More warnings about China's bubble economy

Following on from Yesterday's post on Jim Chanos' crusade against China, another two reports have come to light sounding the alarm bell on China's bubble economy.

The first article from Bloomberg quotes Richard Duncan from Blackhorse Asset Management, who claims that China's economy is the biggest bubble in history that may be headed for collapse.

A more than 50% surge in China’s money supply since 2008 helped fuel economic growth in excess of 9% per year, even as trading partners sank into recession. The expansion also saddled the country with factories that produce three times more goods than can be bought by China’s workers, 80% of whom make less than $5 a day, said Duncan.

“China has the greatest economic bubble in history...There’s a real risk it’s going to collapse in a Great Depression-style scenario.”

The pin that may prick China’s bubble, Duncan said, is a backlash against free trade among voters in the U.S., where unemployment last month rose to the highest since April. The U.S. House of Representatives in September enacted legislation that would let U.S. companies petition for duties on Chinese imports to compensate for the effect of an undervalued yuan. Protectionist sentiment could gather steam in the next two to three congressional election cycles, Duncan said.  

Meanwhile, The Telegraph ran an article on a recently released report from the Chinese Academy of Social Sciences (CASS), which claims that China's housing bubble has grown so large that 85% of Chinese living in cities can no longer afford to purchase a home.

The Chinese Academy of Social Sciences (CASS) said in its annual Economic Blue Paper that a typical Chinese property now costs 8.8 years of average earnings.

In addition, CASS said that house prices are still rising far in excess of wages, putting property more and more beyond the reach of average Chinese.

CASS estimated that Chinese property prices had risen by 15% this year, although the rises in some cities have been far steeper.

By contrast, the UK's typical house costs five years of wages to buy, according to the Nationwide Building Society, and the UK's long-term average is four years of earnings.

"House prices have risen steadily for years," said Zhou Linhua, the co-author of the CASS report. "This has inflated investor expectations of a high return, which has brought more money flooding into the market, and fed the bubble"...

"Property prices are likely to remain high for a while," predicted Matthew Fang, an analyst at Guosen Securities, adding that demand was still strong and that inflation was rising.

Negative real interest rates have helped to persuade many Chinese to invest in bricks and mortar rather than leaving their money in the bank, and there is a continuing requirement for Chinese men to own their own property before they can get married.

Attempting to quantify the size of the property bubble, CASS calculated what it believed was a "real" house price in 35 large and medium-sized cities in September, using an index of eleven statistics, including per capita disposable income, saving deposits, number of doctors and university students, retail sales volumes and local capital investment levels.

According to its figures, new homes in seven out of the 35 cities were more than 50% over their fair value. Property prices in Fuzhou are 70% too expensive, while those in Hangzhou are 66% overpriced. New homes in Shanghai are 37% overpriced and those in Beijing are almost 50% overpriced.

The CASS' findings are similar to those of my China's Colossal Housing Bubble article from August 2010. And my conclusion then is just as relevant now:

A key reason why Australia was able to ride-out the GFC of 2008/09 was because of continued strong demand for commodities by China. China is Australia’s number one export destination, accounting for 22% of our exports. As such, Australia benefited directly from the massive building boom that emerged following the Chinese Government's 4 trillion yuan ($US590 billion) stimulus package, which led to sharp rises in the prices of commodities, including iron ore, aluminium and copper.

However, if a significant slowdown emerges, evident by a fall in China's infrastructure construction and/or apartment and home building, then demand for Australian commodities will fall sharply, leading to both lower commodity prices and decreased volumes being exported into China. The economic consequences for Australia from a sharp slowdown in China could, therefore, be enormous and would manifest itself through significantly lower economic growth, higher unemployment and falling asset prices.

What deeply concerns me is that while most of Australia's mainstream commentators are alive to the opportunities that stem from Australia's heavy exposure to China, they are completely unaware of the significant potential risks to China's (and by extension Australia's) economic outlook.

I hate to always be the bearer of bad news. But a slowdown of the Chinese economy is, in my view, the biggest threat to Australia's 'miracle' economy. Those banking on continuing record high commodity prices and perpetual economic sunshine could be in for a rude shock. Forewarned is forearmed...

Cheers Leith