Chart of the Year – China’s shadow banking collapse means deflation may be round the corner

Last year it was Bitcoin, in 2016 it was the near-doubling in US 10-year interest rates, and in 2015 was the oil price fall.  This year, once again, there is really only one candidate for ‘Chart of the Year’ – it has to be the collapse of China’s shadow banking bubble:

  • It averaged around $20bn/month in 2008, a minor addition to official lending
  • But then it took off as China’s leaders panicked after the 2008 Crisis
  • By 2010, it had shot up to average $80bn/month, and nearly doubled to $140bn in 2013
  • President Xi then took office and the bubble stopped expanding
  • But with Premier Li still running a Populist economic policy, it was at $80bn again in 2017

At that point, Xi took charge of economic policy, and slammed on the brakes. November’s data shows it averaging just $20bn again.

The impact on the global economy has already been immense, and will likely be even greater in 2019 due to cumulative effects.  As we noted in this month’s pH Report:

“Xi no longer wants China to be the manufacturing Capital of the world. Instead his China Dream is based on the country becoming a more service-led economy based on the mobile internet.  He clearly has his sights on the longer-term and therefore needs to take the pain of restructuring today.

“Financial deleveraging has been a key policy, with shadow bank lending seeing a $609bn reduction YTD November, and Total Social Financing down by $257bn. The size of these reductions has reverberated around Emerging Markets and more recently the West:

  • The housing sector has nose-dived, with China Daily reporting that more than 60% of transactions in Tier 1 and 2 cities saw price drops in the normally peak buying month of October, with Beijing prices for existing homes down 20% in 2018
  • It also reported last week under the heading ’Property firms face funding crunch’ that “housing developers are under great capital pressure at the moment”
  • China’s auto sales, the key to global market growth since 2009, fell 14% in November and are on course for their first annual fall since 1990
  •  The deleveraging not only reduced import demand for commodities, but also Chinese citizens’ ability to move money offshore into previous property hotspots
  • Real estate agents in prime London, New York and other areas have seen a collapse in offshore buying from Hong Kong and China, with one telling the South China Morning Post that “basically all Chinese investors have disappeared “

GLOBAL STOCK MARKETS ARE NOW FEELING THE PAIN

As I warned here in June (Financial markets party as global trade wars begin), the global stock market bubble is also now deflating – as the chart shows of the US S&P 500.  It has been powered by central bank’s stimulus policies, as they came to believe their role was no longer just to manage inflation.

Instead, they have followed the path set out by then Federal Reserve Chairman, Ben Bernanke, in November 2010, believing that:

“Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”

Now, however, we are coming close to the to the point when it becomes obvious that the Fed cannot possibly control the economic fortunes of 325m Americans. Common sense tells us that demographics, not monetary policy, drive demand. Unfortunately, vast amounts of time and money have been wasted by central banks in this  failed experiment.

The path back to fiscal sanity will be very hard, due to the debt that has been built up by the stimulus policies.  The impartial Congressional Budget Office expects US government debt to rise to $1tn.

Japan – the world’s 3rd largest economy – is the Case Study for the problems likely ahead:

  • Consumer spending is 55% of Japan’s GDP.  It falls by around a third at age 70+ versus peak spend at 55, as older people already own most of what they need, and are living on a pension
  • Its gross government debt is now 2.5x the size of its economy, and with its ageing population (median age will be 48 in 2020), there is no possibility that this debt can ever be repaid
  • As the Nikkei Asian Review reported in July, the Bank of Japan’s stimulus programme means it is now a Top 10 shareholder in 40% of Nikkei companies: it is currently spending ¥4.2tn/year ($37bn) buying more shares
  • Warning signs are already appearing, with the Nikkei 225 down 12% since its October peak. If global stock markets do now head into a bear market, the Bank’s losses will mount very quickly

CHINA MOVE INTO DEFLATION WILL MAKE DEBT IMPOSSIBLE TO REPAY

Since publishing ‘Boom, Gloom and the New Normal: how the Ageing Boomers are Changing Demand Patterns, Again“, in 2011 with John Richardson, I have argued that the stimulus policies cannot work, as they are effectively trying to print babies.  2019 seems likely to put this view to the test:

  • China’s removal of stimulus is being matched by other central banks, who have finally reached the limits of what is possible
  • As the chart shows, the end of stimulus has caused China’s Producer Price Inflation to collapse from 7.8% in February 2017
  • Analysts Haitong Securities forecast that it will “drop to zero in December and fall further into negative territory in 2019

China’s stimulus programme was the key driver for the global economy after 2008.  Its decision to withdraw stimulus – confirmed by the collapse now underway in housing and auto sales – is already putting pressure on global asset and financial markets:

  • China’s lending bubble helped destroy market’s role of price discovery based on supply/demand
  • Now the bubble has ended, price discovery – and hence deflation – may now be about to return
  • Yet combating deflation was supposed to be the prime purpose of Western central bank stimulus

This is why the collapse in China’s shadow lending is my Chart of the Year.

Chemical output signals trouble for global economy

A petrochemical plant on the outskirts of Shanghai. Chinese chemical industry production has been negative on a year-to-date basis since February

Falling output in China and slowing growth globally suggest difficult years ahead, as I describe in my latest post for the Financial Times, published on the BeyondBrics blog

Chemicals are the best leading indicator for the global economy. Data for both Chinese and global chemical production, shown in the first chart, are warning that we may now be headed into recession.

China’s stimulus programme has been the key driver for the world’s post-2008 recovery, as we discussed here in May (“China’s lending bubble is history”).

It accounted for about half of the global $33tn in stimulus programmes and its decline is currently having a dual impact, as it reduces both demand for EM commodities and the availability of global credit.

In turn, this reversal is impacting the global economy — already battling headwinds from trade tariffs and higher oil prices.

Initially the impact was most noticeable in emerging markets but the scale of the downturn is now starting to hit the wider economy:

  • China’s demand has been the growth engine for the global economy since 2008, and its scale has been such that this lost demand cannot be compensated elsewhere
  • China’s shadow banking bubble has been a major source of speculative lending, helping to finance property bubbles in China and many global cities
  • It also financed a domestic construction boom in China on a scale never seen before, creating excess demand for a wide range of commodities

But now the lending bubble is bursting. The second chart shows the extent of the downturn this year. Shadow banking is down 84%  ($557bn) in the year to September, according to official People’s Bank of China data. Total Social Financing is down 12% ($188bn), despite an increase in official bank lending to support strategic companies.

It seems highly likely that the property bubble has begun to burst, with China Daily reporting that new home loans in Shanghai were down 77% in the first half. In turn, auto sales fell in each month during the third quarter, as buyers can no longer count on windfall gains from property speculation to finance their purchases.

The absence of speculative Chinese buyers, anxious to move their cash offshore, is also having a significant impact on demand outside China in former property hotspots in New York, London and elsewhere.

The chemical industry has been flagging this decline with increasing urgency since February, when Chinese production went negative on a year-to-date basis. The initial decline was certainly linked to the government’s campaign to reduce pollution by shutting down many older and more polluting factories.

But there has been no recovery over the summer, with both August and September showing 3.1% declines according to American Chemistry Council data. Inevitably, Asian production has also now started to decline, due to its dependence on exports to China. In turn, like a stone thrown into a pond, the wider ripples are starting to reach western economies.

President Trump’s trade wars aren’t helping, of course, as they have already begun to increase prices for US consumers. Ford, for example, has reported that its costs have increased by $1bn as a result of steel and aluminium tariffs. Trump’s withdrawal from the Iran nuclear deal has also caused oil prices as a percentage of GDP to rise to levels typically associated with recession in the past.

The rationale is simply that consumers only have so much cash to spend, and money they spend on rising gasoline and heating costs can’t be spent on the discretionary items that drive GDP growth.

It seems unlikely, however, that Trump’s trade war with China will lead to his expected “quick win”. China has faced far more severe hardships in recent decades, and there are few signs that it is preparing to change core policies. The trade war will inevitably have at least a short-term negative economic impact but, paradoxically, it also supports the government’s strategy to escape the “middle income trap” by ending China’s role as the “low-skilled factory of the world”, and moving up the ladder to more value-added operations and services.

The trade war therefore offers an opportunity to accelerate the Belt and Road Initiative (BRI), initially by moving unsophisticated and often polluting factories offshore. It also emphasises the priority given to the services sector:

  • Already companies, both private and state-owned, are focusing their international acquisitions in BRI countries. According to EY, 12 per cent of overall Chinese (non-financial) outbound investment was in BRI countries in 2017, versus 9 per cent in 2016, and 2018 is likely to be considerably higher. Apart from south-east Asia, we expect eastern and central Europe to be beneficiaries, given the new BRI infrastructure links, as the map highlights
  • Data from the Caixin/Markit services purchasing managers’ index for September suggests the sector remains in growth mode. And government statistics suggest the services sector was slightly over half of the economy in the first half, with its official growth reported at 7.6 per cent versus overall GDP growth of 6.8 per cent

We expect China to come through the pain caused by the unwinding of the stimulus bubbles, and ultimately be strengthened by the need to refocus on sustainable rather than speculative growth. But it will not be an easy few years for China and the global economy.

The rising tide of stimulus has led many investors and chief executives to look like geniuses. Now the downturn will probably lead to the appearance of winners and losers, with the latter likely to be in the majority.

Paul Hodges and Daniël de Blocq van Scheltinga publish The pH Report.

Budgeting for the end of “Business as Usual”

Companies and investors are starting to finalise their plans for the coming year.  Many are assuming that the global economy will grow by 3% – 3.5%, and are setting targets on the basis of “business as usual”.  This has been a reasonable assumption for the past 25 years, as the chart confirms for the US economy:

  • US GDP has been recorded since 1929, and the pink shading shows periods of recession
  • Until the early 1980’s, recessions used to occur about once every 4 – 5 years
  • But then the BabyBoomer-led economic SuperCycle began in 1983, as the average Western Boomer moved into the Wealth Creator 25 – 54 age group that drives economic growth
  • Between 1983 – 2000, there was one, very short, recession of 8 months.  And that was only due to the first Gulf War, when Iraq invaded Kuwait.

Since then, the central banks have taken over from the Boomers as the engine of growth.  They cut interest rates after the 2001 recession, deliberately pumping up the housing and auto markets to stimulate growth.  And since the 2008 financial crisis, they have focused on supporting stock markets, believing this will return the economy to stable growth:

  • The above chart of the S&P 500 highlights the extraordinary nature of its post-2008 rally
  • Every time it has looked like falling, the Federal Reserve has rushed to its support
  • First there was co-ordinated G20 support in the form of low interest rates and easy credit
  • This initial Quantitative Easing (QE) was followed by QE2 and Operation Twist
  • Then there was QE3, otherwise known as QE Infinity, followed by President Trump’s tax cuts

In total, the Fed has added $3.8tn to its balance sheet since 2009, whilst China, the European Central Bank and the Bank of Japan added nearly $30tn of their own stimulus.  Effectively, they ensured that credit was freely available to anyone with a pulse, and that the cost of borrowing was very close to zero.  As a result, debt has soared and credit quality collapsed.  One statistic tells the story:

“83% of U.S. companies going public in the first nine months of this year lost money in the 12 months leading up to the IPO, according to data compiled by University of Florida finance professor Jay Ritter. Ritter, whose data goes back to 1980, said this is the highest proportion on record.  The previous highest rate of money-losing companies going public had been 81% in 2000, at the height of the dot-com bubble.

And more than 10% of all US/EU companies are “zombies” according to the Bank of International Settlements (the central banks’ bank), as they:

“Rely on rolling over loans as their interest bill exceeds their EBIT (Earnings before Interest and Taxes). They are most likely to fail as liquidity starts to dry up”.

2019 – 2021 BUDGETS NEED TO FOCUS ON KEY RISKS TO THE BUSINESS
For the past 25 years, the Budget process has tended to assume that the external environment will be stable.  2008 was a shock at the time, of course, but time has blunted memories of the near-collapse that occurred.  The issue, however, as I noted here in September 2008 is that:

“A long period of stability, such as that experienced over the past decade, eventually leads to major instability.

“This is because investors forget that higher reward equals higher risk. Instead, they believe that a new paradigm has developed, where high leverage and ‘balance sheet efficiency’ should be the norm. They therefore take on high levels of debt, in order to finance ever more speculative investments.

This is the great Hyman Minsky’s explanation for financial crises and panics. Essentially, it describes how confidence eventually leads to complacency in the face of mounting risks.  And it is clear that today, most of the lessons from 2008 have been forgotten.  Sadly, it therefore seems only a matter of “when”, not “if”, a new financial crisis will occur.

So prudent companies will prepare for it now, whilst there is still time.  You will not be able to avoid all the risks, but at least you won’t suddenly wake up one morning to find panic all around you.

The chart gives my version of the key risks – you may well have your own list:

  • Global auto and housing markets already seem to be in decline; world trade rose just 0.2% in August
  • Global liquidity is clearly declining, and Western political debate is ever-more polarised
  • Uncertainty means that the US$ is rising, and geopolitical risks are becoming more obvious
  • Stock markets have seen sudden and “unexpected” falls, causing investors to worry about “return of capital”
  • The risks of a major recession are therefore rising, along with the potential for a rise in bankruptcies

Of course, wise and far-sighted leaders may decide to implement policies that will mitigate these risks, and steer the global economy into calmer waters.  Then again, maybe our leaders will decide they are “fake news” and ignore them.

Either way, prudent companies and investors may want to face up to these potential risks ahead of time.  That is why I have titled this year’s Outlook, ‘Budgeting for the end of “Business as Usual“.  As always, please contact me at phodges@thephreport.com if you would like to discuss these issues in more depth.

Please click here to download a copy of all my Budget Outlooks 2007 – 2018.

London house prices slip as supply/demand balances change

London house prices are “falling at the fastest rate in almost a decade” according to major property lender, Nationwide.  And almost 40% of new-build sales were to bulk buyers at discounts of up to 30%, according of researchers, Molior.  As the CEO of builders Crest Nicholson told the Financial Times:

 “We did this sale because we knew we would otherwise have unsold built stock.”

They probably made a wise decision to take their profit and sell now.  There are currently 68,000 units under construction in London, and nearly half of them are unsold.  Slower moving builders will likely find themselves having to take losses in order to find a buyer.

London is a series of villages and the issues are different across the city:

Nine Elms, SW London.  This $15bn (US$20bn) transformation has been ‘an accident waiting to happen‘ for some time.  It plans to build 20000 new homes in 39 developments at prices of up to £2200/sq ft.  Yet 2/3rds of London buyers can only afford homes costing up to $450/sq ft – thus 43% of apartments for sale have already cut their price.

West End, Central London.  This is the top end of the market, and was one of the first areas to see a decline.  As buying agent Henry Pryor notes:

“Very few people want to buy or sell property in the few months leading up to our monumental political divorce from Europe next March, which is why 50% of homes on the market in Belgravia and Mayfair have been on the market for over a year. Yet there are people who have to sell, whether it be because of divorce, debt or death, so if you have money to spend I can’t remember a time since the credit crunch in 2007 when you could get a better deal.”

NW London.  Foreign buyers flooded into this area as financial services boomed.  Rising bonuses meant many didn’t need a mortgage and could afford to pay £1m – £2.5m in cash.  But now, many banks are activating contingency plans to move some of their highly paid staff out of London ahead of Brexit.  Thus Pryor reports buying a property recently for £1.7m, which had been on the market for £2.25m just 2 years ago.

W London.  Also popular with foreign buyers, even areas such as Kew (with its world-famous Royal Botanic Gardens) have seen a dramatic sales volume decline.  In Kew itself, volume is down 40% over the past 2 years.  And, of course, volume always leads prices – up or down.  Over half of the homes now on sale have cut prices by at least 5% – 10%, and the pace of decline seems to be rising.  One home has cut its offer price by 17.5% since March.

Outer London.  This is the one area bucking the trend, due to the support provided by the government’s ‘Help to Buy’ programme.  This provides state-backed loans for up to £600k with a deposit of just 5%.  As Molior comment, this is “the only game in town” for individual purchasers, given that prices in central London are out of reach for new buyers.

The key issue is highlighted in the charts above – affordability:

  • The first chart shows how prices were very cyclical till 2000, due to interest rate changes.  They doubled between 1983 – 1989, for example, and then almost halved by 1993.  In turn, the ratio of prices to average earnings fluctuated between 4x – 6x
  • But interest rates have been relatively low over the past 20 years, and new factors instead drove home prices
  • The second chart shows the impact in terms of first-time buyer affordability and mortgage payments.  Payments were 40% of take-home pay until 1998, but then rose steadily to above 100% during the Subprime Bubble.  After a brief downturn, the Quantitative Easing (QE) bubble then took them back over 100% in 2016

The paradigm shift was driven by policy changes after the 2000 dot-com crash.  As in the USA, the Bank of England decided to support house prices via lower interest rates to avoid a downturn, and then doubled down on the policy after the financial crash – despite the Governor’s warning in 2007 that:

“We knew that we had pushed consumption up to levels that could not possibly be sustained in the medium and longer term. But for the time being if we had not done that the UK economy would have gone into recession… That pushed up house prices and increased household debt. That problem has been a legacy to my successors; they have to sort it out.”

  • The 2000 stock market collapse and subprime’s low interest rates led many to see property as safer than shares.  They created the buy-to-let trend and decided property would instead become their pension pot for the future
  • The 2008 financial crisis, and upheavals in the Middle East, Russia, and parts of the Eurozone led many foreign buyers to join the buying trend, seeing London property as a “safe place” in a more uncertain investment world
  • Asian buyers also flooded in to buy new property “off-plan”.  As I noted in 2015, agents were describing the Nine Elms development as: ” ‘Singapore-on-Thames’. Buying off-plan was the ultimate option play for a lot of the buyers [who are] Asian. You only need to put down 10% and then see how the market goes. A lot of buyers are effectively taking a financial position rather than buying a property”

But now all these factors are unraveling, leaving prices to be set by local supply/demand factors again.  Recent governments have taken away the tax incentives behind buy-to-let, and have raised taxes for foreign buyers.  As the top chart shows, this leave prices looking very exposed:

  • They averaged 4.8x earnings from 1971 – 2000, but have since averaged 8.7x and are currently 11.8x
  • Based on average London earnings of £39.5k, a return to the 4.8x ratio would leave prices at £190k
  • That compares with actual average prices of £468k today

And, of course, there is the issue of exchange rates.  Older house-owners will remember that the Bank of England would regularly have to raise interest rates to protect the value of the pound.  In 1992, they rose to 15% at the height of the ERM crisis.  But policy since then has been entirely in the other direction.

Nobody knows whether what will happen next to the value of the pound.  But if interest rates do become more volatile again, as in 1971-2000, cyclicality might also return to the London housing market.

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China’s lending bubble is history

As China’s shadow banking is reined in, the impact on the global economy is already clear, as I describe in my latest post for the Financial Times, published on the BeyondBrics blog

China’s shadow banking sector has been a major source of speculative lending to the global economy. But 2018 has seen it entering its end-game, as our first chart shows, collapsing by 64% in renminbi terms in January to April from the same period last year (by $274bn in dollar terms).

The start of the year is usually a peak period for lending, with banks getting new quotas for the year.

The downturn was also noteworthy as it marked the end of China’s lending bubble, which began in 2009 after the financial crisis. Before then, China’s total social financing (TSF), which includes official and shadow lending, had averaged 2 times gross domestic product in the period from 2002 to 2008. But between 2009 and 2013, it jumped to 3.2 times GDP as China’s stimulus programme took off.

It is no accident, for example, that China’s Tier 1 cities boast some of the highest house price-to-earnings ratios in the world or, indeed, that Chinese buyers have dominated key areas of the global property market in recent years.

The picture began to change with the start of President Xi Jinping’s first term in 2013, as our second chart confirms. Shadow banking’s share of TSF has since fallen from nearly 50% to just 15% by April, almost back to the 8% level of 2002. TSF had already slowed to 2.4 times GDP in 2014 to 2017.

The start of Mr Xi’s second term has seen him in effect take charge of the economy through the mechanism of his central leading groups. He has also been able to place his supporters in key positions to help ensure alignment as the policy changes are rolled out.

This year’s lending data are therefore likely to set a precedent for the future, rather than being a one-off blip. Although some of the shadow lending was reabsorbed in the official sector, TSF actually fell 14% ($110bn) in the first four months of the year. Already the economy is noticing the impact. Auto sales, for example, which at the height of the stimulus programme grew more than 50% in 2009 and by a third in 2010, have seen just 3% growth so far this year.

The downturn also confirms the importance of Mr Xi’s decision to make “financial deleveraging” the first of his promised “three tough battles” to secure China’s goal of becoming a “moderately prosperous society” by 2020, as we discussed in February.

It maps on to the IMF’s warning in its latest Global Stability Financial Report that:

In China, regulators have taken a number of steps to reduce risks in the financial system. Despite these efforts, however, vulnerabilities remain elevated. The use of leverage and liquidity transformation in risky investment products remains widespread, with risks residing in opaque corners of the financial system.”

The problems relate to the close linkage between China’s Rmb250tn ($40tn) banking sector and the shadow banks, through its exposure to the Rmb75tn off-balance-sheet investment vehicles. The recent decision to create a new Banking and Insurance Regulatory Commission is another sign of the changes under way, as this will eliminate the previous opportunity for arbitrage created by the existence of separate standards in the banking and insurance industries for the same activity, such as leasing.

As the IMF’s chart below highlights, lightly regulated vehicles have played a critical role in China’s credit boom. Banks, for example, have been able to use the shadow sector to repackage high-risk credit investments as low-risk retail savings products, which are then made available in turn to consumers at the touch of their smartphone button. This development has heightened liquidity risks among the small and medium-sized banks, whose reliance on short-term non-deposit funding remains high. The IMF notes, for example, that “more than 80% of outstanding wealth management products are billed as low risk”.

Mr Xi clearly knows he faces a tough battle to rein-in leverage, given the creativity that has been shown by the banks in ramping up their lending over the past decade. The stimulus programme has also created its own supporters in the construction and related industries, as large amounts of cash have been washing around China’s property markets, and finding its way into overseas markets.

But Mr Xi is now China’s most powerful leader since Mao, and it would seem unwise to bet against him succeeding with his deleveraging objective, even if it does create short-term pain for the economy as shadow banking is brought back under control.

As Gabriel Wildau has reported, the official sector is already under pressure from Beijing to boost its capital base. Analysts are suggesting that $170bn of new capital may be required by the mid-sized banks, whilst Moody’s estimates the four megabanks may require more than double this amount by 2025 in terms of “special debt” to meet new Financial Stability Board rules.

Essentially, therefore, China’s lending bubble is now history and the tide of capital flows is reversing. It is therefore no surprise that global interest rates are now on the rise, with the US 10-year rate breaking through 3%. Investors and companies might be well advised to prepare for some big shocks ahead. As Warren Buffett once wisely remarked, it is “only when the tide goes out, do you discover who’s been swimming naked”.

Paul Hodges and Daniël de Blocq van Scheltinga publish The pH Report.

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China’s lending bubble sees Beijing home prices jump 63%

China lend v auto Apr17Greed and fear are the primary emotions driving China’s housing and auto markets today, as China’s lending bubble hits new heights.  For ordinary citizens, greed is the key driver:

   Average home prices in Beijing rose an eye-popping 63% between October 2015 – February 2017
   In Shanghai, one enterprising estate agent (realtor) has married 4 of his clients to enable them to buy a home

Mr Wang’s story highlights the bubble mentality that has taken over the market.  As the Daily Telegraph reports, 30-year old Mr Wang:

Married, and then quickly divorced 4 women to allow them to circumvent strict property laws which seek to cool prices in China’s booming cities, and pocketed more than £8000 ($10k) from each transaction. Once the paperwork is put through, Wang applies for a divorce and puts himself on the market again”.

This is just the latest phase of a market craze, as I noted in November, when one Shenzhen resident told the South China Morning Post:

“The only thing I know is that buying property will not turn out to be a loss. From several thousand yuan a square metre to more than 100,000 yuan. Did it ever fall? Nope.”  He and his wife got divorced in February, in order to buy a 4th apartment in Shanghai for 3.6m yuan (US$530k) on the basis that “ If we don’t buy this apartment, we’ll miss the chance to get rich.”

A collective delusion has swept China’s Tier 1 cities, just as happened in the USA during the sub-prime bubble. Amazingly, China’s property bubble is even larger than sub-prime. Unremarkable pieces of land in Shanghai are now being sold at $2000/sq foot ($21500/sq metre), nearly 3 times the average land price in Manhattan, New York.

It is understandable in some ways, as Chinese buyers have never known a downturn, as I noted in September:

“It is also easy to forget that housing was all state-owned until 1998, and still is in most rural areas.  Urban housing was built and allocated by the state – and there wasn’t even a word for “mortgage” in the Chinese language.  Not only have home-buyers never lived through a major house price collapse, they have also had few other places to invest their money”.

The scale is also much larger, as UBS have reported:

“Chinese banks’ outstanding loans extended to the property industry were between Rmb 54tn – Rmb 72 tn in 2016 ($7.8tn – $10.4tn).”

The chart above confirms this analysis.  In reality, the key driver for the bubble has been the growth in lending.  As with the US subprime bubble, this has not only impacted housing markets, but also auto sales:

   Q1 lending (Total Social Financing) averaged Rmb 2.4tn/month, 2.2x the Rmb 700bn/month level in Q1 2008
   Q1 auto sales averaged 1.9 million, 2.06x the 733k/month average in Q1 2008

China’s GDP was only $11.2tn last year, meaning that its property sector loans are more than 2/3rds of GDP.

China incomes Apr17The problem is that everyone loves a bubble while it lasts.  And so, as in the US during subprime, most analysts are keen to argue that “everything is fine, nothing to worry about here”.

   In the US, we were told at the peak of the bubble in 2005 by then Federal Reserve Chairman, Alan Greenspan, that house prices would never fall on a national basis
  Today, similar wishful thinking dominates, based on the myth that China has suddenly developed a vast middle class, with Western levels of incomes

The problem, of course, as the second chart shows, is that this is also not true.  Annual disposable income for city-dwellers averaged just $5061 last year, whilst in rural areas it averaged only $1861.  You really don’t buy many homes or cars with that level of income, unless a massive lending bubble is underway.

And this is why fear is the right emotion for everyone outside China.  Its lending bubble has driven the “recovery” in global growth since 2009 – pushing up values of everything from homes to oil prices.  So anyone who remembers the end of the US subprime bubble should be very scared about what could happen when – not if – China’s bubble bursts.

We can all hope that President Xi’s new policies will enable a “soft landing” to occur, and gently unwind the stimulus policies put in place by Populist Premier Li and his predecessor Premier Wen?  But hope is not a strategy.  And as the Guardian reported last month:

“Goldman Sachs is said to estimate the chance of a financial crisis in China this year at 25%, and in 2018 at 50%.