A new surge of urban development may create a new wave of “ghost cities” in China, as the country draws up plans to house as many as 3.4 billion people, far in excess of its current population.
… According to Xinhua, the trend for development of new urban areas is spreading from provincial capitals to smaller local and county-level cities, with construction on county land and in development zones also heating up. A lack of coordination means that in some cases several new cities are being planned in an area of only some dozens of square kilometers. __ Diplomat
Local government officials can get rich by seizing land and selling to developers at a high price. As new infrastructure is built on the land, governments can gain revenue via taxation.
…according to Citi, “in China, property is not only a type of consumption goods to satisfy housing needs, but also takes up a big responsibility to act as investment products. In the past 20 years, the China property market has acted as a huge capital reservoir” (Citi 2011, 31). Due to the extreme volatility of China’s stock markets, legal restrictions on moving money overseas, low returns to bonds and other savings vehicles, and a frothy real estate market, Chinese investors often buy at least 3 different houses – either as short term investments they hope might rise in value and become wealth-generating or as stores for the long-term preservation of their existing wealth.
… Because of this, any significant drop in Chinese housing prices threatens to wipe out truly massive amounts of private wealth… __ http://seekingalpha.com/article/3390255-chinas-ghost-cities-will-haunt-the-world
Unfortunately, new buildings in China do not hold up well — lasting roughly 23 years or less before necessary demolition.
Last year, China Economic Review reported on a controversial study that said poor building quality and China’s short-sighted land-lease system would lead developers in major urban areas to neglect reinvestment in city centers. The study, published by an international team of scholars, said the conditions would push investment to the outskirts of cities, leading to urban sprawl. More alarming, it could also cause city centers to decay into slums. __ http://www.chinaeconomicreview.com/china-housing-shoddy-building-quality-energy-incentives-GDP
All of this new building around the periphery requires new lending, and credit growth contributes to economic growth — GDP — even if what is built is unnecessary or of poor quality.
When credit is expanding, consumers can borrow and spend more and businesses can borrow and invest more. Increasing consumption and investment creates jobs and expands income and profits. Moreover, the expansion of credit tends to cause the price of assets such as stocks and property to increase, thereby boosting the net worth of the public.
Rising asset prices give the owners of assets more wealth (i.e. collateral) against which they can borrow still more. This cycle of expanding credit leading to increased spending, investment, job creation and wealth, followed by still more borrowing produces a happy upward spiral of prosperity….so long as it continues. Eventually, however, every credit-induced economic boom comes to an end when one or more important sector of the economy becomes incapable of repaying the interest on its debt.
We are seeing a growing number of defaults on debt by large, too big to fail, Chinese state owned enterprises.
Respected China economist Michael Pettis cautions against this dangerous trend of out of control credit growth in China:
What matters is the associated growth in credit. If growth next year of 7% were achieved with 18% growth in credit, things would actually be getting worse, not better. On the other hand if China grew next year by 5%, with credit growing at “only” 8%, this would represent a significant improvement in China’s medium- and long-term growth prospects. This is something that a lot of economists seem to have real trouble in understanding. There is no “good” level of economic growth independent of the associated growth in credit.
… There is so much evidence supporting the view that high debt levels in an economy reduce that economy’s growth that it is surprising how few economists understand the urgency of getting credit growth under control. In the past whenever growth has slowed sharply in an overly indebted economy, economists blame the inadequacy of reforms and the cowardice of policymakers, but if slower growth has happened in every single case of excessive debt, it is absurd to blame the pusillanimity of policymakers. We are already seeing how rising debt levels have caused Chinese growth to drop below projections year after year, and already economists are shifting the blame from their ineffective models to the incompetence of Beijing’s economic stewardship. And as debt continues to grow, the economy will continue to slow, and economists will continue to blame Beijing’s incompetence. __
China Doesn’t Have Much Time Left to Get it Right
Capital outflow defies government restrictions (see graphic above)
If China were a good investment, wealthy Chinese would be investing in China, instead of using ingenious tricks to move their wealth overseas. So we see Chinese investment in real estate propping up markets from Sydney to London to Vancouver to New York City.
Al Fin has been saying many of the same things as the authors quoted above, since 2009 when the scope of the Chinese government’s response to the collapse of its export markets became clear.
Obviously, the parts of the world that have grown dependent upon Chinese investments — Africa, Russia, Venezuela, Brasil, etc. — are likely to go through a rough period, depending upon the quality of management involved.
Geopolitically, the Chinese government is likely to maintain its military, espionage, and nuclear development for the sake of global “throw-weight” and international clout. Ordinary people are likely to bear the brunt of any economic downturn — as is happening in Russia.
Here at the Al Fin Institutes, we have always expected that Russia will begin to fragment before China undergoes a similar breakdown. That continues to be our expectation. But there is a penalty to be paid for corruption and incompetence, even for economies that have grown as large as China’s.
68% of China’s population lives on less that $5 a day. China’s working-age population is beginning to fall, as a result of the former “one-child” policy.
The deep notching seen in the lower part of the 2010 population pyramid of China portends a sharp drop in working-age population over the next several years, beginning in 2015. China grows old while it is still poor.
Does it make sense to build a housing infrastructure for 3.4 billion people in a country where the population is half that size, and likely to slowly decline? Yes, it makes sense to the local government officials who grow wealthy from land seized from farmers. It makes sense for developers as long as they can obtain both credit and buyers. It makes sense for the national CCP as long as they can take credit for high growth rates. But for middle class Chinese who are stuck with real estate investments unlikely to last much over 20 years before starting to crumble, perhaps it is best for them to remain in ignorance.
What we are seeing in China and Russia today, is paranoia on a grand scale — perhaps not without reason, given much of the corruption and incompetence so prevalent inside the governments concerned.
China will need to insinuate itself more and more deeply within the manufacturing, commercial, military, economic, telecommunications, and governmental infrastructures of Russia, until the time is right to strike.
If done properly, Russia will be so weak as to be incapable of putting up any resistance. Putin is already moving Russia in the direction of deep depletion on many levels. If Putin thinks that Erdogan “stabbed him in the back,” just wait until he sees what China has in mind.
If China’s traditional and shadow banking systems end up holding loans amounting to more than 300% of GDP, then somewhere there will be companies, households, and government entities with bank deposits or other fixed-income assets equal to over 270% of GDP (with the other 30% or so being investments in bank equity). Those apparently low-risk claims cannot really be worth 270% of Chinese GDP if a significant proportion are matched by loans to borrowers who cannot repay. One way or another, the real value of those claims will have to be reduced.
… Bank lending has accelerated over recent months. Total debt is still growing at a faster pace than nominal GDP. And if current trends hold, the debt burden could amount to well over 300% of GDP by 2020.