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The Biggest Bubble In the World. Who Wins If It Doesn't Burst?

May 16, 2011 4:51 AM ET
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Jim Trippon's Blog
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China's housing "bubble" is the current bogeyman of the global economy. Ever since the disastrous US real estate implosion, the world has been watching anxiously for the next great bust. China's booming real estate sector has been singled out as the newest global danger zone.

Sure, the Chinese real estate sector has enjoyed explosive growth in recent years. But do explosions always burst bubbles? China's real estate values are indeed exceptionally high, but are they likely to implode? And if the sector does implode, should western investors care?

Absolutely we should care. We live in a global economy. American unemployment numbers mean much less to the global system than China's overwhelming rise. China Business Services calls China's property market "the single most important global economic indicator".

A collapse of this massive market would be felt around the world. But will it happen?

One of Britain's most respected sources of analysis, The Economist, says fears about Chinese real estate are overblown. The Economist says there may be a mild, short-term correction but a collapse of the sector is highly unlikely.

That's very good news for investors who take a global view of their portfolio's performance and potential. Yes, commodities have suffered sharp setbacks in the past month. But an extended Chinese housing boom would create bigger markets and better prices for commodity investments.

Building Rome in a Day (almost)

The current rate of housing construction in China is breathtaking. The Economist Intelligence Unit captured the size of the housing boom in a few sentences: "At China's current rates of construction, it would take roughly two weeks" to build an entire city the size of Rome!

The authors warn, "In an economy that is building as much housing each year as there is in all of Spain the repercussions of a major collapse would be severe enough to send the world into a mini-recession".

Other pessimists have warned of a potential real estate collapse like "Dubai on steroids". Many of these critics, some who have never set foot in China, point to the huge scale of construction and warn that the demand just isn't there.

Incredibly, China has built a housing stock the size of all the homes in Europe in just 15 years.

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But Chinese demand is healthy and set for a very long run.

The Economist Intelligence Unit says there are two factors driving ongoing demand for new housing in China.

The first factor is increasing wealth.

Between 2011 and 2020, China's urban disposable incomes per head will increase 2.6-fold to 51,310 yuan. That is about $7,500 at current exchange rates.

Triple this per-capita number to reflect the size of an average family and you get an average of $22,500 per family, a substantial rise from today's figure of $4, 382 per person (according to the IMF).

And good housing is the number one priority on every Chinese family's must-have list.

The second factor driving a long rise in housing demand will be rapid urbanization.

The Economist estimates:

Between 2011 and 2020, we expect China's urban population to increase by 26.1 percent, or over 160m people.

Residential floor space per head in urban areas will increase from 30 sq meters (in 2008) to 41 sq meters by 2020. (That's a little more than 441 square feet – not huge but more than the average Japanese and a 25 percent increase from current housing space.)

And much of the expansion will happen in China's fast-growing interior cities.

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Adding to the viability of China's real estate boom is a policy to reinforce the nation's banks.

Unlike America's ill-fated banking regulators, Beijing has constantly raised bank reserve ratios – the proportion of money that banks must hold in reserve relative to their outstanding loans. Last week Beijing raised the reserve ratio by another half point, the fifth such raise this year.

Mortgage rules have just been tightened again. Several banks have just have raised the minimum down payment to 40 percent from the official minimum 30 percent required by China's banking regulator.

Compare that to America's NINJA loans. (No Income, No Assets, No Job.)

Global Investment Opportunities

Ongoing real estate investment on a Chinese scale will have a powerful, long-term effect on commodities including metals, timber and energy.

The Economist estimates that steel demand will rise by 25 percent. Many new homeowners will purchase cars to travel from their new homes to their places of work. Oil demand is expected to rise by 50 percent.

Other commodities including timber, copper and the other basics of construction will also face rising demand and higher prices.

China's exploding real estate demand will amount to an $11.5 trillion shot in the arm for the world economy.

Although there may be some bumps along the way, the future of Chinese demand seems to be a very long term, sustainable trend. China's double-digit GDP growth is moderating but that won't lead to a sudden drop in housing demand.

The outlook from many sources indicates that China will continue to outpace the U.S. in growth for the remainder of the decade. Investments that feed that mega-trend seem like reasonable bets for long-term investors.

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Global Profits Alert (GPA) is published by Trippon Financial Research, Inc. a financial media organization with offices in the United States, Hong Kong and Mainland China. GPA is written by Jim Trippon in conjunction with George Wolff, Sunny Wang, Todd Shriber, Kelley Damiani and J. Daryl Thompson.

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