Tuesday, March 26, 2013

Update on China's Real Estate Bubble, Credit Risk (March 2013)

Ever since hedge fund manager Jim Chanos, founder of Kynikos Associates, made public in early 2010 that his firm was shorting China's fixed asset investment bubble and credit fueled property bubble (Bloomberg TV interview, 57-minute Presentation video), it seems like he timed the Chinese market perfectly when it started to price in monetary tightening by the PBOC (1, 2) and an economic slowdown. The Shanghai Stock Exchange Composite (currently at 2,328) is down 33% from its reflationary peak in 2009, and down 62% from its parabolic peak of 6,124 in 2008. Similarly, the Shanghai Property Index is down 41% from its peak in July 2009, and down 50-60% from its peak in 2007. So now the question is whether China's real estate bubble will actually pop, destroy its credit market, and be the catalyst for a hard economic landing.

Shanghai Stock Exchange Property Index (SHPROP via Bloomberg.com)

It was widely televised in 2011 that there were ghost cities and malls in China and 64 million vacant apartments. And on 60 Minutes recently, Wang Shi, owner of China Vanke, mainland China's largest home builder, said there was definitely a real estate bubble in China, and if it popped, it would be a disaster. He even thinks an Arab Spring type event could occur if people lost all of their money in real estate. It's interesting because according to China Vanke's long-term chart, China's housing bubble already popped in 2007. It reminds me of Lucent's chart in the mid-2000s.

Transcript Source: CBSNews.com:

"The prognosis of a bubble about to burst isn't only coming from financial gloom-and-doomers. We heard it from the most unlikely source.

Lesley Stahl: Are you the biggest home builder in the world?

Wang Shi: I think. Maybe.

Lesley Stahl: You may be?

Wang Shi: Yes. Only the quantity, not quality.

Wang Shi is modest, but his company, Vanke, is a $53 billion real estate empire, building more homes than anyone in China. He was born on the frontlines of communism, and joined the Red Army. But he secretly read forbidden books about capitalism, so that when China liberalized its economy, he rushed to the frontlines of the free market. Even he thinks today's situation is out of control.

Lesley Stahl: Are homes in China too expensive today?

Wang Shi: Yeah.

Lesley Stahl: Here's a number I saw. A typical apartment in Shanghai costs about 45 times the average resident's annual salary.

Wang Shi: Even higher, even higher.

Lesley Stahl: What does that mean for your economy if it's just too expensive for the vast majority of people to buy?

Wang Shi: I think that dangerous.

Lesley Stahl: Dangerous.

Wang Shi: That's the bubble. So I think that's the problem.

Lesley Stahl: Is there a bubble?

Wang Shi: Yes, of course.

Lesley Stahl: There is a bubble and the issue is will it burst or not? That's the big issue--

Wang Shi: Yes, if that bubble - that's a disaster.

Lesley Stahl: If it burst?

Wang Shi: If it burst, that's a disaster."

After the 60 Minutes segment, Jim Chanos told CNBC's Squawk Box that his hedge fund Kynikos Associates was still short companies directly exposed to China's economy (quotes are not from the official transcript).

"I think that you have to understand that the people that sell into China, commodity makers and iron ore and that sort of thing, they're going to feel it."

"Look at anybody selling heavy construction or construction related... We're pretty much short anything affected in that."

"Basically we've made a lot of money in the past almost 30 years now in being short anything that was leveraged using a lot of credit where the asset did not throw off enough cash to support the debt. There's one place where that's happening right now in the globe and that's China. None of these assets can support the debt being incurred to take them. So all the knock on effects, construction equipment, cement, steel, iron ore are going to have a rough go of it I think when this all subsides."

But the Chinese government and its central bank are in full control of its economy and prices, right? Well hopefully in this case. So if China were to experience a severe real estate and asset price crash and deleveraging cycle, wouldn't the Chinese government and PBOC just bailout its banking system and print money like every other overleveraged developed economy that crashed? According to U.S. Global Investors, China's money supply has been growing year-over-year since 2012. This of course risks high inflation and social unrest.

Source: U.S. Global Investors (via guest post)

If you compare China's Debt/GDP ratios to developed economies before they crashed, China's leverage ratio is much lower, but its credit growth rate is very high. According to the CIA, China's debt/gdp ratio ("central government debt and local government debt") was at 38.5% in 2011 (ranked 95 in the world); and according to the IMF's initial estimate, China's debt/gdp ratio will be 22% in 2012. It was at 25.8% in 2011. Here is FT's beyondbrics on China's domestic credit/GDP ratio:

"China’s domestic credit to GDP ratio (DCG) at 155 per cent at the end of 2012 is well below Japan’s ratio of 237 per cent in 1989 and the US’s of 224 per cent in 2008. But even if China has a long way to “leverage up before reaching the crisis zone”, what matters is “not only the level of leverage, but also the change in leverage,” say Zhiwei Zhang and Wendy Chen in a new Nomura report. China’s leverage, as measured by the DCG ratio, rose from 121 per cent in 2008 to 155 per cent in 2012."

Michael Pettis, author of the China Financial Markets blog and Professor of Finance at Peking University, told Radio Australia yesterday that China's debt/gdp ratio is much higher than the official figure (quotes are not from the official transcript).

"China's GDP is probably significantly overstated... Debt becomes the key issue, and, I think by now there's a consensus that if this continues another 3-4 years, we run the risk of a debt crisis... Officially debt levels are not very high, 20-25% of GDP. But, because most of the expenditures done by the government aren't done directly by the government, they're done through the banking system.  All of the losses on the banking system effectively should end up on the government balance sheet. And how much debt is there? We don't really know but it's at least 80% of GDP for government debt, and it could be significantly higher, we just don't know. It's a much higher number than people expect. And I think to it's credit the government recognizes that." (full interview here)

Pettis believes that China needs to rebalance its economy away from the "Asian development model" (export driven production with low domestic consumption and high savings) and towards domestic consumption. He gave a detailed explanation at the Instituto Fernando Henrique Cardoso (iFHC) in 2009 ('The Global Crisis Seen From China'). Watch it below.

Here also gave a speech at Columbia University in 2009 on the same topic.

Other interesting videos on China featuring Professor Michael Pettis:
950) China's Bubble: Only Days to Come? (Youtube)
950) China's Bubble only days to come Part II (Youtube)

Zhang Monan: China's hidden debt risk (Project Syndicate, 3/20/2013)
China Banks to Benefit From Railway Restructuring, Moody’s Says (Bloomberg, 3/20/2013)
China tightens grip on loans to local government financing firms (Reuters, 3/14/2013)
Moody's: Revenue Slowdown Could Spur Rise in China Local Govt Debt (WSJ, 3/10/2013)
China Bails Out Local Governments (AsiaSentinel, 3/6/2013)
China PBOC Adviser Says Monetary Tightening Pressure Eased (Bloomberg, 3/3/2013)
Hard Landing Ahead for China’s Local Governments? (WSJ China Real Time, 3/1/2013)
Gordon Chang: How Will China Pay Off Its Debt? (Forbes, 2/26/2013)
Ruchir Sharma: China Has Its Own Debt Bomb (WSJ, 2/25/2013)

Part 2 will be on the technicals of SSEC, FXI, and FXI/SPY.

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