20 December 2011

Beijing Faces a Delicate and Dangerous Balance of Crises

What makes the future look particularly bleak is the lack of escape routes. If Chinese investors panic and rush for the exits, they will discover that in a market awash with developer discounts, buyers are very hard to find. The next three months will be a watershed moment for a Chinese investor class that has been flush with cash for years but lacking a place to put it. Instead of developing a more balanced, consumer-based economy, an entire regime of Beijing technocrats — drunk on investment-led growth — let the real estate market run red hot for too long and, when forced to act, lacked the credibility to cool the sector down. That failure threatens to undermine the country’s continued economic rise.

Real estate woes are already sending shockwaves through China’s broader economy. Chinese steel production — driven in large part by construction — is down 15 percent from June, and nearly one-third of Chinese steelmakers are now losing money. Chinese radio reports that half of all real estate agents in the southern city of Shenzhen have closed up shop. According to Centaline, more than 100 local government land auctions failed last month, and land sale revenues in Beijing are down 15 percent this year. Without them, local governments have no way to repay the heavy loans they have taken out to fund ambitious infrastructure projects, or the additional loans they will need to keep driving GDP growth next year.

In a few cities, such as coastal Wenzhou and coal-rich Ordos, the collapse in property prices has sparked a full-blown credit crisis, with reports of ruined businessmen leaping off building rooftops; some are fleeing the country. _Patrick Chovanec
Outside analysts must read between the lines of what information the authoritarian governments in Beijing allow to leak out. But it is becoming more clear by the week that Beijing did not anticipate the power of the tiger which was unleashed when China began to pursue world-class industrialisation.
Entrepreneurs in China who have gotten rich by exploiting the government-fed demands to build cities and infrastructure to house the coming wave of residents are now getting out of China while the getting is good. Back in June Forbes magazine wrote that 60 percent of China’s high-net-worth individuals are either considering emigration or have already left the mainland for safer havens elsewhere. Global Financial Integrity estimates that the sums of money that have already left the country are huge, exceeding $2 trillion dollars through 2008. Such a financial exodus has naturally been criticized by the Chinese government. Writing in the communist newspaper Global Times, Zhong Dajun protested, “We have been working hard to develop the economy in the past 30 years, but now these elite members of society are fleeing with the majority of the wealth.”

It’s the financing of those efforts to “develop the economy” that is the problem. The Chinese government’s plan to move 350 million people from rural areas into cities required building those cities in advance. Here was their perfect opportunity to use the Keynesian approach to create wealth out of paper: The government set up 10,000 investment companies to build them, and provided financing through banks funded by the government. It would put people to work, stimulate the economy, and “provide for the common good” on communist terms. It was also designed to foster a change in the economy from rural to a demand-driven consumer society. It was “jump-starting” to a degree never seen in history — “pump-priming” to push the economy ahead.

The pending implosion is the natural result of such efforts. Twenty new cities were being built every year, but few citizens were moving into them. “Ghost cities” they were called, and thanks to Time magazine’s photographer, Michael Christopher Brown, pictures of them can be seen here and here and of empty apartment buildings here. _New American Bob Adelman
It was a grand plan, and many people still believe that it may succeed. Whether these same people are still throwing their money into Chinese investments or not is another question.
In 2008, China sent over $700 billion to states to invest in things like roads, trains, bridges, housing and entire cities. Some of these projects were bridges to nowhere. Although the government estimates that public debt as a percentage of GDP is just 17%, Bloomberg estimates that it is at 80% because of fixed investment.

...Construction has played a big role in the country’s full employment and urbanization strategies. “The people you see climbing bamboo scaffolding in Shanghai all came from the interior of China and they are now moving back,” said Kalish. “It happened in 2008 when the country lost about 20 million manufacturing jobs because export markets were basically closed off because of the credit crisis. About half of them moved out of the coastal cities and the rest were laid off. The stimulus package got most of them back to work quickly, but a lot of those migrant workers stayed in the interior cities because wages had improved along with working conditions. China is changing and with it come a host of new problems. _Forbes
Even with all its problems, it is still not very difficult to find China boosters who talk up China at every opportunity. But where are they putting their own money, personally? No one seems to ask them that.

Problems are flaring up across China, as Beijing faces its once a decade transition of power. More on that particular problem from Gordon Chang

And once again, global investors must face the question of what happens to commodities and currency markets should the Chinese economy take a significant nosedive? Do your investments take that possiblity -- along with a possiblity of the collapse of the Eurozone -- into consideration? They should. The secondary fallout from a cascading collapse of economies presents both hazard and opportunity.

Image credit via Forbes

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