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Winners and losers from the end of China’s property bubble

Economic growth
By Paul Hodges on 13-Jun-2014

China dream

As promised yesterday, the blog looks today at the potential Winners and Losers from President Xi Jinping’s ‘China Dream’.  It is a complete break from the policies of the previous leadership, which ended up being based on a ‘wealth effect’ created by an unsustainable property bubble.

Xi’s programme is emphatically about the longer term.  There will be 2 or 3 years of pain, as he resolves the issues connected with the ‘lost decade’ of the previous leadership. Then, if he is successful, many opportunities will open up for the future.  It therefore seems sensible to start with the Losers, as they will be many, and then look at the long-term Winners.

The Losers can be summarised as follows:

1.  Anyone dependent on Chinese demand for growth

  • Industries currently based on exports to China such as autos, metals, energy, chemicals, luxury goods
  • Countries based on exports to China including Latin American exporters, Asian exporters

2.  Anything for which Chinese lending has been critical

  • Official and shadow banking borrowers in China’s SOE and private sector
  • Real estate, and commodities financed by the ‘collateral trade’ in China

1.  Service sectors supported indirectly by China’s growth and lending

  • Areas supported by the post-2008 stimulus impact on global trade flows eg shipping, finance
  • Investors in financial assets eg almost 50% of S&P 500 earnings come from outside the US

2.  Markets where Chinese buyers have become major players overnight since 2008

  • Real estate markets around the world eg London, New York, Singapore
  • M&A undertaken to boost China’s overseas asset base eg energy, trophy assets

At the same time, Xi’s dream opens up major new opportunities.  These will sustain new types of demand for future decades if he is successful, and create the potential for a wide range of companies to become Winners.

1.  Areas that will help China become a ‘moderately well-off society’ by 2020

  • Xi wants a Strong economy and government, where GDP/capita will double
  • He also want a Beautiful China where today’s toxic levels of land, air and water pollution have been remedied

2.  Modernising China so it becomes a fully developed nation around 2050 (the centenary of Communist rule)

  • He wants a Creative society where China re-establishes a leading position in science, technology, business etc
  • He aims to create a Bountiful China by raising urbanisation levels within 20 years to 75% from today’s 50%

There really seems to be no going back.  China’s property bubble is now collapsing with central Beijing prices falling 40% since December.

Investors and companies cannot afford to indulge in wishful thinking about what is happening in China.  Xi Jinping is indeed starting to act as his father’s son, just the blog suggested a year ago on his appointment.  Anyone who does not now change direction fast will soon find themselves left hopelessly behind.

But the indirect impact of the new policies on the rest of the world may in the end prove even greater.  The great tap of liquidity that was China’s post-2008 stimulus programme is now being turned off, slowly but surely.

As described yesterday, this is an earthquake which is set “to eliminate up to half of its industrial base“, as well as “costly building projects in cities that never find a niche and industrial facilities unable to compete in the world.”

It will almost certainly trigger massive earthquakes in other countries, as its impact moves along “the debt-fuelled ‘ring of fire” constructed by central banks” over the past few years.  Good assets will be as vulnerable as bad ones, as investors may have to sell whatever they can to pay down their debts.  And bad assets tend to become illiquid, so ‘safe assets’ will be hit temporarily people scramble for cash to avoid bankruptcy.

The important fact to remember, however, is that this will provide well-managed and far-sighted companies with the opportunity to develop major competitive advantage for the future whilst others struggle.

As the summary above shows, the government has made clear what they have to do to be Winners in the new world of Xi’s China Dream.  Those who ignore the message will likely end up instead as Losers.