Is China a bubble? And what if it bursts?

Sat, Jan 22, 2011, 00:00

Luxury goods are selling fast, houses are barely affordable, and there are too many office buildings. China’s economy is showing signs of overheating, but economists say it won’t boil over. Sound familiar?

THE VIEW FROM the 52nd floor of the Ritz-Carlton in Shanghai is spectacular: China’s high-net-worth individuals can gaze across some of the world’s most expensive properties while choosing pricey reds from the encyclopaedic wine list and tucking into antipasti so authentically Tuscan they are guaranteed to melt the heart of even the stoniest of billionaires. The sleekly groomed staff are French and Indian as well as Chinese, and the sight of Shanghai’s new rich is so far removed from the China of 20 years ago that it has an almost science-fiction quality.

Could all this simply go pop? Something about the sheer level of luxury brings to mind the decadence of the last days of the Raj, ancient Rome or the latter part of the Celtic Tiger. It’s not hard to see why people are fearful that the strong rise in China’s property market, which is a key factor in the country’s economic rise, could turn out to be a bubble that will burst and take the fragile global economy with it.

Satellite images released recently showed thousands of empty “ghost towns”, much like the ghost estates in Ireland, and there are lots of empty offices in the central business districts of many major Chinese cities.

A few floors down in the same hotel, at a showcase fair for China’s luxury-minded billionaires, Norah Jones warbles softly through Harman Kardon speakers as Rupert Hoogewerf, publisher of the Hurun Report, which counts China’s wealthy and analyses what they do, lists off the brands favoured by the country’s rich: Patek Philippe watches, Mercedes E-Class cars, Gulfstream jets, Armani suits, Azimut yachts and Louis XIII brandy.

This is the luxurious reality behind the 10.3 per cent increase in China’s gross domestic product (GDP) last year.

They also like to spend money on diamonds – no surprise there – wine, travel and their children’s education, a message that our universities are well aware of as they try to woo Chinese students to study in Ireland. More than 50 per cent of rich parents are sending their children to schools in the US and Britain. Canada is ranked third, followed by Switzerland.

According to Hurun’s most recent data, and in Chinese yuan terms, the country had 875,000 multimillionaires and 55,000 billionaires last year – 6.1 per cent more millionaires and 7.8 per cent more billionaires than in 2009.

More than 50 per cent of the mainland’s wealthiest, who each have assets of more than 10 million yuan (€1.15 million), spend between one million yuan (€115,000) and three million yuan (€230,000) every year, and own more than three cars. These cars – the white BMW 7-Series, the black Audi A6 models with extended wheelbases, the Porsche Cayenne SUVs – throng China’s fabulous new network of motorways.

The tycoons are young, too. The average age of the respondents with at least 100 million yuan was 39; that of those with at least one billion yuan was 43. Both averages were a year younger than last year.

EVEN MORE THAN WATCHES,or cars, or yachts, what China’s wealthy people like to buy is property. Their main investment choice is real estate, and the figures are of a kind to make any Irish person nervous.

Look at the rise in property prices last year. About €310 billion was spent on land transactions in 2010, a 70 per cent rise on the previous year. The biggest jump in property prices was in Beijing, where they rose 42 per cent, with the average price 20,328 yuan (€2,345) per square metre.

Shanghai’s price hike ranked second, with 40 per cent, although it is the most expensive market, with prices reaching 22,261 yuan (€2,561) per square metre, and €24 billion worth of residential properties were traded, despite government efforts to cool the market.

Prices in the southern boom town of Shenzhen rose 33 per cent last year, and they were up 23 per cent in Guangzhou.

Some of the scenarios will ring depressingly familiar to Irish readers.

Bian Xiaosong, who is 33, and Zhao Xiaohui, who is 32, both work for local firms and have a family income of about €1,400 a month, which is a pretty good salary in China. In 2008 they bought an apartment in Beijing for about €120,000, paying 20 per cent down. They pay about half their income every month on their 20-year mortgage.

“Sure, we feel pressure that we can hardly save our money to do other things, and we need to think carefully before we decide to have a baby. But we had no choice: we have to buy an apartment to live in, and the price has doubled now anyway,” says Bian.

“Really, we don’t care so much about whether the price was rising up or going down, since we bought it to live in, not to invest in, unless the price fell so much that it cost less than we bought it for. All my friends bought apartments like we did; it’s our main expense,” he says. “We believe the government won’t let the real-estate market collapse, especially here in Beijing, the capital. If the real-estate market collapses, the whole economy will go down.”

“There is some research out there looking at housing and asset prices in China, and there are indications that the property market is somewhat overvalued in China,” says Brian Lucey, associate professor of finance at Trinity College Dublin. “The question is whether that could be a major problem, and that I don’t know. It could be that it doesn’t go to the heart of the economy and could be absorbed by the broader economy.”

Much like Ireland, however, China is tied to an inappropriate exchange rate, because the yuan is not a free-floating currency. “They’ve got to think of floating, and that will mean a significant appreciation,” says Lucey.

“They are coming up against the limits of freedom to manoeuvre in controlling the political economy. I would be confident these boys are smart enough, but there are significant risks. If the Chinese economy slows down in a wrenching manner, you are going to have a significant slowdown in the world economy.

“China has to act in a responsible manner, and that involves loosening the exchange rate, and the longer they delay doing that the more wrenching the slowdown. It will have to happen gradually, but if they don’t move swiftly it will only get worse. They really need to get moving,” says Lucey.

MAO YUSHI ISone of China’s best-known economists and a director of the Tian Ze Economic Research Centre. “We have a lot of problems now, for example the real-estate bubble,” he wrote on his blog. “Much of the increase in GDP is actually because of this bubble. When one building sells at an incredibly expensive price, beyond the normal market price, it is a distortion, which inflates the bubble in the real-estate market. This bubble relates for sure to a series of macroeconomic policies, including the savings made from having the renminbi [or yuan] currency at a low exchange for a long time.”

A realtor surnamed Jiao, who is 45, has managed a property agency for the past 14 years. “There is no bubble, but there is a conflict between supply and demand. In the past four or five years the number of new apartment buildings in Beijing is falling, probably by about 60 per cent, while demand has doubled or trebled. So for sure the price will go up. People’s incomes are rising; the numbers of people moving to the city is rising,” he says.

“People about 30 years of age need a home, want to start a family, but their parents are still young, and they don’t want to share with them. So what do you do? And with the move from the rural areas and villages to the cities in recent years, more and more people are here in the big city. With such huge demand in a city such as Beijing, where land is limited, demand is sure to rise,” says Jiao. “The government has gotten smarter; they understand that it’s better to let the market decide the price, and then they set up a scheme to protect middle- and low-income earners.”

Much of the rise of the market is attributable to China’s incredible process of urbanisation. China has seen the number of city dwellers rise from 18 per cent of the population in 1978 to 46 per cent in 2008, a rise of 28 per cent in three decades. About 300 million Chinese now living in rural areas – the equivalent of the population of the United States – will move into cities in the next 20 years, and by 2025 at least 220 Chinese cities will likely have more than a million inhabitants.

The visions of luxurious living in Shanghai and Beijing mask a growing wealth gap in China, a factor that has prompted the government to try to boost incomes in the countryside by offering tax breaks and other subsidies, as it fears the inequality could destabilise society.

The broader expansion of the economy has also given most Chinese people a better life than ever, taken hundreds of millions off the poverty line and given people here power over their own destiny for the first time.

Many people have done well – perhaps too well, if it turns out that these luxurious lifestyles are built on air.

Soft landing? ‘What happened in the West will not happen in China’

China’s real-estate boom stems from a powerful cocktail of factors. With inflation running at about 5 per cent, there is no point keeping your money in the bank because the deposit rate is only about 2.5 per cent. So people look for other investment vehicles. With the stock market looking pricey, the classic investment is property.

Fears of a bubble bursting in China and bringing the rest of the stuttering world economy down with it are real, but collapse is probably not imminent, according to analysts.

Andy Xie, an independent economist who was formerly Morgan Stanley’s star Asia-Pacific economist, does not see a bubble bursting. “I thought the current bubble, fuelled by rapid monetary expansion and expectations of a stronger yuan since the beginning of 2007, would go the same way. Recent developments have changed my mind. This bubble may not end suddenly, but with a slow leak,” he wrote.

The government isn’t relaxing the credit restrictions on second and third mortgages, and liquidity is also tightening, leading to a slower fall in prices.

“The economy will hold up. Exports, consumption and infrastructure should sustain a 7 per cent to 8 per cent growth rate for the next decade. That seems low compared with recent years, but it will be much better for lifting wages, household living standards and corporate profits,” he says.

The government, understandably, is keen to dampen talk of a bubble developing. A report by an economic-analysis team under the state council, China’s cabinet, said that inflation was stable and that more stable growth was easing fears of a bubble.

Meng Xiaosu, chairman of the China National Real Estate Development Group Corporation, does not believe that China’s property market is in bubble mode right now.

“For me the key to whether it’s a bubble or not is whether it can be burst, and I believe the Chinese real-estate market will increase in a stable way, without any kind of exaggerated increase,” says Meng. “And, even better, if the supply of houses pulls the economy along while avoiding prices going too high, while guaranteeing that low-income families can afford to buy or rent homes for their own use.”

Ye Tan, an independent economist and commentator, believes the fallout from an end to the bubble can be managed.

“What happened in the West a couple of years ago will not happen in China in the same way, since there is no subprime lending here, but if the bubble bursts people will have no money, consumption will dry up, there will be a lot of bad bank loans and no one will borrow money any more,” she says.

Luxury and land: The young rich splash the cash

  • Half of the richest people on the Chinese mainland are spending at least a million yuan (US$115,000) a year, mainly on real estate, luxury watches and diamonds, and Rupert Hoogewerf, head of the Hurun research group, says this shows that luxury brands have a very special place here. “Lots of people like to receive luxury brands to improve their status. It’s a noticeable trend,” Hoogewerf says. “The time for China to learn from Europe is over. People here are becoming better educated. They are getting to know luxury brands that are not even familiar to some Europeans.”
  • Ni Xiao owns a chain of shops and spends a lot of his money on the stock market. “My monthly outgoings are about 100,000 yuan [€11,500], which I spend on eating, entertainment and my girlfriends. I travel a lot to the US. I probably spend about a third of my time there. My annual income is about four million yuan [€460,000], and I own a few apartments in Beijing and Shanghai.”
  • Zhang Hongli, marketing manager of a publishing company, owns two apartments in Beijing and one in her home town, in Hubei province. “I never spend more than 100,000 yuan [€11,500] a year on luxury items, which is about a third of my income,” she says.
  • Zhang Yue, an actor (above right), spends between 30,000 yuan (€3,500) and 50,000 yuan (€5,800) on shopping each month. “Most of this is on luxury brands, because as an actress I need it. Together my husband and I spend about a million yuan [€115,000] a year, and we change our cars frequently. My annual income is more than 500,000 yuan [€58,000], and we own five or six apartments here in Beijing.”
  • Mr Yang, a marketing manager in a foreign company, is buying a present for his girlfriend in the China Wold Trade Centre shopping mall. “My monthly expense is around 30,000 yuan [€3,500], and my annual income is around 600,000 yuan [€69,000]. I seldom buy luxury things for myself, but, as all girls love Louis Vuitton bags or Chanel, sometimes I buy this for my girlfriend. My expense on luxury things is about 100,000 yuan [€11,500] to 150,000 yuan [€17,300] per year.”