Wednesday, August 11, 2010

Understanding China's property boom

A fellow supply-sider, Michael Kurtz (head of China research for Macquarie Securities) has written an excellent article in the Asian WSJ: "The Price of China's Property Boom." He explains the reasons behind China's property boom and how it all might work out. It's not necessarily a disaster—and it's all very rational. The good news is that it could lead to some much-needed reforms. Here's an excerpt, but do read the whole thing:

China's citizens, raised with an awareness of their country's heartbreakingly tumultuous history of messy dynastic successions, invasions and expropriation, have come to value tangibility as an attribute. A housing unit is solid and intrinsically valuable, although not portable. By comparison, from the Chinese perspective a share of stock is merely a claim on a distant and impersonal management's promise of a future that may never materialize. 

So a well-off middle-income Chinese family with savings to deploy may rationally choose to put their savings into even an empty housing unit. Without an annual property tax, the carrying cost of a vacant unit is effectively zero. This also reduces incentives to seek rental yield as an offset to carrying costs, one reason why empty units are so prevalent. Presumptive capital gains seem to be satisfactory for most investor-owners. 

With such demand distortions entrenched, and particularly assuming inflation remains a factor, China would not appear to be an oversupplied market. The modest price pullbacks of May-June have enticed buyers back out of the woodwork in recent weeks. Centaline Property in Shanghai estimates that even at China's now-reduced monthly transaction volumes (half of where they were in late-2009), the primary residential market has only three to four months of outstanding supply, well below the long-term average of seven to eight months. 

Those same demand distortions, though, also portend at least three difficult eventual transitions for China's property market in the not-distant future: interest rate reform, which over time would increase returns to bank savings and reduce property's relative attractions; capital account liberalization, which would broaden Chinese households' access to the world of cross-border investment alternatives; and the introduction of value-based property ownership taxes to reduce local governments' reliance on land-sale revenues, which would impose a carrying cost for empty housing.

Tricky as these reforms may prove, each is central to the economic restructuring and efficiency improvement Beijing hopes to pull off in the next few years, meaning difficult decisions and trade-offs lie ahead. The true risk may be that by having allowed a potential property overhang to come into existence, Chinese policy makers paint themselves into a corner where essential reforms such as financial liberalization and fiscal restructuring seem too dicey to implement. If so, China may be able to keep its firm property market, but at the cost of postponing progress beyond a capital-wasting bank-SOE complex ill-suited to China's economic future.
UPDATE: This is very encouraging news, as it would directly address one of the sources of China's property boom (artificially low deposit rates):

China should target a rise in banks' deposit interest rate ceiling, rather than hiking the benchmark interest rates, to pull real deposit rates out of negative territory, a senior government economist said in remarks published on Friday.
'We must give the market a signal that we are pulling it (the real deposit rate) to a positive level,' Xia Bin, an adviser to the cabinet and the central bank, told the official People's Daily overseas edition.
China puts a lid on banks' deposit rates and a floor under lending rates, but the negative real deposit rates at banks have created an incentive for savers to seek other investment opportunities.


Public Library said...
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Public Library said...

Rationalizing irrational market behavior. Gotta love it.

I follow this blog about China. Very well written from someone living there.

Benjamin Cole said...

That guy Pettis seems to know his stuff.
Misallocation of capital--I have wondered about that in China. Still, they seem to have gobs of money to solve any mistakes.

On the other hand, the USA uses a mortgage interest tax deduction to help funnel hundreds of billions of dollars extra into residential and even luxury housing every year, on top of the woeful Fannie and Freddie albatrosses.

In the USA, spending on defense, homeland security and the VA is snaring about 7 percent of GDP. Close to $1 trillion every year.

So who is misallocating capital?

Public Library said...


Everyone is mis-allocating capital by all means necessary. Therein lies your problem. Eventually, the rotting from the inside out takes its toll.

Benjamin Cole said...

So the big Q: Every economy mis-allocates capital. How much is survivable?

The US over-allocates to housing, welfare, rural areas and militaries.

China overallocates to infrastructure , manufacturing and militaries.

China, however, runs big trade surpluses and we run huge trade deficits.

Who's house will stand last?

Public Library said...

The most interesting piece about China is how similar it is to Japan 30-40 years ago. However, we all know how Japan's story turned out.

Ironically, we now look like Japan two decades ago. I could care less about what kind of Federal Reserve we have. Any Federal Reserve is a parasitic feature of commerce.

The engine block cracked in 2008. Unless you replace the engine block it is akin to adding more poor regulation on top of already bad legislation. It is still broke. No pun intended.

There is plenty of fractional reserve capital out there so printing more will do you no good. The more quickly we remove the fractional reserve capital from the system and reinvest from real savings the more quickly we can get on with our lives.

It just seems like simple commonsense to me. Perpetuating a lie nobody believes in anymore is ludicrous.