Why the Chinese Government Cannot Afford a Bubble Bust

A recent disturbing sturdy reveals how deep the wealth of Chinese households have been tied to real estate sector. The massive concentration of wealth poses as a grand policy dilemma for the Chinese political leadership. 

Writes Bloomberg’s William Pesek (hat tip Mark Thornton) [bold mine]

Gan, a professor at Southwestern University of Finance and Economics in Chengdu, Sichuan and at Texas A&M University in College Station, Texas, recently crunched some disturbing numbers on the level and distribution of household income and wealth. After examining survey results from 28,000 households and 100,000 individuals, Gan believes that roughly 65 percent of China’s household wealth is sitting in real estate.

An astounding 90 percent of households in nation of more than 1.3 billion people already owns homes. In the first half 2012, he found, about 42 percent of demand for properties came from buyers who already owned at least one. Many of these homes and apartments, it goes without saying, were bought in the midst of one of history's biggest real estate booms and bubbles.

“The Chinese housing market is clearly oversupplied,” Gan told Tom Orlik, a Bloomberg economist based in Beijing. “Existing housing stock is sufficient for every household to own one home, and we are supplying about 15 million new units a year. The housing bubble has to burst. No one knows when.”

When is does, the damage to household wealth will reverberate across the second-biggest economy, devastate consumption and increase risks of social unrest. In other words, it's something the Communist Party can't allow to happen. While Xi's promises to tolerate less gross domestic product growth as he weans China off its addiction to exports, the pressure to sustain property prices will take precedence over reform.

While it may be true that the Communist Party can't allow bubbles to pop, this assertion would seem like the modern day equivalent of King Canute who in trying to “rebuke the flattery of his courtiers” to show them the limits of a king's power, “set his throne by the sea shore and commanded the tide to halt and not wet his feet and robes”. In other words, Chinese political leadership may kick the can down the road but they will be unable to stop economic reality from coming to fruition. This is a question of 'when' and not an 'if'. And that 'when' may be soon.

In reality, the current unsustainable real estate bubble signifies the “unintended consequences” or policy backlash from the policies adapted by the Chinese government, particularly financial repression (to corral the resources of her constituents via mandates) along with PBoC’s inflationism as earlier explained here.

China’s boom phase of the bubble cycle seems to have reached an advanced or maturing state.

When the political leadership tried to restrain the bubble in June 2013, Chinese markets went haywire as exhibited by soaring interest rates. Rising interest rates and price inflation are signs of the deepening insufficiencies of resources to supply or finance these bubbles.

The Chinese government then backtracked and began infusing money into the system. The outcome has been to escalate a runaway credit which underpinned a juggernaut in the run up of property prices.

Moreover, with new regulations aimed at curbing lending growth, credit dynamics has fundamentally shifted from banking sector into shadow banks. Local governments, whose career has been underpinned by meeting statistical economic growth quotas, resorted to new schemes of availing  credit in order to finance local projects for political goals by circumventing new regulations.

And with huge amount of debt targeted for a rollover this year in the face of rising interest rates, I pointed out that China’s bubbles could serve as a potential trigger to a global Black Swan event.

In addition, fears over looming systemic instability from a major default has compelled the Chinese government owned bank to bail out a troubled Trust product a week prior to the week long celebration of this year's Spring Festival. Yet such bailout is likely to serve as a magnet for more credit inflation.

The Chinese government seems faced with the proverbial devil and the deep blue sea. Accommodate credit, unstable debt conditions compounds, bubble inflates even more. Stop credit, economic depression emerges.

So the Chinese government appears to be approaching her bubble problems with a whack a mole (game) or deal with the problem as they surface. The dilemma will be magnified when the “mole” transmutates into “gremlins”.

The depth of exposure by the Chinese households on her gigantic property bubble means that a bust will bring about a major setback to the Chinese economy (and will most likely ripple across the world). 

This may also extrapolate to a pushback on the much vaunted “Chinese century”. [The Chinese may recover swiftly if real reforms towards a market economy will be pursued]

The predicament of the Chinese government as predicted by the great Austrian economist Ludwig von Mises: 

The boom can last only as long as the credit expansion progresses at an ever-accelerated pace. The boom comes to an end as soon as additional quantities of fiduciary media are no longer thrown upon the loan market. But it could not last forever even if inflation and credit expansion were to go on endlessly. It would then encounter the barriers which prevent the boundless expansion of circulation credit. It would lead to the crack-up boom and the breakdown of the whole monetary system