15/5/14 10:26 pmWhy China Will Implode: Its A Monumental Building Aberration, Not An Economy | David Stockman's Contra Corner

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Why China Will Implode: Its A Monumental Building Aberration,Not An Economy

The thing to understand about China is that it is not just another boomingEM economy that is momentarily struggling to cool-down its excessesin fixed asset investment and make a transition to some kind of more“normal “consumer-based economy. That comforting notion represents anodd-confluence of propaganda from the comrades in Beijing and hopiumfrom Wall Street stock peddlers.

In fact, China is a grotesque economic aberration that bears norelationship to prior economic history or any conventional economicmodels-–not even to the export-mercantilism model originally developed byJapan, and which has now proven itself wholly unsustainable. Instead, China is a nation that has gone madbuilding,speculating and borrowing on the back of a credit bubble so monumental (and dangerously unstable)that its implications are resolutely ignored by observers deluded by the notion that China embodiesa unique economic model called “red capitalism”.

But when a nation’s debt outstanding explodes from $1 trillion to $25 trillion in 14 years, that’s not capitalism,even if its red. What it represents is monetary madness driven by the state.

Occasionally a picture is worth a thousand words, and here’s one buried in a Financial Times story on China’srapidly deteriorating housing market. It seems that during the two-year period 2011-2012, which was thepeak of China’s much praised “aggressive” stimulus response to the Great Recession in the DM world,China consumed more cement than did the United States during the entire 20th century!

That astounding fact needs to sink in, and it is a fact—blessed by the U.S. Geological Survey. Stated differently,imagine the whole urbanization and suburbanization of America over 100 years; the building of all the officetowers, skyscrapers and malls which festoon thousands of city landscapes from coast-to-coast; the building of allthe great public works of the 20th century including likes of the Hoover,TVA and Grand Coulee dams and all theArmy Corps locks, dams, navigation and flood control projects; the Interstate Highway system and all thederivate highways and suburban sprawl which came with it; all the stadiums, auditoriums, airports, bus and trainstations, subways and parking lots that have ever been built in America; and keep imagining because theunderlying proposition is itself scarcely imaginable:

The FT reported overnight that “In just two years, from 2011 to 2012, China produced morecement than the US did in the entire 20th century, according to historical data from the USGeological Survey and China’s National Bureau of Statistics.” We showed this two years ago -little did we know that two years later the situation would be completely out of control.

Here’s the thing. You can’t look at China’s entirely doctored and goal-seeked GDP accounts and have anyunderstanding of the thundering collapse which will actually occur when the building boom ends. The idea thatfixed asset investment at 50% of GDP is just some kind of economic ratio that the comrades in Beijing can

15/5/14 10:26 pmWhy China Will Implode: Its A Monumental Building Aberration, Not An Economy | David Stockman's Contra Corner

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shimmy down to normality–say25% which is still high by everyother economy in the world—failsto comprehend what China’seconomy really is. That is, its acontinent-wide constructionproject in which everything flowsinto obtaining, moving, fabricatingand erecting infrastructure—bothpublic and private, retail andindustrial.

So when the building stopsbecause the inflated prices of realestate are collapsing and creditexpansion can no longer prop upthe bubble, the implosion will bethunderous. Cement productioncould drop from 2 billion tons peryear to 500 million; rebar consumption would crater proportionately; industrial fleets of cement trucks and steelhaulers would lie idle; demand for tires, engine parts and truck fuel would vaporize; vendors of all the servicesthat support this gigantic flow of cement and steel will be out of business; they empty apartment “investments”held by their owners will be worthless.

That’s what will happen when the building stops. This article from the Telegraph suggest such a turn of eventmight not be all that far down the road. As one observer ventured:

They can keep on building but no one will buy.”

By Ambrose Evans-Pritchard

China’s authorities are becoming increasingly nervous as the country’s property market flirts withfull-blown bust, threatening to set off a sharp economic slowdown and a worrying erosion of taxrevenues.

New housing starts fell by 15pc in April from a year earlier, with effects rippling through the steeland cement industries. The growth of industrial production slipped yet again to 8.7pc and hasbeen almost flat in recent months. Land sales fell by 20pc, eating into government income. TheChinese state depends on land sales and property taxes to fund 39pc of total revenues.

“We really think this year is a tipping point for the industry,” Wang Yan, from Hong Kong brokersCLSA, told Caixin magazine. “From 2013 to 2020, we expect the sales volume of the country’sproperty market to shrink by 36pc. They can keep on building but no one will buy.”

The Chinese central bank has ordered 15 commercial banks to boost loans to first-time buyers

15/5/14 10:26 pmWhy China Will Implode: Its A Monumental Building Aberration, Not An Economy | David Stockman's Contra Corner

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and “expedite the approval and disbursement of mortgage loans”, the latest sign that it is backingaway from monetary tightening.

The authorities are now in an analogous position to Western central banks following years ofstimulus: reliant on an asset boom to keep growth going. Each attempt to rein in China’s $25trillion credit bubble seems to trigger wider tremors, and soon has to be reversed.

Wei Yao, from SociétéGénérale, said theproperty sector makes up20pc of China’s economydirectly, but the broadernexus is much larger.Financial links includes$2.5 trillion of bankmortgages and directlending to developers; afurther $1 trillion ofshadow bank credit tobuilders; $2.3 trillion ofcorporate and localgovernment borrowing“collateralised” on realestate or revenues from land use.

“The aggregate exposure of China’s financial system to the property market is as much as 80pc ofGDP. This is not a sector that can go wrong if China wants to avoid a hard landing,” she said. Therisk is that several cities will face a controlled crash along the lines of Wenzhou, where priceshave been falling non-stop for two years and have dropped 20pc.

President Xi Jinping has made a strategic decision to pop the bubble before it spins further out ofcontrol, allowing bond defaults to instil market discipline. But the Communist party is in delicateposition and may already be trapped.

Reliance on “fair weather” land revenues to fund the budget is like the pattern in Ireland before itshousing bubble burst. The IMF says China is running a fiscal deficit of 10pc of GDP once the landsales and taxes are stripped out.

Zhiwei Zhang, from Nomura, said the latest loosening measures are not enough to stop theproperty slide, predicting two cuts in the reserve requirement ratio (RRR) for banks over the nexttwo quarters. He warned that any such move will merely store up further problems.

Nomura said the inventory of unsold properties in the smaller third and fourth tier cities – whichmake up 67pc of residential construction – has reached 27 months’ supply. The bank warned in a

15/5/14 10:26 pmWhy China Will Implode: Its A Monumental Building Aberration, Not An Economy | David Stockman's Contra Corner

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recent report that the property slump could lead to a “systemic crisis”.

The Chinese state controls the banking system and has $3.9 trillion of foreign reserves that canbe deployed in a crisis. The RRR is extremely high at 20pc and can be slashed if necessary. A cutto 6pc, the level in 1998, would inject $2 trillion in liquidity.

Nomura said residential construction has jumped fivefold since 2000 from 497m square metres to2,596m last year. It is unclear whether fresh migrants will continue to pour into the cities and soakup supply. Nomura said migrant numbers have already halved from 12.5m to 6.3m over the lastfour years.

What is certain is that China’s demographic profile is already changing the economic calculus.The workforce contracted by 3.45m in 2012 and another 2.27m in 2013. For better or worse,China is already starting to look very like Japan.

http://www.telegraph.co.uk/finance/china-business/10828912/China-reverts-to-credit-as-property-slump-threatens-to-drag-down-economy.html

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