That sound you hear: Part 3, the silence of the lambs?

December 30, 2011 | Capital markets, China, Credit, Global markets, Markets, Recession, Speculation, Subprime

[Concluded from yesterday’s  Part 2 and the preceding  Part 1.]


By:David A. Smith


In yesterday’s Part 2, using as main text a Telegraph story by long-time China skeptic Ambrose Evans-Pritchard, and a doom-saying report a month ago from The Epoch News (13 November 2011), we discovered that the long-foretold but long denied correction may be coming to the Chinese housing markets, – and we see China’s central bankers and government officials acting like they believe a price drop is coming:


To convert to dollars per square foot, divide by 60


Professor Patrick Chovanec from Beijing’s Tsinghua School of Economics said China’s property downturn began in earnest in August when construction firms reported that unsold inventories had reached $50bn. It has now turned into “a spiral of downward expectations.”


A ‘spiral of downward expectations’ is financial-analysts speak for ‘an emerging panic.’


Lost our liquidity, everything must go!


A fire-sale is under way in coastal cities, with Shanghai developers slashing prices 25% in November – much to the fury of earlier buyers, who expect refunds. This is spreading.


This is backed up by a series of really detailed posts on Patrick Chovanec’s thorough, readable, and excellent blog:


Caijing reported that one high-end housing developer in Ordos had sold only 1/4 of its units, and was now slashing prices and promising to make up the difference to previous buyers.


And Professor Covanec adds a chilling detail:


Shanghai Securities News reported in late November that many developers in Ordos had borrowed from underground lenders, who were now pushing them to repay. 


When the shadow system is that big, it’ll distort the economy


If a corrupt system has been awash in capital from unregulated and possibly illegal lenders, that can only add to both the overheating of prices and the difficulty of managing the slowdown. 


Cheng Xiaonong, an economist and former aide to ousted Party leader Zhao Ziyang, said that high praise of the “China model” is often made on the basis of [a] the high-visibility construction projects, [b] a big GDP, and [c] much money in foreign reserves.


Bearish on China ever since his boss was ousted: Cheng Ziaonong


Unfortunately for economic health, the first two can be manipulated by channeling money into unproductive investments (e.g. real estate properties, so you can produce praiseworthy visible talismans without, in fact, building a successful economy:


Cheng says that for the last decade the Chinese regime has accumulated its wealth primarily by promoting real estate development, [borrowing money from state-owned banks], buying urban and suburban residential properties at low prices (or simply taking them), and selling them to developers at high prices, [without having genuine consumer demand to buy and live in the flats].


And such statistics are popping up everywhere:


Property sales have fallen 70% in the inland city of Changsha. Prices have reportedly dropped 70% in the “ghost city” of Ordos in Inner Mongolia.


Not surprising, especially if the kneecappers are pushing for collections. 


Consider this your delinquency notice


Prices definitely have further to fall, and if history is any guide, the weakness will start in the periphery, moving toward the center and the stronger cities:


China Real Estate Index reports that prices dropped by just 0.3% in the top 100 cities last month, but this looks like a lagging indicator.


In general, value is a lagging indicator anyhow, and in any case we know that larger city mayors have many means of conniving with developers to keep reported prices high:


CNN spelled his name wrong …


Ever-rising land prices serve as one crucial underpinning for China’s entire financial system (the other, as we will see, is the nominal fiscal balance sheet of the central government).


Another lagging indicator, one less prone to manipulation, is this:


Meanwhile, the slowdown is creeping into core industries. Steel output has buckled.


Not holding up


If steel’s not being produced, it means the skyscrapers aren’t going up.


What to do when the cranes stop flying?


Beijing was able to counter the global crunch in 2008-2009 by unleashing credit, acting as a shock absorber for the whole world. It is doubtful that Beijing can pull off this trick a second time.


I fear that the world used up all its bullets on the US recapitalization.


Sorry, all out


“If investors go for growth at all costs again they are likely to find that it works even less than before and inflation returns quickly with a vengeance,” said Diana Choyleva from Lombard Street Research.


The International Monetary Fund’s Zhu Min says loans have doubled to almost 200% of GDP over the last five years, including off-books lending.


“That’s two times GDP,” says Mr. Zhu


Loan volume that high implies a complete lack of financial control, same moral hazard and balance sheet turbocharging as in Fannie/ Freddie – with the additional problem that Fannie/ Freddie were buying loans scheduled to produce income.  China’s lenders own flats that have no income-producing value unless occupied.


This is roughly twice the intensity of credit growth in the five years preceding Japan’s Nikkei bubble in the late 1980s or the US housing bubble from 2002 to 2007. Each of these booms saw loan growth of near 50 percentage points of GDP.


Things that cannot go on forever, don’t.


The IMF said in November that lenders face a “steady build-up of financial sector vulnerabilities”, warning if hit with multiple shocks, “the banking system could be severely impacted”.


Mark Williams from Capital Economicssaid the great hope was that China would use its credit spree after 2008 to buy time, switching from chronic over-investment to consumer-led growth. “It hasn’t work out as planned. The next few weeks are likely to reveal how little progress has been made. China may ride out the storm over the next few months, but the dangers of over-capacity and bad debt will only intensify.


In truth, China faces an epic deleveraging hangover, like the rest of us.

A massive price correction is coming.  Will it be a hard crash for China?  At Patrick Chovanec carefully puts it:

How investors in the secondary market will react to the collapse in primary market prices is the biggest question of all.  As I’ve mentioned many times, many people in China buy multiple units of housing in order to hold them empty indefinitely, as a form of savings.  They do this because they have few attractive alternatives and because they have faith that housing prices will go up. 

Throughout the world, we’ve seen the emerging upper-middle-class like investing in homes for precisely those same reasons, so their presence here contributed to the price mania.  Now that prices are turning, these buyers are stuck:


This shouldn’t have happened


Since many have paid cash, they aren’t under the same immediate pressure to sell as developers. 


Normally, the emergence of all-cash buyers signals a bottom, and while that’s not true here, Chinese investors having already buried their cash into property will be unable to extract it, and they won’t be generating any new effective demand.  In a downturn, you can live in only one of the homes, so the others will sit empty.


But they do tend to look to rising primary market prices for assurance that their investments are profitable and safe, and now those prices are now plummeting.  A great deal depends on whether they hunker down to weather the storm, or join the fire sale.


Capital frozen?  Investors hunkering down?  Mercantilist protectionism arising?  A global credit contraction?

Welcome to the 1930s?


Will blog for food?