China interest rates hit 28% as property bubble targeted

Barrons Jun13

China’s new leadership are in a very difficult position.  They have inherited an economy that has been run on stimulus programmes for the past 5 years. And as the head of the country’s largest developer, China Vanke, has warned,If the bubbles are not controlled, the result will be catastrophic.”

This follows his March warning that the housing bubble could spell “disaster”, and that debt held by developers is a “serious problem”.  He also repeated the blog’s long-held worries about empty cities such as Ordos, noting there are “ghost towns where homes are built and left unoccupied”.

Now Barron’s, the leading US investment magazine, has added its concerns. As the above cover from this week’s issue notes,:

“Chinese companies and local governments have borrowed recklessly to build factories, train stations and bridges to nowhere, like this 26-mile span south of Beijing. Why last week’s cash crunch could be just the start of trouble”.

Faced with this situation, it would be stupid to further inflate the bubbles.  And the new leadership are certainly not stupid.  Instead they are starting to follow through on policies first announced a year ago.

This will be a very bumpy road.  House prices will probably have to crash, as they did under Jiang and Zhu in 1993, in order to solve the problem.  Thus China is now restricting credit, with short-term rates hitting 28% for 7-day money on Thursday.  We can expect that bankruptcies will start to occur in H2 as lending continues to tighten.

Meanwhile, industrial output is weakening.  Electricity consumption rose just 1.1% in the primary industry sector in January-May versus 2012.  This major slowdown is also leading to falling producer prices, down 2.9% in May.

China’s leadership would clearly like to have inherited a better position.  But pain today, and for the next few years, is inevitable if China wishes to achieve its long-term growth ambitions.  Another stimulus progamme, as in 2008, would only add to the problems of its increasingly fragile economy.

As we warned in Chapter 6 of Boom, Gloom and the New Normal, China’s stimulus programme has recreated the US sub-prime bubble – but on a larger scale. Its Minsky Moment is now underway. Investors are now suddenly realising that the idea of China being about to reach western middle class status was wishful thinking and not reality.

About Paul Hodges

Paul Hodges is Chairman of International eChem, trusted commercial advisers to the global chemical industry. Paul is also an invited member of the World Economic Forum’s Global Agenda Council. The aim of this blog is to share ideas about the influences that may shape the chemical industry over the next 12 – 18 months. It will try to look behind today’s headlines, to understand what may happen next in important issues such as oil prices, economic growth and the environment. We may also have some fun, investigating a few of the more offbeat events that take place from time to time. Please do join me and share your thoughts. Between us, we will hopefully develop useful insights into the key factors that will drive the industry's future performance.