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When the markets doubt government, government loses…

Finance Blogger: Anthony Harrington Anthony Harrington

After the success of its US$600 billion fiscal stimulus policy, the Chinese government (PRC) currently needs to dial down the property boom the stimulus package has inflated. All through 2009, residential developers in cities across China made money hand over fist, filling their coffers as first, second, and third-time buyers all found plenty of cheap mortgages available. This is one direct consequence of the stimulus that the PRC is really going to struggle to unwind, and if it can’t or won’t then its chances of avoiding a mega property bubble look slim.

In a very readable and closely argued article first published in the South China Morning Post, Andy Xie, an independent economist, points out that this “winding back” exercise is proving to be a bit more difficult than an “all-powerful” central government might wish (no government is all-powerful when it comes to the market—the occasions when the PRC has told the market in a commanding tone to go left, only to find it veering sharply right, and vice versa, are numerous indeed).

The problem is one that governments everywhere face if the market senses a gap between what a government is saying and what it is likely to end up doing, so it will be interesting to see how this plays out. As Xie explains, the PRC’s first move has been to reduce the mortgage discount rate for first-time buyers and to raise down payment requirements for second-time buyers to 40%, while third-time buyers must have 60% of the value of their target home as a down payment. This has effectively removed second and third-time buyers from the market for the present, and the PRC’s hope is clearly that their absence will force developers to bring down unit prices within the reach of the country’s vast army of less-well-off migrants to its cities. Such a move would also help greatly to knock back the average house price rise of 10.7% recorded for the year ending February 2009. It would thus help to cool the housing bubble and put thousands more first-time buyers on the property ladder.

Unfortunately for the PRC, Xie points out, it has a record on mortgage crackdowns that does not help its case. Local governments (who do a lot of developing of land within their remit) and developers, he says, are sitting on massive amounts of liquidity and they are betting that Beijing will crack first in the face of any protracted stagnation in the housing market. In other words, they feel they can wait out the government, and past form suggests they may be right. From a developer’s point of view, what is the point of cutting your profit on units if you can get your price simply by sitting on your hands for a bit?

There is another China-specific angle to this story. As local governments have moved to resettle large numbers of people, buying property for them at continually inflating prices, they have had to take bank loans to finance those deals. They have used land and property as collateral for those loans. As such, both local governments and many of China’s banks have a vested interest in land values not deflating. If the PRC was to succeed in winding back price inflation in the property market that in itself could have severe consequences for many banks.

Xie points out that far and away the majority of property purchases in China over the last year or two have come from resettled residents using the compensation cash from local governments as down payments. “Resettlement compensation is the biggest transfer of wealth from the government to the household sector, since the privatization of low-cost public housing a decade ago. It is probably the most important government action supporting today’s economy,” he comments. Which goes to show that even if you are a one-party, all-powerful government, able to issue any command you see fit, grappling with a growing asset bubble is not an easy task.

The hedge fund guru Jim Chanos recently gave an interview to CNBC (see below) where he poured scorn on the idea that 25 members of the Chinese politburo could fine tune such a vast, rapidly growing economy. Chanos claims that China is inflating its GDP figures quite grandly. “We think that they are massively inflated by under-depreciating a very, very shaky capital asset base,” he says. Bubbles, he argues, with good reason, are best identified by credit excesses, not valuation excesses, and China is committed to increasing the loan volume by US$1.2 trillion, which is massive. The best way of shorting China, he says, is by shorting the stocks of commodities companies shipping to China, a “derivatives” play. China is going full bore on a construction boom and that is where shorting opportunities will lie, he says. “We are actively looking for shorting opportunities on the China boom which we think will burst at some point. Demand in China is over-inflated. That is clear,” he warns.

Further reading on China and the markets

Tags: asset price bubbles , China , fiscal stimulus , real estate
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