West’s recovery mission encounters hitch as harness slips off Chinese dragon
by Edmund Conway
Originally published 07 Aug 2010
ONE OF THE STORIES THAT MERVYN KING, THE GOVERNOR OF THE BANK OF ENGLAND, likes to tell is of the moment it dawned on him that recovery from what he calls the Great Recession would be almost as difficult as dealing with the crisis itself. Sitting at a summit listening to his fellow central bankers and finance ministers go round the table and explain how they would escape from the economic doldrums, he realised, with both horror and amusement, that they all had precisely the same plan: export their way out.
Now, economics is a weird and wonky subject, but on one point it is gratifyingly clear: the world’s ledger of imports and exports has to balance out – hence why we call it a balance of payments. Unless you are planning on exporting to the Moon or Jupiter, you must rely on another country buying your goods.
In other words, the US and UK’s plans to focus on exports as a source of growth in the future are dependent on the world’s big exporters – and specifically China – suddenly discovering an appetite for those American and British goods. Fail in this and a double-dip recession is almost assured. GDP statistics published late last month showed this was America’s worst recession since the 1930s – bar none. But it would have been far worse had the world economy not been supported by demand from China, India, and other emerging economies. As activity elsewhere cratered, Beijing pumped adrenalin into its economy by spending and encouraging bank lending, and briefly saw its trade balance go into deficit, a sight for sore eyes in Washington.
This now looks to have been an aberration. Those GDP figures also showed that the pace of US growth has suddenly slowed – and the main reason is an abrupt increase in reliance on imports. The reality is that just as the US and UK are in most need of demand from Chinese consumers for their goods, Beijing is facing an economic crisis of its own, and is resorting to its most reliable weapon: exporting the hell out of it.
Here in the US it is finally dawning on the public that the developed world’s prospects of recovery, of whether it can withstand a domestic double-dip, are almost entirely dependent on the health of the Chinese economy and its counterparts. For whereas there was at least a healthy chunk of deficit spending the US and UK could throw at things last time around, in the event of a future economic crunch they really would find themselves in the lap of the gods – or rather Beijing. Time, then, for a quick health check on the Chinese economy. The latest signs are not particularly encouraging.
Ignore for a moment official GDP growth, which always hangs so close to the 10pc mark that it is difficult to discern any trends from it. More useful are data on how much businesses are producing and spending, which are clearly pointing towards a slowdown. The official Purchasing Managers’ Index, released last week, fell to its lowest level on record – if you exclude the crisis, when world demand collapsed. A rival index by HSBC and Markit suggests that output is actually shrinking. Domestic appetite to spend is drying up. To put it bluntly, China is fast becoming a drag on global demand rather than helping support the broader recovery.
It would be cause enough for concern if Beijing was merely engineering a benign domestic slowdown. But unfortunately there is a far nastier threat: a potential housing market crash of dimensions far in excess of the ones either Britain or the US have just endured. Now, there is nothing particularly new about the idea that Chinese property is overheating, but until recently sceptical economists and investors have had to rely on anecdotes and euphemistic official data. The anecdotes are worrying enough. One I heard recently concerned the biggest town you’ve never heard of – Hangzhou, a secondary city a few hours drive from Shanghai – where one developer recently visited by British investors boasted of selling 160 $1.4m homes in two hours. Not bad for a town where the average wage is $5,000.
China-watcher and economist Andy Xie talks of vast stretches of newly-built property left unoccupied as rich investors increasingly treat bricks and mortar as a pure asset class, citing a recent story that power companies had detected a staggering 64.5m urban electricity meters registering zero consumption over a recent six-month period. The sheer desperation to invest in property (residential or business) is matched only by the will to build it. The country’s own official statistics show there are 2.6bn square metres of commercial property under construction – about 130 times central London’s entire commercial property floorspace.
House prices have more or less tripled nationwide in four years. And while on its own this fact doesn’t clinch the argument that the country is facing a property bubble (given its breakneck economic growth rates anything is possible) the picture is more worrying when you look at actual affordability.
For these disparate datapoints have now been bolstered by stark statistical evidence of overpricing, prepared by Jing Wu, Yongheng Deng and Joseph Gyourko of the Universities of Tsinghua, Singapore and Pennsylvania respectively. Remember that the best way to determine whether property is overpriced is to compare it to either the cost of renting a similar property or to a buyer’s income. You may recall that when the US market was at its most overheated, sometime in 2007, the average property in Los Angeles was changing hands for just over 10 times median income.
In Britain, this multiple peaked at around six times income for first-time buyers in London. The economists calculate that the average house price-to-income multiple in Beijing is now around 18 times. In Hangzhou (home to those $112m-an-hour apartments), the multiple is well over 20 times. The picture is no less disturbing if you concentrate on rents: in Beijing, the average price-to-rent ratio is over 40 times – which compares with a ratio of about 27 times at the very worst point of the US housing bubble.
Ultimately, house prices have to be within reach of buyers or else the market will soon collapse, and that is what will surely happen in China – perhaps within months, perhaps within years. The authorities clearly realise this. The China Banking Regulatory Commission is planning stress tests on local banks which envisage a 60pc fall in house prices. According to economists at Standard Chartered, such an eventuality would push many buyers into negative equity and send shockwaves through the nascent banking industry. However, like most outfits, the bank seems convinced that Beijing will be able to engineer a broadly benign slowdown. Which sounds spookily similar to what economists muttered before the US and UK crashes.
But don’t think for a moment that this slump changes the bigger picture. China’s relentless rise to economic superpowerdom will continue. For one thing, unlike Western housing crises, this property bubble is built not on leverage but on cold hard cash, with the average mortgage representing a far smaller proportion of the house price than on either side of the Atlantic. Rich investors will have to take the loss of income on the chin, but the country’s capacity for economic growth remains undimmed.
However, in the short term, a housing slump will mean Chinese consumers will spend less, import less and work harder. In other words, America and Britain will find it even harder to export their way out of trouble. Barring the sudden discovery of trade routes with Jupiter, there is simply no easy way out.