June 6, 2016

The Myth That Prices Defy Gravity

A report from Bloomberg on China. “It’s quiet these days on a Sunday afternoon in the streets of Dongguan, where almost every block outside the center is a factory or housing for workers. A red banner advertising for staff above one plant says it has enough orders to keep production lines busy for a year. Locals say the sign has been there at least two years and it’s no longer true. Many, like factory worker Yu, made it their home. Now she is considering moving back to Chongqing in the center of China, which she left 20 years ago. ‘This is the worst time ever,’ said Yu, who saw her earnings almost triple during her time in the province. ‘The factories hurt by the 2008 financial crisis were the smaller ones, but this time the big ones are affected.’”

“Factories in the province continue to close, stirring discontent. The number of strikes and protests in China doubled last year, according to the China Labour Bulletin. Rising discontent has brought a tough response from city officials, according to some workers, who asked not to be identified for fear of retaliation. They said their mobile phones were being monitored by the government. ‘None of us likes this situation we’re in but we didn’t have much choice,’ said Yu, the factory worker. ‘The factory owner was going to run out of cash, and the government should take some responsibility.’”

The Nikkei Asian Review. “China’s real estate binge has left it with a stock of unsold homes so big that their combined floor space is the size of Singapore. How did things get so bad? And how can the housing market’s precarious balance of supply and demand hold? China still has believers in the myth that home prices defy gravity. Thirty-year-old Yu Zhonghuan is one of them. Though confessing to be the type that spends all of his monthly earnings, he says he wants to buy a home.”

“Yu’s 6,000 yuan monthly pay goes mostly toward good times with friends. In a few years, he will have the option to buy the 400-yuan-a-month rented apartment in public housing where lives now. He reckons that reselling the place will give him enough money for a down payment on a home. ‘Everyone around here has become rich buying one or two houses,’ Yu says.”

“Urbanization and the belief that real estate prices cannot fall go a long way toward explaining how China’s housing market staves off collapse. Migration from the countryside to cities will continue for some time, but running down inventories of existing homes will take years. Any attempt by authorities to rev up residential investment in hopes of a rush of economic growth could precipitate a crash. For a glimpse of what a housing market looks like after myth gives way to depressing reality, China need only look to Japan.”

From Investors Business Daily. “Triggered by yuan devaluation fears, the Shanghai composite tumbled more than 25% from the end of 2015 to its Jan. 27 low. Yet the risk of even more major shocks coming out of China, rather than going away, has continued to grow. The reckoning has only been postponed by Chinese government efforts to keep the economy afloat with an unsustainable rise in debt. China’s $1 trillion first-quarter credit surge, equal to an annualized 46.5% of GDP, was ‘one of the highest ratios ever,’ wrote Societe Generale economists Wei Yao and Claire Huang.”

“Unlike China’s debt binge at the end of 2008 that helped lift the global economy out of recession, this latest surge of government-funded infrastructure spending and an easy-credit-fueled spike in property values didn’t buy much growth. China’s GDP expanded just 6.7% in the first quarter, the slowest pace in seven years. Slowing growth amid rapidly escalating debt has troublesome implications. Much of the credit is going to unproductive uses and propping up bad debts. The longer that continues, the bigger the eventual debt implosion may be.”

“From the end of 2007 through mid-2014, China’s government, corporate and household debt surged from 158% of GDP to 282%, McKinsey noted in a 2015 analysis. Nominal debt levels quadrupled from $7 trillion to $28 trillion. A more up-to-date analysis from the Institute of International Finance finds debt-to-GDP rising to 295%.”

“China is ‘walled in’ between two likely fates, Goldman Sachs said. It could try to keep the economy from slowing further, letting bad debts fester and swell, ultimately triggering a financial crisis. Or China heads off a debt meltdown with reforms that aren’t aggressive enough to prevent ‘a prolonged period of slow growth and possibly deflation,’ similar to Japan. ‘Every major country with a rapid increase in debt has experienced either a financial crisis or a prolonged slowdown in GDP growth. History suggests that China will face the same fate,’ Goldman wrote.”

The New York Times. “Mr Chen Furong and his wife bought their home 23 years ago for its proximity to the city centre and for the tree-lined canal just outside. Their dream was to pass it on to their children and grandchildren, a piece of wealth giving their family a share of China’s economic miracle. Then, their neighbour tried to sell her place — and it was all thrown into doubt.”

Like every other homeowner in China, Mr Chen and his neighbour own their homes but not the land underneath them. All land in China is owned by the government, which parcels it out to developers and homeowners through 20- to 70-year leases. When the neighbour — whose surname is Wang — tried to sell her apartment, local officials told her that her lease on the land had expired. To sell her apartment, they told her, she would have to pay them one-third of the sales value.”

“Ms Wang protested in a move that drew national attention. Suddenly millions of Chinese who had socked away billions — and possibly trillions — of dollars were worried as well. If the local authorities in other parts of China did the same thing, they thought, a big chunk of their own wealth could end up with the government as well. Several blocks away, residents of another affected neighbourhood, Shuixin, wondered what would happen when they tried to sell their apartments.”

“‘People don’t know what to do,’ said Mr Ge Qingchuan, a retired real estate agent. ‘No one paid attention to land leases, but now there are problems. For example,’ he added, ‘if you are buying a new apartment and using your current apartment, with a 20-year lease, as collateral to borrow money, you won’t be able to do so. If the banks see your land lease is expiring, they won’t lend you money.’”

The Australian Financial Review. “ME Bank is the latest lender to ban foreign borrowers from taking out mortgages, adding to growing fears about the scale of possible fraud and money laundering under investigation by the nation’s top five banks. It is the second lender partly relying on securitisation and foreign investors to have cut back on mortgage lending in the past week. Major banks banned foreign borrowers after detecting potentially fraudulent applications that included documents with missing pages and income and employment statements from overseas’ employers that could not be located.”

“Fraudulent applications using Bank of China letterhead and bank statements are being sold for $250, according to industry sources. Last week Firstmac, a Brisbane-based non-bank lender, withdrew lending to purchasers of high-rise apartments because of concerns about over-supply and falling demand. The lender, which also raises most of its funds from overseas investors, warned about growing investor concern about a local property market bubble.”

“CBRE managing director of residential projects, David Milton said problems loomed for Chinese buyers, who have invested into a Foreign Investment Review Board-approved development as ‘Australian banks specifically want to see an onshore source of income to service the loans.’ ‘Many Chinese buyers don’t have this,’ Mr Milton said in comments reported in a research note from broker CLSA. CBRE markets more than 60 per cent of Sydney’s new apartment projects. ‘In the near term, for projects settling in the next 3-6 months, it’s going to create a potential problem for FIRB buyers, who were banking on the mortgage from an Australian bank to settle their purchase.’”

The Independent Financial Advisor. “Research house BIS Shrapnel offers some insight into how the end of the mining boom and the plateauing property market will affect the Australian economy. Frank Gelber, chief economist and director, BIS Shrapnel: ‘The mining boom, or the investment part of it, is over and we’ve known that for a long time. Now, with the collapse in commodity prices – well, you wouldn’t expect a really big rebound in commodity prices because now there are plenty of producers that the Chinese can screw down on price at around about current price levels. And so all of the little producers, the high-cost ones, they’re dead. They will gradually go broke – well, maybe not so gradually.”

“‘So, we all know the mining investment phase is over. We speak as though [the decline is] finished, but it’s only just beginning. We’re 12 per cent into a 60 per cent decline in mining investment. The housing boom has been a big contributor to growth, but we’re looking at effectively the next stages of plateauing of house building or residential building, followed by a moderate decline. At the end of the day, in terms of the macro effect, the housing cycle is just running its course, and we’re all waiting for non-mining business investment.”

“Audience question: ‘You mentioned that mining is dead for a long time and that people shouldn’t be waiting for the next mining boom. What does that mean for property investors out in those regions?’ FG: ‘The technical term is they’re stuffed for a long time, but you always knew that they would be. The point is, in those mining regions, you need a lot less people to run production phase than the construction phase and so everyone came in for the period of construction and investment, and they’ve all gone. They’re all going or gone.’”

“Audience question: ‘So if you made a lot of money out there in the boom times what is next for those people?’ FG: ‘It’s also a case of buyer beware – they should’ve been more careful when they went in. They went in with dollars in their eyes and now they have sand in their eyes.’”

“Richard Robinson, associate director, economics, BIS Shrapnel: ‘The fly-in and fly-out is not good for the local communities, and all of the state governments know this. FG: ‘They’ve priced the locals out of the market, they couldn’t live there anymore. Cut your losses and run – it’s not going to come back real quick, there’s nothing they can do. Some of the housing is demountable and to the extent that they can get rid of it that takes away the oversupply, but just wander around NSW to some of the old gold towns. There’s an awful lot of houses there.’”

“RR: ‘With one of those they tried to put a nuclear waste dump on it.’ FG: ‘Well, they might as well – there’s nobody there.’”