A couple of interesting news items and observations to share:
Item 1: Property Market Peak? On Thursday, the Wall Street Journal ran an article declaring "The Great Property Bubble of China May Be Popping." The authors noted that a prominent index of property prices in nine major Chinese cities dropped, for the first time in nearly two years, by 4.9% in April compared to a year earlier and that transaction volumes have also been on the decline. The rest of the article focused on the potentially dire consequences, for both China and the world, if booming real estate prices do in fact plummet.
I've been worried for quite some time that China's property prices — not only in 1st-tier cities, but 2nd and 3rd-tier ones as well — are dangerously overvalued. But I'll need to see more evidence before I'm convinced we've seen the peak. As I've also noted before, the factors that cause so many people in China to pour so much money into real estate — in particular, unproductive real estate — are deeply rooted in the structure of the Chinese economy. The market has seen dips before and they've always been seen as buying opportunities. I'm not saying the current state of the Chinese real estate market is sustainable, only that it's extremely persistent. (To get an idea just how much property prices have risen across China, province by province, since 2000, check out this great interactive graphic published last week by the Financial Times — registration required).
It will take a significant change in attitude for Chinese investors to starting bailing out of property. How and when that will happen, I am not sure. But of course, that's the tricky thing about bubbles — since the beliefs that sustain them are not based in economic reality, but in economic misconceptions, psychology, not economics, is what finally tilts the balance one way or the other. If the market stumbles, and that stumble confirms growing fears on the part of investors, the turn in sentiment can be severe, all out of proportion to any real change in underlying conditions. Will this happen in China now that property prices seem to be going soft? Possibly.
If the Chinese do start pulling their money out of real estate, one reporter called to ask me, where would they put it? After all, one of my arguments for why people in China use property as a "store of value" is lack of attractive alernatives. Well, assuming they successfully find a buyer (which is always the problem when everybody decides to sell), there are three possibilities:
- They put it into other assets. Last spring, when Chinese investors got spooked about government plans to "cool" the real estate sector, a lot of them started putting their money into gold instead. Jade, artwork, antiques, or even stockpiles of commodities like copper or nickel are potential alternatives. We could even see a situation where Chinese investors bail out of real estate in some cities, which they see as vulnerable, only to buy property in others — in which case, we could see some markets drop while others continue rising, for now at least.
- They spend the proceeds. If Chinese investors decide to cash out of real estate and try to turn the proceeds into buying power to improve their quality of life, expect a surge in consumer inflation. Given the explosion in China's money supply (by more than 50% over the past two years), the question isn't why inflation is treading 5%, but why we haven't seen more inflation sooner. The main reason is because most of that new money went into investment rather than consumption, mainly fueling asset inflation. But if those inflated asset values are suddenly transformed into higher consumer demand, the CPI rates we've seen so far will look like small potatoes.
- They hoard the cash. If this happens, the velocity of money will drop and the money supply will decline — in effect, a lot of the money that was created the past two years will simply disappear. This is what happens during a credit crisis and it's called liquidation. The good news: no more worries about inflation. The bad news: a lot of financial assets people thought they owned will go up in smoke.
Item #2: Growing Unrest. Tom Lasseter at McClatchy Newspapers had a fascinating article on Thursday about the bomb attacks on government offices in the southeast city of Fuzhou last week, a story so sensitive that Chinese censors have issued explicit orders banning any domestic media coverage. According to Lasseter, the bomber (Qian Mingqi, who himself died in one of the blasts) was not, as official reports indicated, some deranged and disgruntled farmer, but a successful small businessman who had been dispossessed by corrupt officials, then harassed and beaten up by local thugs when he attempted to appeal to Beijing. Far from condemning the attacks, at least one fellow entrepreneur (who owns a small car dealership in the city) told Lasseter she considers Qian a "hero." I was also struck by these revealing comments by Fuzhou's official city spokesman:
"The system in China has contradictions with the improvement of people's understanding of the law," said Li … "People have learned a lot about the Western world; they know how to use law to defend their interests. But the system here, or some people in the system, won't allow them to do that."
I suspect Mr. Li is rueing the day he ever let that slip out — which is why most official spokesmen in China wisely prefer to speak as little as possible.
Now, on the heels of the Fuzhou bombings, comes word of another unfolding incident, this one in the central province of Hubei. The story goes as follows: On May 26, an anti-corruption activist in the remote town of Lichuan (population 73,000) named Ran Jianxin was arrested, ironically, on suspicion of taking bribes. His friends say he was framed in order to silence him. If so, it worked all too well — within 10 days of his arrest, Ran, otherwise healthy, was dead. The body, photographed by his relatives, showed signs of torture. Thousands of protests gathered outside the town's police and government buildings, throwing eggs, water bottles and garbage. In response, hundreds of People's Armed Police, accompanied by armored cars, were sent into action. These photos, posted on Weibo, give a vivid impression of the angry stand-off.
Both incidents (Fuzhou and Lichuan) are excellent examples of how inequality of privilege, rather than inequality of income, is the key driver of social unrest in China (a point made in an article I posted here). Together, they give you get some idea of why China's leaders seem so nervous these days.
Item #3: China's "adjustment" on Libya. I was on CCTV News Dialogue last night, talking about the latest negotiations over the civil war and NATO intervention in Libya. You can watch it here. On of the topics that came up, near the end, is China's (and Russia's) efforts to reach out to the eastern rebels after abstaining from the UN Security Council resolution authorizing military intervention. What I find interesting about this turnaround is how it illustrates the limits of China's "non-interference" policy (the principle that China does not interfere in the internal affairs of other countries, hence it is free to do business with anyone — Sudan, Zimbabwe, Iran, Burma — regardless of what they do to their own people). China is very proud of this policy, which it believes distinguishes it from the hegemony-seeking U.S. The problem is, what happens when that "non-interference" (which effectively translates into active support for unsavory regimes) provokes resentment among the oppressed? Worse yet, what do you think their attitude towards China is going to be if they ever succeed at rising up and overthrowing their oppressors? Not too friendly. Which might account for this video, on YouTube, of Syrian protestors burning Chinese and Russian flags. "Blowback," it seems, works both ways.
Item #4: Chinese Backdoor Listings in the U.S. Right after Dialogue, I also appeared on the nightly news program, China 24, talking about the market impact of recent accounting scandals involving Chinese backdoor-listed stocks in the U.S. You can watch the lead-in story here and my short interview here. To tell you the truth, this is a situation that a lot of people — myself included — saw coming years ago. I remember a bunch of dubious pibao gongsi ("suitcase companies" – guys with little more than a suitcase and a cellphone) running around offering to do backdoor listings for pretty much anything and it seemed like a very murky business. I'm hardly surprised to learn that some of the companies that did list this way were outright frauds. That being said, there are plenty of companies — I'm not going to name names, but I think I could name quite a few — that are perfectly legit and are being tarred with the wrong brush. As I say in my interview, this presents a real opportunity for someone to take these companies private and reposition them — something I think you'll see quite a bit of in the days ahead.
Item #5: Germany's Nuclear Shutdown. Looking a bit farther afield: in the wake of Japan's earthquake-caused nuclear disaster, Germany's leaders have decided to shut down all of its nuclear power plants by 2022. That's a pretty drastic step, given that nuclear plants currently provide 23% of the country's electricity. While the move has boosted Chancellor Angela Merkel's popularity in the short-term, I predict that in 10-20 years time, the Germans will sorely regret what history will show to be a short-sighted, foolhardy decision.
It's not just that the move may prove expensive, as the Wall Street Journal points out. The real concern is what will fill the gap. Although German leaders are denying it, the answer, inescapably, is Russian natural gas. There are already concerns — especially in Poland and the Baltic republics — that German dependence on Russian natural gas is hobbling its willingness to stand up, as a fellow NATO member, to Putin's efforts to re-exert influence in Eastern Europe. Several times in recent years, Russia's state-owned natural gas monopoly, Gazprom, has shown itself willing to cut off gas supplies mid-winter as an instrument of Russian foreign policy.
The nuclear decision – together with a new direct gas pipeline running underneath the Baltic Sea — will only increase Germans' exposure to Russian "power" politics (a fact that makes Germany's total disinterest in the NATO mission in Libya, a potential alternative source of natural gas, all the more mystifying). What we're talking about, down the road, is a profound realignment of interests in Central Europe — one that eventually may call into question the integrity of NATO and the EU. In the wake of reunification and the euro-zone debt crisis, Germany's interests — which for so long have been assumed to be identical with Europe's interests — can no longer be taken for granted.
Item #6: Reliability of Chinese Statistics. And finally, back to China: Tom Orlik has a good piece in yesterday's Wall Street Journal discussing the reliability of China's official GDP statistics. I find the alternative numbers proposed by economist Harry Wu to be interesting, if only because they're clearly a lot more volatile than the unusually (and suspiciously) smooth official data. As it notes in his byline, Tom is coming out with a book on Chinese economic indicators, which I look forward to reading.