...time to short the AUD. If only I knew how (without having to be exposed to stocks )- any AUD short ETF out there?
What happens when Beijing’s housing bubble bursts?Evergrande’s financial woes are raising fears China’s huge house price boom could soon bust, which will deal a hefty blow to economic growth.
Karen MaleyColumnist
Sep 21, 2021 – 5.02am
You just have to look at the stunning collapse in the iron ore price to realise how nervous investors have become about the outlook for China.
Of course, the ostensible reason for the steep slide in the
iron ore price is Beijing’s move to impose production cuts on the country’s steel industry due to environmental concerns.
But Beijing is simultaneously trying to take some heat out of the torrid property market by forcing debt-addicted property developers to deleverage. This, of course, will translate into a slowdown in the country’s property construction industry, and lower demand for steel.
Evergrande – which owes more than $US300 billion ($415 billion) – is the poster child of Beijing’s crackdown on debt-addicted property developers.
And horrified investors are coming to the belated realisation that Beijing has decided to punish excessive risk-taking by allowing
Evergrande’s holding company – which owes most of the debt – to collapse.
Chinese policymakers will, of course, be aware of the risks of allowing such a massive corporate collapse, and they will be anxious to avoid a repeat of the 2008 failure of US investment bank Lehman Brothers, which triggered a meltdown in global financial markets.
The Chinese central bank has already taken steps to alleviate liquidity strains, injecting 90 billion yuan ($19.2 billion) into the country’s banking system last week. And Beijing will probably encourage the state-owned banks to step up their lending to other sectors of the economy.
But it is far from clear Beijing will be able to prevent Evergrande’s problems from causing the country’s massive house price bubble to burst.
Kenneth Rogoff says a slowdown in the real estate sector will act as a major brake on Chinese activity. Bloomberg
That is because although Beijing clearly appreciates there is some undesirable speculation in the housing market, the scale of this speculation is undoubtedly far greater than policymakers realise.
This means the country’s housing market – and the entire economy – is much more vulnerable than Chinese policymakers appreciate.
What’s more, Beijing has had little experience of the abrupt changes in market psychology and the devastating consequences of a collapse in confidence, which means it is probably underestimating the contagion effects of an Evergrande collapse.
Other debt-laden property developers are already feeling the fallout from Evergrande’s problems, as investors and bankers have become wary of lending to the troubled sector.
That means that to survive, highly geared property developers will have little choice but to dump apartments and undeveloped land onto the market, putting intense downward pressure on real estate prices.
Given average Chinese households typically plough their surplus savings into property, a sharp drop in housing prices would quickly cause consumer confidence to plummet.
Given the severity of many economic indicators, China’s decades-long housing boom shows many signs of having hit a potentially precarious peak.
— Kenneth Rogoff, Harvard University, and Yuanchen Yang, Tsinghua University
The combination of an imploding housing market and a souring of consumer sentiment would deal a heavy blow to the Chinese economy and significantly reduce its appetite for raw materials,
particularly iron ore.
In a paper titled “Peak China Housing” published in August 2020, Harvard Professor Kenneth Rogoff and Yuanchen Yang, from Beijing’s Tsinghua University, highlighted how central the real estate and construction sectors are to the Chinese economy, accounting for a staggering 29 per cent of Chinese GDP.
Not surprisingly, they argued that a slowdown in the real estate sector would act as a big brake on Chinese activity.
“We find that a 20 per cent fall in real estate activity could lead to a 5 to 10 per cent fall in GDP, even without amplification from a banking crisis or accounting for the importance of real estate as collateral,” they wrote.
The paper also highlighted the similarity between China’s housing boom with other housing bubbles.
House price surge“Despite the repeated argument that China is different, we note that it shares striking similarities with other boom episodes in the run-up of housing prices, the scale of the construction sector, the debt accumulation etc.
“Indeed, given the severity of many economic indicators, China’s decades-long housing boom shows many signs of having hit a potentially precarious peak.”
One striking feature of China’s housing boom is the unprecedented surge in house prices.
Prices in China’s Tier 1 cities have risen more than six-fold since 2002, compared with the increase in Ireland of 100 per cent and Spain of 230 per cent in their respective housing booms.
“Currently, the home price to income ratios in Beijing, Shanghai, Shenzhen and Guangzhou are comparable to the world’s most expensive cities”, the paper says.
“In particular, the price to income ratios in Beijing, Shanghai and Shenzhen exceed a multiple of 40, compared to 22 in London and 12 in New York.”
The paper notes that these multiples could be justifiable on the assumption that China will continue to enjoy very fast income growth indefinitely.
But, it adds, “even aside from the COVID-19 pandemic, China’s rapidly ageing population, a shrinking technological gap with the West, and normal decreasing returns to investment all suggest that future growth will likely be trending downward.”
The paper also points out that the real estate and construction industries are intertwined in China because property developers basically make their profits by managing the construction process and turning raw land into saleable properties.
“In 2016, real estate and construction industries combined accounted for around 29 per cent of China’s GDP, comparable only by pre-crisis Spain and Ireland,” it says.
High vacancy rates“Real estate and construction are also crucial for job creation, making up around 20 per cent of urban non-private employment.”
But there are worrying signs – such as high vacancy rates and the existence of “
ghost cities” – that China could be grappling with an excess supply of housing.
“It is sobering to recall that US regulators never expected that housing prices would fall by 36 per cent from peak to trough ... even the very cautious pragmatic Chinese regulators may not yet be fully anticipating the depth of the possible fall in China’s housing prices.”
The paper notes that because Chinese local governments are heavily dependent on land sales to earn revenue, and because many companies rely on real estate as collateral for their borrowings, “even modestly declining prices ... could pose a considerable risk”.
But it adds that a sharp slowdown in home sales would place a huge strain on developers’ cash flows, forcing many out of business.
In turn, a surge in real estate insolvencies would result in people losing their jobs, or at least part of their income, which would reduce demand for housing.
What’s more, a fall in property prices will leave households and corporates with less capacity to borrow, which could reduce credit growth.
The paper warns that because real estate is so closely linked to other sectors of the economy, such as construction and demand for household appliances and furnishings, “a reduction in housing activities may contribute to a downward spiral in the economy, leading to further declines in employment, income, consumption and investment”.
