Quantum Pranx


Chinese Real Estate and the Civil Unrest Powder Keg

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by Justice Litle
Editor, Taipan Publishing Group 
Posted 20 July 2011

In China, a massive real estate bubble has left 64 million apartments vacant – and millions of laborers angry.

Things are getting heated in western China. Via The Wall Street Journal:

BEIJING — Chinese police “gunned down” several rioters after four people were killed in an attack on a police station in the northwestern region of Xinjiang, the state media reported, in what appeared to one of the most violent incidents in the mostly Muslim area since it was shaken by ethnic rioting in 2009.

Two security personnel and two hostages were killed, and one other security officer was injured in the attack, which began around midday Monday in Hotan, a small, remote oasis city on the edge of the Taklamakan desert, the state-run Xinhua news agency said. The agency gave no details of how many attackers were killed or injured.

It is hard to know the frequency or intensity of “civil unrest” incidents, due to media suppression and spotty regional coverage. But it is clear the necessary conditions for sparking unrest – a civil unrest brushfire if you will – are in place.

One dynamic that could touch off the inferno – empty Chinese apartments.

By some estimates, China has as many as 64 million apartments that remain unlived in. This is a function of the “ghost cities” phenomenon (more on that in a minute), in which vast metropoli are constructed with no rhyme or reason.

Why would this be a factor for unrest? Because even as these apartments go empty, gathering dust waiting for renters who never come, poor Chinese laborers are living in epically crowded conditions. For all of China’s phantom real estate, there are multiple families sharing tiny domiciles, with as many as 11 in a two-bedroom apartment.

It doesn’t make sense. With so many residences barren and empty, why is the Chinese labor class packed in like human sardines?

Because the shiny new apartments are far too expensive for the average Chinese worker to afford – orders of magnitude more than the average salary, with very strict payment terms (50% up front, 36 months for the rest).

The Chinese real estate market is booming, nonetheless, because property developers keep finding ways to finance construction – and wealthy Chinese investors keep buying. Empty buildings will often see units snapped up by out-of-town buyers, only to have “for rent” signs go up in the windows a short time later.

The vast majority of apartments remain empty. Sold by Ponzi real estate developers… bought by Ponzi investors… a self-sustaining cycle in which prices go up because the buyers are making them go up. It’s the “greater fool theory” in full effect.

Here’s a thought: Why don’t Chinese officials just order large price markdowns on these expensive, empty albatrosses, so that the crowded laboring class can move into them and have nice places to live?

There is just one big problem with that notion: A wholesale markdown on Chinese real estate, to levels anywhere near what real buyers can afford, would potentially bankrupt China’s property developers… thoroughly outrage the well-connected property investor class… and lead to a full-blown banking crisis as hundreds of billions in loans went bad.

Some say that China can’t suffer from a property bust. They’ve got too much money, $2 trillion in reserves and so on. But turning around a busted Ponzi scheme is not so easy as that. With leverage on top of leverage, no one even knows how big the problem is.

Regional governments alone could be on the hook for half a trillion in bum debts if the real estate market goes south. Meanwhile many Chinese State-Owned Enterprises, or SOEs, have gotten into real estate — even businesses that hypothetically should have nothing at all to do with real estate. (China’s largest metals trading company, for example, is financing the construction of an Austrian village replica — a sort of alpine Disneyland for rich Chinese.)

China has really gone about things badly with the real estate bubble. In an effort to maintain full employment and keep up the illusion of growth at all costs, China has (1) inflated a massive infrastructure and property bubble that could dwarf America’s housing bubble, and (2) just about guaranteed massive civil unrest as a result.

On the one hand you have the bulk of the economy — investors, developers, banks, SOEs — caught up in unsustainable speculation. On the other hand, you have China’s disenfranchised labor classes forced to endure subhuman standards as new buildings get thrown up all around them. The disconnect is price and leverage. Both will contract dramatically in a crash.

Why did the dragon do this? Plain old temptation, perhaps. The Greenspan/Bernanke playbook — pumping the system full of easy money, then ignoring the consequences until far too late — was just too appealing to pass up, especially given the “growth at all costs” mindset.

Journeyman Productions produced an excellent “Ghost Cities” video earlier this year. You can watch it via YouTube here. (Don’t forget, you can sign up for Taipan Daily to receive all of my and fellow editor Joseph McBrennan’s investment commentary.)

Gillem Tulloch, a Hong Kong-based analyst, notes the following:

It’s essentially the modern equivalent of building pyramids. It doesn’t really add to the betterment of people’s lives. All it does is promote GDP growth. It’s basically happening because China is a command economy, and the Chinese government can basically dictate where resources are spent… if the central government sets a GDP target, they have to meet that target, and the easiest way to do it is just to build…

People forget that it’s not the quantity of GDP that matters, it’s the quality of GDP, and essentially they are just building stuff for which there’s no demand. Ultimately that means they are creating a large problem in the future… It can’t stay this way because we are in the upswing of a bubble. And when the bubble bursts, it will simply impoverish vast numbers of people.

To add insult to injury, members of the Chinese labor class are being pushed out of their shared dwellings as old buildings are torn down… to make room for more shiny new properties that the laborers can’t afford.

As a prominent Chinese sociologist tells the Journeyman TV interviewer: “…It is clear that polarization will cause conflicts in society. Poor people may come out and start a revolution.”

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