Western Understandings, Eastern Worlds: the China Asset Bubble

Over on a post at the excellent blog Peking Duck I left the following comment on a post about the asset bubble in China:

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I’m not sure this bubble thing is being read properly. Let me see if I can articulate my thoughts. First, Chinese buy real estate and hang on. Forever. Hence this bubble might simply peter out in permanently high property prices, rather than go ka-boom. I mean, the houses aren’t being sold on 99% credit, I would bet money that most of the mortgages are with substantial amounts up front. Owners will rent and if they can’t rent, they will sit on it. Second, what is the break even point for developers? In Taiwan one need only sell half of a typical development to break even. Developers can keep putting up buildings with 50% occupancy and make money, in that case — I would bet given China’s low costs and massive corruption, the actual break-even point is even lower.

Hence, it’s not a bubble of speculative money driven by easy credit, but an outlet for savings — money that actually exists, not money that exists in some unspecified future. People thus will not be in debt when it “pops” but will rather have manageable mortgages out of current incomes because they paid much up front, with an actual asset to show for their expenditure. Hence what we will see is not KA-BOOM but rather, going out with a whimper of permanent high property prices in large cities, because no one will sell at low prices.

Is this just another case of viewing eastern practices in western terms? It sure feels like it to me, looking at the fact that Taiwanese have cheerfully been scammed by KMT-connected construction firms for 50 years now with nary a complaint. At some point “high prices” will become the norm and part of the lived environment, as they are here, and no one will notice except puzzled westerners who keep waiting for the price collapse that never comes. You are just experiencing the transition right now and calling it a “bubble”. Perhaps, “price orogeny” might be a better term.

But this is just speculation. The real losers will be the future working-class hordes who will not be able to live in the cities.

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As a friend of mine noted in a private response, landlords sustain high rents because the alternative is that the price of their massive capital investment falls. Everyone understands this. Therefore rents never fall. Better to let the flat sit empty. Another factor holding up prices is the ratchet effect of land taxes, which are fixed and take a substantial chunk of the building's value. Is China the same? I don't know. Since the ideal of land ownership is so rooted in local culture, people endlessly speculate in property, and new construction is purchased for that reason. With government support and low costs, profits are automated. In other words, as my friend points out, the key is to keep leveraging.

Offered here for your thoughts. Discuss!

UPDATE: Forbes' Gary Epstein has a set of great pieces on the asset bubble collected at Status of Chinese People. One, two, three, four. Epstein notes:

The U.S. government’s $7.2 trillion in debt at the end of June represented 50% of gross domestic product. The Chinese government’s officially disclosed $840 billion in public debt represents less than 20% of GDP. But the People’s Bank of China and the treasury are also on the hook for potentially $1.5 trillion in off-balance-sheet debt owed by cities and provinces and entities they control. They’re also implicitly obliged to backstop $1 trillion, both in loans that “policy banks” were directed to issue, even when they made no economic sense, and nonperforming loans that the government removed from the books of state-owned commercial banks over the past decade.

Add it up and the national government is responsible for debt equal to over 70% of 2009 GDP. That doesn’t count any loans generated this year that might go sour amid a 30% increase in debt balances nationwide. (The U.S. government, in addition to its direct debt equal to 50% of GDP, is responsible for cosigning of mortgage borrowers’ obligations equal to another 18% of GDP.)

Like the U.S. housing industry a few years ago, China’s big developers are highly leveraged and dependent on low interest rates and rising prices. Municipal governments are knee-deep in this asset swamp. They use land sales as a means of funding themselves.

Yowza!
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