Middle class fall prey to Beijing’s manipulation of the property market
Andy Xie says grief awaits Chinese taken in by government policy moves that in fact help to sustain the bubble
Beijing is talking about tightening the property market again, the latest of many similar episodes over the past decade. It will leave the same impression: that the government is holding property prices down and, if it changes its mind, prices will go up again. This is the foundation of China’s vast property bubble: any dip is not natural and is a buying opportunity.
Starting from the middle of 2015, following a year-long slump that looked like the first stage in the bursting of a big bubble, the property market began to heat up again. The driving force was shadow banks funding down payments.
After the stock market crashed, the shadow banks that supplied leverage there were looking for other demand. Down-payment financing in tier-one cities became a hot market. Like ordinary speculators, the shadow banks believed prices would never fall in the three tier-one cities (Beijing, Shanghai and Shenzhen). Hence, why would down-payment loans be risky?
As the market began to heat up, land kings appeared in these cities. Some developers were paying more for the land than the completed properties were going for. This phenomenon of “dough costing more than the bread” poured oil on the fire. People were led to believe that the bread’s price would surely catch up. By this spring, property sales were rising by over 50 per cent in value.
In a bubble, there are often urban legends about how buyers show up with bags of cash. Unfortunately, the real story has to do with debt. As the market exploded, the banks joined the game in a roundabout way, allowing so-called consumption loans to be used for down payments. It’s hard to believe that the banks that provided both consumption loans and mortgages to the same individual or family did not know the real story.
China’s household debt has risen from 5.6 trillion yuan to 31.1 trillion yuan (HK$35.8 trillion) between August 2008 and 2016, according to official statistics.
To get a fuller picture, we should add the debt incurred in the shadow banking system. Take the rise since August last year. On the books, household loans have increased by 5.4 trillion yuan. If the shadow banking system extended loans of 2 trillion yuan, the increase would be 7.4 trillion yuan. This compares with the 10.5 trillion yuan in new residential property sales, of which 78 per cent were contracted for future delivery and often not paid in full. These numbers suggest the current surge in sales could be 100 per cent debt-financed.
Current prices are exceptionally high. In tier-one cities, a working couple could buy just 1 square metre with their annual take-home pay. The 20 per cent down payment is equivalent to 10-20 years’ income. This relative price – that is, price per sq m to disposable income – is already much higher than Japan’s was at its peak, a quarter of a century ago, when it introduced 100-year mortgages.
Fear of renminbi devaluation was the initial spark for this round of speculation. It is not a coincidence that the market took off just when the government cracked down on underground currency exchanges to slow capital flight. While money couldn’t leave, the devaluation expectation remained. Property became a hedge. When the market frenzy followed, greed took over from fear.
The government is trying to take advantage of the bubble. By holding down demand in tier-one cities through purchase restrictions, the hope is that the speculative fire would shift to the tier-three and tier-four cities, where huge inventories remain. The speculation has indeed spread to tier-two cities but it is unlikely to take hold in tier-three and tier-four cities. The supply there is just too massive. The current stock of 7 billion square metres of properties under construction, of which 4.8 billion sq m is residential, is mostly in these cities.
Some argue that China’s household debt, likely to reach 50 per cent of GDP this year, is still low. Hence, the government could encourage the household sector to leverage up to absorb the property inventory. This is fantasy. The current level is already over 100 per cent of household disposable income, similar to the level in developed countries. If the current growth rate continues, the debt will double in less than four years. The current trajectory will hit a wall pretty soon.
Further, when the markets in Japan and Hong Kong blew up, their household debt was 50 per cent of GDP. The speed of growth, not just the level, matters. China’s property ownership is over 80 per cent. The debt is likely to be concentrated in a subset of the population, as it was in Hong Kong in 1997.
When a bubble reaches its limit, it will burst. By marketing the downturn as a consequence of the government crackdown, the bubble is sustained. This is the reason China’s property bubble has lasted so long. While government power can stretch a bubble further, it can’t keep it going forever. What’s beyond 100 per cent financing? At some point, the debasing of the currency through lowering the credit standards will eventually take down the real exchange rate. Unless China changes, the renminbi is in for a lot more trouble.
At the property market wobbles, a new theory is emerging that the government wants the stock market to go up, because it is holding down the property market. Nothing about that makes sense. China’s stock market, though down by nearly half, remains the most expensive in the world. Government funds of over 2 trillion yuan have kept the market from crashing. People who get into the market will become another bunch of sacrificial lambs.
In the past 12 years, anything that has set a trap for the credulous masses has gained popularity and eventually government support. Such a system doesn’t favour the rise of the middle class. When people make money from hard labour, they are enticed into a game and lose it. How could the middle class ever prosper?
People’s losses are one form of forced savings that are absorbed by investment. But, weak consumption depresses returns on investment. To keep investment going, the economy needs more bubbles to subsidise investment. This is why China is stuck with bubble- and investment-led growth: fixed asset investment rose to 83 per cent of GDP in 2015 from 54 per cent in 2008 and 33 per cent in 2000.
Could this process go on forever? Will people ever learn not to take the bait? The recent trend of 100 per cent financing may signal the end is near. When people borrow 100 per cent to gamble, they may not intend to pay it back if the bet doesn’t work out. Dead pigs are not scared of boiling water, as they say. The juice in China’s property bubble may be gone already. The puppet masters may already be in the boiling water; it does, after all, take a little while to feel the pain.
Andy Xie is an independent economist