surplus implies that the reserve component of the monetary base is increasing. Some expansion in the monetary policy may be entirely appropriate, especially in an economy with strong long-term growth. But in an economy that is in danger of overheating, the central bank may wish to sterilize the inflow, so as to prevent expansion in the overall money supply.

If the money supply expands, you will create inflation and may also create asset bubbles which [mis]allocate resources from productive efficient. Recently these misallocations have expanded global housing markets and propped up global stock markets.

Sterilization can be a good response to an inflow, for a period of time. It can help the country maintain its exchange rate target without abandoning a target for the money supply or interest rate. But it can become increasingly difficult over time, especially if traditional barriers to capital flows have been gradually eroded. One problem is that it just prolongs the balance of payments disequilibrium, because it by-passes the automatic mechanism of adjustment that reserve flows provide under the monetary approach to the balance of payments. Another potential problem is the quasi-fiscal deficit: if the central bank has to pay high interest rates to get domestic residents voluntarily to absorb “sterilization bonds,” while receiving low interest rates on its reserves of US treasury securities, then it is running a deficit.

Under normal circumstances, Sterilization Bonds would require chinese state banks to purchase bonds from the government, reducing the size of the money supply (because money is handed back to the government). However, in China all foreign currencies collected at state banks are immediately surrendered to the central bank. I believe this policy removes the typical need for “Sterilization”.

Some governments are able to force their bonds down the throats of their banks without paying market interest rates, a form of financial repression; but this just weakens the balance sheets of banks and raises the odds of a banking crisis somewhere down the road.

With the banks all being owned by the Gov’t, this is the case here…

One disadvantage of a balance of payments surplus, on the other hand, is that the reserves, which are typically held in the form of US Treasury bills and bonds and other dollar securities, pay a low rate of return. Interest rates on US treasury bills are low because the market is so liquid and because default is assumed to be very unlikely — and also, during the period 2001-2004, because the Federal Reserve has held short-term interest rates well below normal historical levels. The Chinese authorities have evidently already diversified out of Treasury bills, into agency bonds and other longer term securities, which will probably help the yield somewhat. But it is more likely than not that the dollar will depreciate over the next ten years (not necessarily in the short run), in light of the large US trade deficit, which would reduce even further the return to holding dollar securities. (Diversification into the euro or other currencies has evidently not yet gone far.)

The low interest rates associated with this giant pool of money helped sow the seeds for the global financial crisis. Basically, there is too much money in RMB and not enough good USD investments, yet the Fed set interest rates too low. The result was Chinese bankers buying Fannie, Freddie and boatloads of mortgaged backed securities.

These points are drawn largely from the experience of emerging markets such as Colombia and Korea in the early 1990s. Those countries were able to sterilize capital inflows only for a year or two, before it became too difficult, due to high interest rates on the sterilization bonds and the prolongation of strong capital inflows (as in standard macro models). Chinese officials may be correct that their case is somewhat different, due to a financial system that is less open and less market-oriented.

See the “surrender” policy for dealing with foreign currency.

The capital inflow has consisted largely of Chinese citizens bringing capital flight money back home, speculating on a revaluation, and so far the authorities have not had to pay high interest rates locally to sterilize it. But they may find it increasingly difficult to sterilize further inflows.

The “inflows” are all the Chinese expatriate class returning home story was probably true when this story started, however the size of the bubble today and “Rise of China” being the most read story of the decade indicate the story has been stretched quite a ways now. Interesting that speculators always have a million reasons why it’s different this time and how other people are speculating, but not them and it’s not widespread.

Either way, if this gap is real, better to address it through appreciation than inflation.

But I doubt this is the policy that the CCP will peruse, despite how logical it may be and how much it may benefit the average citizen.

Google Taking Stand Against Chinese Censorship

Caing reported that it’s going online. Now, the guys at google have decided to stop self-censoring, even if it means pulling their operations out of China! Full source (blocked by GFW)

These attacks and the surveillance they have uncovered–combined with the attempts over the past year to further limit free speech on the web–have led us to conclude that we should review the feasibility of our business operations in China. We have decided we are no longer willing to continue censoring our results on, and so over the next few weeks we will be discussing with the Chinese government the basis on which we could operate an unfiltered search engine within the law, if at all. We recognize that this may well mean having to shut down, and potentially our offices in China.

In Mainland Chinese culture, the person with slightly more authority in a situation routinely strong-arms the weaker party, and the weaker party generally goes along with the situation, saying “没办法 – No [other] method”. Google is another recent example 1st worlders of saying “No, are civilized and don’t agree with mafia negociation tactics”. Great job guys! Hope to see an explosion of cases like this in 2010!

The CCP has been using 8% annual GDP growth as the metric of success for years, but has lost sight of WHY 8% GDP growth has been the objective – and the bureaucrats have figured out how to manipulate GDP growth during the bubble years, the same way managers in American firms figured out how to manipulate stock prices in the 60s/70s. The resulting american conglomerate boom didn’t create long term shareholder value any more than the central planners focus on unproductive GDP will create long term financial benefit.

Deng Xiaoping made massive steps forward in Chinese reform by simply getting the gov’t out of the way, and with his support Zhao Ziyang and Zhu Rongji were able to go further. Chinese reform has been in exercise in gradualism, and this gradualism has avoid many undoable mistakes. However, we are left asking who are the reformers today? Wen Jiabao seems to generally came deeply about the welfare of the people, but without a free press and an independent judiciary, I think corruption will eat away at the efficiency of the Chinese economy and prevent mainlanders from reaching living standards of their brethren in Taiwan and Hong Kong.

China Bubble? Jim Rogers “No”. Jim Chanos “Yes”.

The mainstream financial press has recently started picking up on the idea of weather or not “China” is a bubble. Longtime China bull Jim Rogers is quoted as saying: “I find it interesting that people who couldn’t spell China 10 years ago are now experts on China… China is not in a bubble.”

Rogers’ partner George Soros got famous shorting sterling. Meanwhile, Jim Chanos got famous shorting Enron. Chanos noticed that Enron had a very low return on Capital Investment (only 6-7%/year) and is seeing the same low return on invested capital here in China.

The first day I ever came to Shanghai, it was for a lunch invitation with Rogers. I fell in love with the place, and though it took a few months to get here, I plan to stay in Shanghai. Bubble or not. That first day in Shanghai, standing with Rogers on top of the Ritz Carlton, he explained to me the madness of the Shanghai real-estate bubble, and moreover, the world wide real-estate bubble. So there you go: “Rogers, China real-estate Bubble: Yes”.

Listen, Rogers is saying that “There is no commodities bubble”. Rogers has a huge amount invested in this, and if central banks keep printing money, they keep proving Rogers right. When China’s real-estate bubble pops, some commodities will take a short term hit, but the macro trend is that the USD is being devalued.

Chanos isn’t saying that he doesn’t think that China has a bright future, he is said the GDP numbers are “massively inflated by under-depreciating a very, very, very shaky capital asset base.” Chanos’ critics say that China’s different because there’s no leverage here, but that’s not true. The market is leverage by multiple layers of ownership each using existing property as collateral. Not unlike the structured leverage in Dubai, but completely different from the leveraging the the US property market.

Most interesting is that many in the US are vehemently opposed to government involvement in the economy, yet those same people are bullish on the China market because the Chinese Technocrats can “fine tune” the economy at their will. These are the same all powerful technocrats that drop dead regularly bingeing with the hostesses at KTV.

Here’s the relevant China situation, as it stands today, summed up quickly: 1. Everybody in China was dirt poor from 1949-1977 because the gov’t prevented private enterprise (basically the same as North Korea today) 2. In 1977, Deng Xiaoping created the first Special Economic Zone in Shenzhen, beginning the growth of China. 3. In the late 90s, Clinton arranged for China to enter the WTO, speeding up foreign direct investment 4. More investment more, higher efficiency factories and foreign exchange reserves soared 5. The gov’t invested (25%?) these foreign exchange reserves into infrastructure, creating hopes of a modern, industrialized, first world China at some point in the future. 6. The owners of the factories, the beneficiaries of the infrastructure projects earned private profits, and had to invest these profits – due to lack of investment options, most chose to invest in luxury real-estate, pushing up prices to current levels. 7. In ’07, the Global Economic Crisis came and China still had enough foreign reserves to weather the crisis, not only offsetting the drop in exports, but preserving the lucky “8%” GDP “growth”. 8. Throughout ’08/’09, Due to high real-estate prices and weakened global trade and investment options, even more money has been poured into Chinese Real-Estate

Things to remember. The Technocrat “Central Planners” have never had a good track record. We’re all aware of the disasters of Communist Central Planning of Russia, Cuba and the Closed China. In the 80s though, American’s talked about the magic of the METI (Ministry of Economy, Trade and Industry) explaining how America couldn’t compete with Japan’s centrally planned capitalism. That infatuation ended around when American’s bought Rockefeller Center back from Japanese investors for half the price.

Personally, I’m very long on the Chinese entrepreneurs and the Chinese people. In the next 50 years, I hope that most of them are able to join us Americans, and our allies in Japan and Europe in first world living standards – they’ve already done so in Hong Kong and Taiwan and it seems to be a great thing for all of us. Meanwhile, I’m very bearish on bureaucrats everywhere, and nowhere more so than where the bureaucrats are living in a giant bubble – and feeding the bubble for their own benefit.

Leverage and the Chinese Property Bubble

A “bubble” is a sustained but temporary major misalignment between perceptions of value (momentarily reflected in market prices) and actual underlying value (eventually reflected in actual cash flows over time). In this sense, it is primarily a psychological phenomenon, caused by unrealistically high expectations of profit and/or underestimation of risk. I stress the words “sustained” and “major” because minor misalignments are taking place — and being corrected — constantly, which is what markets are all about. If all of us knew what returns would actually be over time, we wouldn’t even need markets — or entrepreneurs — in the first place. But there are times — we call them bubbles — when these misalignments persist and feed on themselves until, somewhere down the road, the market loses faith and valuations suddenly come crashing back to reality in one fell blow.

Some economic bubbles that we’ve experienced:

Non-leveraged bubbles are still bubbles, but fortunately their ends are not as dramatic and there effects are not as long lasting as leveraged (credit boom) bubbles. Frederic Mishkin pointed out this distinction in the Financial Times (Not all bubbles present a risk to the economy [FT subscription required]).

Like the start of the Internet Industry, there were also bubbles at the start of the Automotive, Radio and Television revolutions. Each one changed our life. Each time, too much speculative capital chases too few good assets. Additionally, the excess supply of capital creates an excess supply of assets that can be purchased.

The common thread in these three bubbles is over-excited investors putting money into a relatively new product, financial scheme, or industry that seems, given its limited track record, to offer a sure-fire path to riches but whose real risks and rewards they do not yet fully comprehend. Funding those investments via debt is not a necessary ingredient.

I have not yet been able to find a lot of 3rd party sources covering real-estate leverage in China, for now I’ll quote Prof. Chovanec on the subject (Leverage and China’s Property Market).

According to current rules, Chinese developers must use their own capital to secure land. Once they do so, banks will lend them 65% of the money they need for construction and related development costs, with the land pledged as collateral. But saying developers must use “their own capital” to buy the land is a bit misleading.

Residential Sector: Developers build and offload projects rapidly to buyers, half of whom are paying cash.

  • Many developers do raise such funds by listing on the domestic or Hong Kong stock exchanges
  • Many bring in private equity investors.
  • I’ve also seem them raise it in the form of debt
    • Parent company take out loans and then inject the funds as capital into a real estate subsidiary. (most common)
    • Issuing high-yield bonds (if they’re listed)
    • By taking on loans at multiple layers of holding companies, a developer can leverage up considerably to cover his “capital” commitment to the banks.
    • It’s very hard to quantify the extent of this exposure, due to the indirect way many of these loans were raised and channeled into real estate.
  • Approximately 50% of all residential purchases in China today are financed with mortgages
  • China’s mortgage market is relatively small — about 10% of GDP, compared to 48% for Hong Kong.

Commercial sector, developers are building properties mainly to hold and lease. That means they are raising debt — both from banks and subordinated creditors — and they are not deleveraging.

  • Many commercial buildings sit nearly or completely empty
  • Where does the cashflow to pay the loans on the property come from?
    • Does the bank care, or is it happy rolling over the loan because the (supposed) value of the collateral has risen?
  • This is the Dubai story all over again — multiple layers of leverage, no tenants, no cash flow.

Credit vs Collateral

  • In the West, banks usually make commercial loans to businesses based on an evaluation of their expected profits and cash flows — will they earn enough to repay?
  • In China, as in many developing markets where banks’ technical skills are not so sophisticated, most business loans are made on the basis of collateral — are there assets the bank can seize if the loan goes bad?
    • Asset Chinese banks like most as collateral is real estate
    • Therefore SOEs enjoy both preferential access to land AND lion’s share of bank loans in China
  • Nobody is really arguing that Chinese banks are over-leveraged.
  • It’s their clients, the developers and SOEs, that are leveraged up on real estate.
  • It’s loans to those clients, should property take a tumble, that would hit the banks as losses.

Even the Police Dept is Building Houses!

Cash Rich SOEs Pushing Real Estate Bubble Ever Higher

The National Audit Office data shows that 25 central ministries are involved in real estate violations, worth billions of yuan. Among them, unlisted assets of 51.6917 million yuan from the Ministry of Foreign Affairs have gone into purchasing real estate. The Ministry of Agriculture has developed commercial housing, acting beyond its authority, and has submitted false reports on housing subsidies. In 2008, a real estate rental service center under the Ministry of Finance took in rental income of 5.3193 million yuan. The Ministry of Public Security has approved construction projects worth 422 million yuan, utterly exceeding its authority. Other data show that among 136 central enterprises under the State-owned Assets Supervision Administration Commission, about 70% of the companies are involved in real estate, among which 16 firms are primarily based in the property industry, including Poly, Sino-Ocean, and China Resources, while more than 80 outside firms have business in real estate. Among the top ten highest priced land purchases in major cities in the first half of this year, 60% were gobbled up by SOEs.

Yes, that is 25 central ministries that have been caught speculating in the real-estate market.

  • What is the Ministry of Agriculture doing building houses?
  • And the Police Department (called “Public Security” here) is in the construction business too?

The government here is just as “asleep at the wheel” as the OFHEO was when regulating Fannie-May and Freedie-Mac.

The Office of Federal Housing Enterprise Oversight (OFHEO) was an agency within the Department of Housing and Urban Development. It was charged with ensuring the capital adequacy and financial safety and soundness of two government sponsored enterprises — the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac).

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.

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“.

Chinese GDP as % of US GDP

The Economist put together the following chart of the GDP of Japan and China as compared to the USA. Obviously China is nowhere near as advanced technologically as Japan was in 1990.

Also, note that ever since WWII, economic growth of the USA has been very consistent, averaging 1-2% in inflation adjusted GDP.

If the GDP of China was 12% of the USA in 2000, and 18% in 2005, does it seem reasonable that the economy would grow to be 38% the size of the USA by 2010?

Spending time in China starting in 2003 and living here full time from 2005 onward, I have not seen increases in consumer spending, increases in employee salaries or any other dramatic changes that would account for the massive shift.

What I have seen, is that the “Rise of China” is the most read news story of the decade. When good things happen, everybody wants to be involved and nobody wants to be left out. What happens when everybody is chasing the same asset, without paying attention to underlying value? Bubbles. I’ve also seen huge increases in gov’t spending without attention to ROI.

According to what happened in Japan, perhaps the bubble can hold on for another 5 years before bottoming out. But I doubt it will last that long. Why? Hopefully people will recall the Japan story sooner rather than later.

Also, facts about the true internal debt numbers could burst the bubble of the current Chinese miracle very fast.


The sad thing about this is that China is a great country. When bubbles anywhere burst, there are a lot of average people that get hurt in the process.

China Law: Liu Xiaobo and Akmal Shaikh

The Economist ran a story called “No forgiveness; no quarter. Happy Christmas from China” that had over 450 comments last time I checked. There are two components to the story:

On Christmas Day a Beijing court sentenced Liu Xiaobo, a veteran human-rights activist, to 11 years in prison for “inciting subversion of state power”

On December 21st Akmal Shaikh, a 53-year-old Briton charged with smuggling drugs, had his death sentence upheld by China’s Supreme People’s Court.

Far more interesting than the article itself was a commenter (British citizen living in Australia) “who has spent a large proportion of his career living and working in China”:

I believe this case highlights several problems facing China as it rises in the 21st century. Firstly, there is no rule of law. This is probably the greatest problem currently facing the country. The law remains arbitrary and corrupt. Your ability to defend yourself from the state depends upon your connections and your wealth. If you have neither, it’s a lottery.

Secondly, it illustrates the ability of the Chinese state to whip up nationalism and xenophobia, thanks in no small part to the ignorance of the general population it has done so much to bring about.

I think it is very sad that the CCP has inculcated many Chinese people with the belief that criticism of the Chinese government is criticism of China.

The comment in response from a typical “party line” Chinese author was perhaps even more interesting:

As for chapter 8, I was discussing with one of my friends (who is studying Law) on this matter, it is actually a Chinese copy of American Constitution. It is a good proposal, but not very suitable for current China, really.

Democracy is created to ensure fairness, while autocracy to gaurantee efficiency and unification. China needs to tackle with poverty and separatists, which necessitates a central-controlled government. You may believe that Tibet, or Xinjiang is not a part of China, but for all the chinese, we will fight ultil the last person to protect the integrity of our nation.

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.