By John Richardson
ARE you still playing catch-up on China as events once again take what you think are an entirely unexpected turn? If so, you haven’t learned the lessons of the last three years.
In late 2013, after the critically important Third Plenum meeting of China’s top political leaders, it was crystal clear that there would be a big push for reform.
From January 2014 it was equally crystal clear that reforms were actually happening. The credit data told you this. A bubble can only stay stable if more and more air is pumped into it. So the freely available official data showing a slowdown in lending growth, which continued throughout the year, was your single-most important data point.
Those who took notice of this were well ahead of consensus opinion that was taken totally by surprise in September 2014. It was at that point that the majority realised that China was indeed slowing down because of essential economic reforms. This understanding was a major factor behind the collapse in oil and other commodity prices.
The rally in Chinese stocks during early 2015 should have also been seen for what it really was: A reverse push by the anti-reformers as they tried to create a new “wealth effect” to replace the lost wealth effect of a deflating real estate bubble.
But if you looked at the number of Chinese people who owned stocks, it was obvious that this new wealth effect – just like the real estate wealth effect – was never going to be broad-based enough to suit the purposes of the reformers who want greater income equality.
It was also equally obvious that the equities bubble, because it was confined to a relatively narrow number of people – and because valuations were not related to the real profitability of companies – would do nothing to help China escape its “middle income trap”.
And because all bubbles are built on perception of value rather than real value, you should have been prepared for Chinese equities to collapse. Events in June 2015 should therefore not have taken you by surprise.
The start of this year should have set your alarm bells ringing again. The freely available lending data indicated another take-off in credit growth, with most of the credit flowing once again going to real estate.
A sustainable new wealth effect? Surely not, given the still-narrow base of the bubble and the further build-up in bad debt. The only logical conclusion about the reason for this latest bubble is that the anti-reformers regained the upper hand.
But President Xi Jinping and his fellow reformers have now put themselves in a much-stronger position to push ahead with reforms. This explains today’s attempts to contain China’s new property bubble. Measures recently introduced include new limits on the number of properties investors can buy have been announced. Minimum down payments on mortgages and set minimum occupancy quotas for new developments have also been announced.
Three Outcomes of The New Property Bubble
Concerns over the sustainability of the rally in real-estate prices helps to explain the recent fall in the value of the Yuan to a six-year low in the offshore market. Some investors could have cashed-in their profits.
But currency analysts had to some extent expected the Yuan to fall in value following the inclusion of China’s currency in IMF special drawing rights from early October, reports the Financial Times.
You can, though, easily imagine further downward pressure being exerted on the Yuan if efforts to deflate the property bubble continue.
What happens next? Here are my three scenarios:
- The anti-reformers are able to kick the can down the road and the real-estate bubble continues. There are plenty of people who still want this to happen.
- Reforms gather pace and we see a bit of a dip in crude – and also a slight reduction in chemicals demand. Nothing dramatic, but the falls could be significant enough to damage those who are still fixed on “one track”, or one scenario, budget planning.
- A major collapse in crude prices, in chemicals prices and demand. All sorts of factors could trigger this, including a financial sector crisis in China resulting from the real-estate bubble and/or rising global trade protectionism because of a weaker yuan.
I don’t think 1 is likely because of the stronger position of Xi and the other reformers. They also realise that the longer this bubble goes on the more economic damage it will do.
I hope 2 is the outcome, but I very much worry that 3 is a very realistic prospect. You clearly must as a result build business plans for 2 and 3 – and this is where we can help.