Saturday, April 14, 2012
Busting the myth of China’s property bubble
Five years on, the US economy remains sluggish after the bursting of a house-price bubble.
More recently, the focus has been on China — the world’s second-largest economy — and whether it too might be overwhelmed by a similar event. Reports of ‘ghost cities’ and of property developers facing bankruptcy have become commonplace. Some commentators have even asserted that the bubble may have already ‘popped’.
The stakes are certainly high. The IMF notes that since 2007 China has contributed more — much more in fact — to world growth than any other country, and this is projected to remain the case into the foreseeable future. And Australia now has more to lose than most if China’s economy sours, given the Chinese construction sector is a significant source of demand for Australia’s natural resources.
Before commenting on the Chinese case, it is worth briefly reviewing the chain of causality in the US, where house prices began to appreciate from 1997. During the 2000s, the market became increasingly infected by debt-funded speculators betting on continued capital gains, and banks lent money to borrowers of marginal credit worthiness requiring little or no collateral. When prices stalled and then went into sharp reverse in 2006, the banks were left holding the bag, ultimately requiring a bail out by taxpayers. Banks (and firms and households) then spent the next few years seeking to rebuild their balance sheets — as opposed to extending new loans — and this process continues today.
The above story breaks down at several points when it comes to China. It is true that house prices in China increased rapidly during the 2000s. But that is about where the similarities end, despite several claims to the contrary.
First, while recent headlines have reported that house prices in China have fallen for a fifth straight month, what we have actually seen is a levelling off in prices.
According to official data, prices nationwide remain steady compared to a year ago and remain marginally up since 2010. Unofficial data points to stronger price growth since 2010. Examples of more significant price declines in certain cities can be found. But to tell a macroeconomic story based on these is to miss the forest for the trees.
To put the above numbers in perspective, last year house prices fell more in Australia than they did in China.
Second, there is little evidence that any deterioration in the housing market has infected the banking system. Given that nationwide house prices have not in fact declined, this is perhaps not surprising. There are other reasons for this as well.
One is simply that the Chinese are much more likely to fund home purchases from savings, often calling upon the assistance of family members in the process. In part this reflects cultural differences, but also strict down payment requirements imposed on borrowers by Chinese banks.
Third, it should not be forgotten that the key institutions in China’s banking system remain more or less government owned. This changes the rules of the game considerably. Standard risk management variables, such as the capital adequacy ratio — which, incidentally, is extremely high among Chinese banks — and the non-performing loan ratio are only of marginal relevance because the integrity of the biggest banks is guaranteed by the government. China’s central government is willing and able to act on that guarantee. The level of outstanding public debt is modest and even when contingent liabilities are taken into account, such as local-government debt, the prospect of China falling victim to a European-style public debt crisis is remote.
Another example is that amid a deteriorating macroeconomic environment in which privately owned banks might elect to slow credit growth, the Chinese government can instruct banks to do the opposite, as was seen in 2009. This remains within the banks’ capability today, given the extremely high reserve requirements they maintain.
Fourth, in addition to continuing government ownership, there is also the fact that the banking system remains heavily regulated. For example, the government can act to boost the margins and profits of the banks by fixing interest rates. This may be a negative from an efficiency perspective, but it can still act to promote the system’s stability.
Property prices in China may well be inflated; price-to-income ratios, particularly in the major cities, suggest that they are. But for high prices to constitute a bubble, they must be able to burst. In the case of China, it is not clear that they have, nor where a trigger might come from.
We will more likely see a period of no or low price growth, rather than sharp declines. Of course, even stagnant house prices have implications for China’s overall growth rate and therefore the demand for Australian natural resources. But as China’s premier, Wen Jiabao, recently noted, the days of average annual growth rates in excess of 10 per cent are over. The sooner Australia accepts and adjusts to this new reality, the better.
James Laurenceson is Senior Lecturer at the School of Economics, University of Queensland.A version of this article was first published on The Conversation. East Asia Forum