Inquiring minds are reading the Wall Street Journal for their coverage of the China real estate frenzy that is occuring:
Last week I sold an apartment in Beijing for more than 2.5 times what I paid for it five years and three months ago. When I asked the buyer why he was optimistic about real estate, he explained that land was limited in Chinese cities and government policies would keep the market going up.
So far that argument has proven right. Understanding government policy has long been the key to making money in China’s property and stock markets. The atmosphere at the Beijing tax and land bureaus brought to mind California during the gold rush.
It’s impossible to say definitively that a market has strayed into bubble territory until after the collapse. But prices rising out of the reach of average buyers is one indicator. Housing prices in the U.S. peaked at 6.4 times average annual earnings this decade. In Beijing, the figure is 22 times.
There is no decimal point missing and it is not a typo. Real estate really is selling for 22 times average annual earnings.
Since many people pay for homes in cash and Chinese banks supposedly only lend a prudent amount to buyers, it is said that there is little risk of China having a real estate correction. So little, as a matter of fact, that if the market falls by a third, they will still be above water. Many think this immunizes the market (and in turn the banks) from a “bubble”. However, what appears to be happening is the Chinese verzion of a “Martingale”.
Basically, a Martingale is a system believed to be ‘can’t miss’ moneymaker that has an unforeseen or underestimated risk factor. Think of Roulette and the idea of doubling your bet each time you lose. Many people mistakeningly think it is a can’t miss way to make money. Unfortunately, newbie players forget that those two green numbers come up just as often as any others and throws the odds of this betting system over to the house. And the kicker is, statistically speaking, the Martingale player will actually lose much more than the non-system player.
In “financial systems”, AKA economic policy”, this is caused by not backing the observer’s perspective out far enough to see outside the model’s known “universe”. Today we see this mistaken policy in that where people are actually saying a nation’s debt never has to be paid off. Before that it was the idea that real estate would continuously go up. At the beginning of the millenium it was the idea that internet stocks were going to continually go up.
Where is the problem in this China Martingale?
The wealth itself comes from the credit machine that drives China’s investment-led economy. Fixed-asset investment grew 23.5% this year, and it is forecast to grow 20% next year. After 2008, Beijing paid lip service to the need to rebalance the economy in favor of consumption instead of investment. Meanwhile it doubled down on investment, with a stimulus package for 2009, equivalent to 15% of GDP, that was made up mostly of bank loans. The torrid pace of lending continued this year.
And guess what? The Chinese have even come up with a unique self-blinding machine:
Pushing loans out the door throws off large amounts of cash to the managers and cadres involved, which they then use to buy apartments. For instance, local governments depend on the revenue from land redevelopment, and the officials then take a cut and buy property. As long as the music keeps playing, everyone keeps dancing.
In the past, when China could depend on growing export markets, technocrats in Beijing were able to keep speculative frenzies in check with periodic crackdowns. Moreover, with ample supplies of cheap labor, the real economy was unlikely to overheat. The main tools to regulate growth were administrative: government orders to banks to stop lending and to companies and local governments to halt projects. And that’s what Beijing is still trying, increasing banks’ reserve ratios and cutting lending quotas.
But this time nobody is listening. Local governments and banks have set up off-balance sheet vehicles to conceal loans and keep the spending boom going. Fitch Ratings estimates that not only did banks exceed the central bank’s 7.5 trillion yuan ($1.1 trillion) cap on lending for this year, they made an additional three trillion yuan of these shadow loans.
Greed is the same the world over.
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