Easy credit, rising home values, massive expansion in construction: Sound familiar? There is a growing unease in the markets, as the world watches China on a trajectory of growth that could prove unsustainable and fear of an asset bubble spreads every day.
China has weathered the global financial crisis better than most. While developed nations faced a major contraction in GDP, China only slowed to 6.2 % growth, climbing back to 10.7% in the fourth quarter of last year. China is growing at the fastest pace in the world, but can it continue unabated?
What is fueling this growth? In the past, China’s economy has been driven by exports. But now, we are beginning to see a shift to a nation of consumers. In December, while exports grew 17.7% from one year earlier, imports jumped 55.9% (this narrowed China’s trade surplus to $18.4 billion). The growth in exports made China the world’s largest exporter (surpassing Germany), and the expansion of imports tells us that Chinese domestic demand is a powerful force.
Is China’s economy overheating? A first look at the expansion of real estate would lead to one conclusion: Yes. Housing starts were up 194% (yes, 194%) in November over one year earlier. Property prices climbed 7.8% in December year-on-year. New loans totaled 9.59 trillion yuan ($1.4 trillion) in 2009, a record number. Add it up, and it looks like an asset bubble. But, as you know, things are not always what they seem. Maybe China can manage these record numbers.
With all the right ingredients in place, how can China avoid a bubble when the U.S. could not? The answer is simple: the U.S. and China are two very different economies, with very different governments.
While China is an emerging economy and a giant of global trade with capitalist tendencies, it still has the characteristics of a communist country, and the government’s reach is wide. While the U.S. bubble was the result of loose monetary policy and regulatory failure, the Chinese government has taken a proactive approach to cooling its real estate market with stringent government controls. After last year’s lending spree, the People’s Bank of China has limited loans in 2010 to 7.5 trillion yuan and tightened lending practices; the government also raised reserve requirements for banks. Another critical difference: mortgages are not securitized in China (which was key to the U.S. bubble), so even in the event of a housing bubble, the impact would be limited.
It is not only the actions of the government, but the actions of the people, that matter. The U.S. is a country of consumers; China is a country of savers. According to consulting firm McKinsey, on average, Chinese households save 25% of their discretionary income. This is out of necessity. Chinese citizens do not have social safety nets like unemployment insurance and social security, so they are savers for their own financial survival. This means two things: the Chinese people have a cushion if a bubble bursts, and the Chinese government does not have to spend on social welfare programs.
There is also less speculative real estate investment in China. Like gold, real estate is considered a safe investment, a store of value. There is little short turnover, or flipping, of homes, as they are viewed as long term investments. To discourage any speculation, the government set a tax on homes sold within five years of purchase.
Can demand justify the massive growth in real estate? One important thing to remember is this: over the next fifteen years, urban migration in China will result in more than 240 million people moving from rural China into cities. So, this massive expansion in housing will find a population expanding and ready to absorb it. As New York Times columnist Thomas Friedman said, “Ten years ago, China had a lot of bridges and roads to nowhere. Well, many of them are now connected”. The next ten years will find those bridges and roads filled with people driving the Chinese economy forward. From infrastructure to consumer spending, China has plenty of room to grow.
Will China experience a housing bubble? It’s not impossible. But if it happens, the effect will not ripple through the global economy the way the U.S. bubble did; it will be a small pop in comparison. China’s growth potential is strong, and domestic demand is a new and thriving force. So don’t worry too much about China: they can handle a storm, and besides, they are sitting on over $2.3 trillion in foreign exchange reserves. And the people of China haven’t spent the last several years borrowing their lifestyle on credit. They will be okay….More than okay. And so will investors who decide China is a good place to be.
Disclosure: Clients of Rezny Wealth Management my hold positions in China stocks and ETF's.