China May Have a Housing Bubble

October 16th, 2016 by

While the rest of the world is mired in a period of economic stagnation, China has continued to boast annual GDP growth of better than six percent. Many outsiders have speculated that the government is engineering bubbles in order to keep its markets propped up at these stratospheric levels.

We’ve Seen This Before

It became clear that Shanghai’s stock market was vastly overvalued last year when the central government intervened to devalue the yuan by nearly 2%, causing the Shanghai Composite stock index to shed 40% of its value in a span of a few weeks. It has still yet to recover from this massive correction, lending credence to the idea that Chinese stocks were indeed in a bubble.

Afterwards, it was revealed that Beijing may have contributed to the bubble by aggressively encouraging average citizens to continue to buy equities, placing entire life’s savings into the stock market under the belief that it couldn’t go down. While regulatory authorities did put in place a daily floor below which trading would halt so no more losses could be incurred, they could hardly guarantee that stocks would climb higher forever.

“Smoking Gun” in Housing

Similar concerns about the housing market in China are now being expressed. In the past, the construction of what essentially became “ghost towns” was undertaken in order to pad the country’s GDP. In other words, it’s not far-fetched to believe that the communist government in China might generally engage in such artificial inflation of markets.

Finding hard data that could show how Chinese real estate is overheated is actually quite difficult. Yet the Chief China Economist at Deutsche Bank, Zhiwei Zhang, believes he may have found the “smoking gun” to prove such a housing bubble exists.

china-flag-shanghaiBy analyzing land auctions, Zhang has seen developers paying an extremely high premium for property in China. Land values have already risen 23% year-on-year. In short: Unless such price appreciation continues indefinitely, somebody is going to lose a great deal of money.

The fact that land developers continue to be willing to pay such steep prices means that they expect further price inflation. (They certainly wouldn’t be eager buyers at a loss.) This reveals that the housing market in China is caught in a cyclical “greater fool fallacy”—buyers rely on the logic that (for no good reason, really) someone will come along in the future and pay more for their asset.

In some cases, Zhang has even found, the premium for undeveloped land makes it more expensive than nearby developments that have finished apartments on them! This incredible irrationality has aptly been called the “flour more expensive than bread” phenomenon.

Soft Landing?

house-of-cards-719701_640While Zhang sees the evidence for a bubble already, he notes that China’s central bank will likely attempt to cut interest rates and cool off specific markets in the future in order to avoid a “hard landing.” That is the Communist Party’s M.O., to be sure. Nonetheless, this only delays the bubble popping a bit longer; Zhang sees 2018 as a target date for when the bubble will pop.

Like a top-heavy house of cards, the housing market in China could collapse under its own weight if the government can’t successfully orchestrate an exit strategy.

 

The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.