China Real Estate Glut Widens
By Staff News & Analysis - September 10, 2010

China `Sweet Spot' Is Returning for Investors: To understand what is going on with China's economy, just look at wheel loaders. They are tractors with a big shovel on the front to pick up and move earth or coal. Such machines are used to build roads and railways or to dig black stuff out of shallow mines. China is, as we all know, an investment-heavy economy, so wheel-loader sales are a pretty good leading indicator: Companies only buy them if they plan to use one over the next 24 months. In July, 15,823 new loaders rolled out of the showrooms. That represented a 50 percent increase in seasonally adjusted sales compared with a year earlier. This is hardly the kind of number that one would expect from an economy on the verge of collapse. Instead it is just one of many signs that Chinese gross domestic product is steadily expanding while inflationary pressures have moderated. In short, figures for August may well be what we have all been waiting for: a China sweet spot. – Bloomberg

Dominant Social Theme: Invest in a healthy Chinese economy. Thank goodness one lynchpin country is booming.

Free-Market Analysis: Once again we read an optimistic article about China and the Chinese miracle. We do not understand at this point how anyone looking at China can be positive about where this largest-of-all Asian economies is headed. Citing various kinds of industrial statistics is akin, in our view, to the kinds of numerical citations that might have been accumulated in 2007 in the West prior to the financial crash. The dominant social them could be seen as one which states that "China is a tremendous power-house of industry and will only get more powerful as the years roll on."

But from our point of view, China looks a lot like America in the middle 2000s. There is significant industrial capacity and over-capacity and it is not clear where the consumers are going to come from to mop it up. The West is tapped out, with governments embarking on various kinds of "austerity." The Chinese government is going to have to labor mightily to reconfigure China as a nation of American-style consumers.

Western analysts often point to the amazing surplus of dollars held (mostly) by the Chinese government. But we fail to see how this surplus interacts with the underlying inflationary problems of the Chinese. The money supply in China has obviously expanded and the velocity of money, powerfully ignited, gives us the classic signals of price inflation. Just the other day, more news came out about the reality of Chinese real-estate bubble, as follows:

China: 64 million vacant homes … I just read this and the number jumped out at me-64 million vacant apartments and houses in China. That would be enough homes to house roughly 200 million people. When thinking about China, the scale of its population can lead to misleading statistics as I pointed out in a recent post (China: We're #102). In that post I pointed out that China's economy is very large in total GDP, but it is small in per capita GDP. I took some heat for pointing that out, but it is true nonetheless. (- MarketWatch)

Yes, the Chinese are a most industrious people. But GDP aside, this monetary stimulation must be considerable to generate the kind of systemic distortion that we are seeing in China. We have written about the city that stands vacant in Mongolia, having been built on a speculative basis. But now we see, in this amazing vacancy rate, another signal of a distorted economy.

The poor Chinese, only one or two generations removed from the world's last and most destructive famine, are doing what they can to help ensure their wealth. They are buying gold and real estate. But gold is a much better bet than real estate, which is eminently inflatable in a bubble economy. At some point, there will come a crisis, just as in America, and the real estate bubble will collapse. The valuations will be seen as speculative and Chinese owners will panic and try to sell, facing the sudden realization that it may take a generation or more to recoup their investments. It will be too late.

The Chinese government has done what it can to stem the tide but once price inflation has entered the system it is very hard to stop. In fact, short of raising interest rates dramatically and reducing the supply of money and its velocity, it is difficult to see how price inflation can be halted. Once the demand for money has increased, people tend to spend more and at a faster rate because they expect more inflation. It feeds on itself. We wrote this about Chinese price inflation in late July:

Now the inexorable process of inflation is beginning to show up elsewhere in that vastly populated land, most notably in commodities and food prices. What we have regularly maintained is that the old men running the vast Chinese economy from behind the scenes are in no position to "manage" the Chinese economy into a Keyensian "soft landing." A soft landing is probably the last thing the Chinese leaders want. (They don't want a "landing" at all.) Leading China into a glorious future of ever-expanding wealth and prosperity is a way to cling to power in a country where the alternative to maintaining power at such high levels is pretty awful. Incarceration or even death, we would suggest.

Click here to read the full article: The Spreading Chinese Inflation.

We really wonder about China-centric articles such as the one above on Bloomberg. With the West still unwinding its own bubble, how can China be seen as a healthy economy when it suffers from such obvious real estate distortions? The best that can be said for the Chinese economy at this point is that timelines for unwinding are always variable. China is a huge economy and even with the evident real-estate distortions, price deflation and deleveraging may be years away. Or they could occur tomorrow.

The trouble with what we are seeing in the Chinese economy is that the visible distortions are just the tip of the proverbial iceberg. We have written many times that competition in the Chinese economy is akin to that which takes place in South America. The free-market is mostly operative at the level of the bazaar. The larger industrial and financial institutions are still in grasp of a centralized command-and-control environment with the Chinese communist party and, to a lesser extent, the Chinese military at the top.

We know there are plenty of people who remain most enthusiastic about China. But the Internet, in our view, is revealing a story that is significantly more disturbing than the one that the mainstream press offers, for the most part, when China is discussed at all. The economic distortions of the real-estate market must run all the way up the foodchain. Chinese leaders want the Chinese population itself to fill the purchasing vacuum left by Western collapse. We frankly wonder if this feasible.

After Thoughts

We don't see the communists as able to turn China into an American-style consumer society overnight. If they cannot, then the unwinding may happen sooner rather than later. Once the country enters into an industrial downturn, all the rest of the distortions – especially in banking and other Western-style emergent enterprises such as various Chinese stock markets – shall be revealed. Because China is such a large country and because the distortions in our view run like faults throughout the entire Chinese economy, we think the bust, when it occurs, could be "Chinese sized."

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