China’s urban consumers depend on property ‘wealth effect’

Consumer demand

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China urban Feb14One of the great myths of modern times is that China is now full of middle class people with Western levels of consumption.  Nothing could be further from the truth.

Annual per capita incomes have certainly soared over the past two decades.  But the main impact has been to lift people out of absolute poverty, not to create a middle class on the Western scaleOfficial data shows

  • Average per capita urban incomes were Rmb 29547 ($4769) in 2013 versus $447 in 1993
  • Average per capita rural incomes were $1276 in 2013 compared to $160 in 1993
  • Equally important is that around half of the population now live in cities compared to only a quarter in 1993

But clearly, even average urban incomes are nowhere near Western definitions of middle class.

So why has there been so much confusion over this issue?

Shanghai prop Feb14The answer lies in the ‘wealth effect’ that has taken place as a result of the credit bubble.  This has inflated property values to an extraordinary extent, as shown by the Shanghai house price index chart from 2003:

  • Home prices have risen exponentially over the period
  • They continued to rise after the financial Crisis of 2008
  • This highlights how the government used easy credit to maintain economic growth.

The problem, however, is that wealth effects are essentially Ponzi schemes.  Those who join early get paid out with cash from those who join the party at a later stage.  But eventually economic reality breaks through, as there is nobody left to join.

This seems to be the case in China today:

  • City centre apartments in Shanghai are now selling for Rmb 47k/sq m ($7750/sq m; $720/sq ft)
  • Even apartments outside the centre sell for half this amount
  • Average prices are 29 times average earnings – several times the US subprime peak

Clearly these prices are unaffordable on normal calculations of prices versus earnings.  They only work when governments are prepared to supply low-cost credit with few questions asked about repayment, as in the US subprime era.   In China, this ‘wealth effect’ based on a property bubble has meant that millions of urban residents have appeared to become middle-class.

But in a Ponzi scheme, there had to be a new buyer able to afford to buy the property, each time the existing owner wants to cash out.  This becomes impossible once the tap supplying new credit is turned off:

  • Property transactions, always a leading indicator for prices, fell 31% in Shanghai in January versus 2013
  • Inventories of completed but unsold apartments in urban areas were 42% of annual completions in December

Another concern about the housing market is that ownership is very concentrated, as China Spectator has noted:

“The richest 1% per cent of urban households is also estimated to own around 30% of all real estate assets in the country. Using 2010 values, the richest 1% of households (2.1 million out of about 530 million households) own 40-50% of the country’s $US10.5tn real estate and financial assets”.

This doesn’t sound like a story that will end well, if the new government continues to cutback on the credit bubble.

Instead, consumer demand will be based on the chart above.  This shows government figures for per capita urban consumer expenditure in 2012:

  • Average spend was $2641:  food spend was $957 (blue), housing was $412 (red), transport $389 (green), clothing $289 (yellow), education $251 (light blue)
  • The poorest 5% spent $1157: food was $472, housing $173, clothing $93,  education $79 and transport $78
  • Even those in the top 10% spent only $5966: food was $1635, transport $1263, housing $939, education $672, clothing $622

Companies may prefer to believe that the government will ‘blink’ and do another stimulus package soon to maintain the wealth effect.  But it would seem prudent to also develop a Plan B, on the basis that the new leadership will carry through on its policies.

Failing to prepare for this possibility could result in a nasty shock.  China’s economy will be quite different when, not if, urban spending becomes based on income again, and loses the benefit of the wealth effect.

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