China 2012; the year of the dragon – but is the fire burning out?

A Minsky and Kindleberger approach to the development of the possible Chinese housing bubble:

Displacement: In the early 1980s, the Chinese government experimented with the idea of revolutionising the housing market away from the socialist system (where housing was provided by employers) to a more market orientated system. In 1998, housing reform was passed. As privatisation swept the country, housing prices started to take off. Another displacement moment came in November 2008, when in response to the global crisis, the Chinese government unveiled a $586 billion stimulus package and shortly after revealed a huge interest rate cut, the 4^th in a matter of months. The fixed exchange rate pushed inflationary effects into non-tradable goods such as real estate.

Boom: Since privatisation started in China in 1978, GDP growth took off. The nation was becoming wealthier and the privatisation of housing, with strong urbanisation growth saw house prices increasing. Low interest rates at the start of the decade allowed for cheap credit.

Euphoria: Speculative borrowers exist to capture the huge price gains (although the government is clamping down on this) but Ponzi household borrowers can’t really exist as first time mortgages are given only to those with a minimum of 20-30% down payment. According to PIIE “mortgage debt at the year-end 2007 was the equivalent of 18 percent of household disposable income in China, while it was 100 percent in the United States” and around 80% of the value of a house was financed with cash. The government provides schemes to help low income families. Any subprime crisis in China, comes from excessive lending to local authorities rather than to individual households.

                                          Picture courtesy of Earthsky

New economy: There has been a cultural change away from socialism towards status and the desire for larger and better housing.

Swindles: in America, it was the banks; in China, it’s been government officials accepting bribes in exchange for building permits.

Overtrading – Due to capital controls and a poorly developed financial sector, Chinese investors have little choice but to invest in real estate. And with negative interest rates (inflation higher than interest rates) where else is there to stick the cash?

Profit taking – As of yet, we can’t even be sure if this stage has passed or still ahead. Yes, property prices have been declining slightly recently (“0.18% in January compared to December” according to Forbes) due to measures to ease the housing price boom (such as increased down payment for second time mortgages and gradual interest rate increases) but this doesn't mean they're about to plummet. However house price declines will make an impact; a topic I shall look at in next week’s post. But as we ponder, the authorities just keep on building!