China Inflates Its Real Estate

| About: Guggenheim China (TAO)

I have a Chinese friend who used to teach in a university in China. He reads news from home that doesn't make it into the US media and tells me the more interesting stories.

Lately, he has been reading about real estate. He is frustrated that many of his family members in China have become wealthy through real estate speculation while he missed out. They had tried to get him to invest with them years ago, but he was certain at the time that prices would never rise as they have.

He told me recently the Chinese media reported that total value of real estate in the top three cities, Beijing, Shanghai and Shenzhen, is priced more than all of the real estate in the US. Apartments with a thousand square feet in those cities sell for several million dollars.

My friend told me that China doesn't have a property tax and just recently added a deduction for mortgage interest in order to encourage more speculation. He said the government wants prices to continue to rise because the state owns most of the land, so it reaps huge rewards when prices rise.

One story that he told of several families and their friends pooling their savings, so they could afford the 20% down payment on a small apartment. No one needed the apartment. They were just speculating in real estate.

Some don't think the real estate balloon is a problem. In an article titled "Keynes and Hayek in China's Property Markets," Andrew Sheng relates the following anecdote about real estate:

Chris Watling of Longview Economics compares China's property market today to the Dutch tulip mania that peaked in 1637. He points out that property prices in Shenzhen, in particular, jumped 76% since the start of 2015, bringing a typical home to $800,000, just below the average home price in Silicon Valley. This, he suggests, may be the last hurrah before a market meltdown.

Of course, state officials disagree:

Liu Shijin, former Vice Minister of the Development Reform Center of China's State Council, disagrees. Instead, he posits that after six years of reduced investment in infrastructure and construction, growth in the Chinese property market may be bottoming out, and liquidity and consumer confidence may be shifting back to housing.

Some China observers note that the largest increases have happened in only a few cities, while the rest of the nation has witnessed smaller price increases. But that is always true in housing bubbles. Tokyo suffered the most from real estate price inflation in the early 1980s, before the crash that Japan has yet to recover from completely. And the US housing bubble of the first decade of this millennium happened for the most part in Florida, Arizona, Nevada and California. Mainstream economists always look for rationalizations of abnormalities, especially when their policies cause them.

The Chinese Communist party ignited the nation's explosive wealth creation and poverty reduction by getting out of the way in the 1980s and allowing a tiny opening for freedom. As a result, entrepreneurs lifted over 300 million people from starvation to wealth by the standards of the poor world. But since 2000, the Communist party has taken credit for the nation's miraculous development and, believing their own lies, taken control of the economy.

It appears that the Chinese government's effort to keep their balloon aloft in the grip of a major downdraft has caused them to blow one of the biggest real estate bubbles in history. When the balloon will burst is impossible to tell, but we know from history that the higher the balloon flies, the greater its velocity when it crashes and the bigger the crater it makes in the economy.

Several issues on the world stage are competing for the trigger that launches the next recession. The Chinese real estate market is one of the leading contenders.