The Macroeconomics of Chinese kleptocracy
brontecapital.blogspot.co.uk
brontecapital.blogspot.co.uk
* The ghost city of Ordos. Built on spec for one million residents, this city sits empty in the middle of nowhere. A lot of money went into building all its plazas, museums, parks, office buildings, and residences, but no one needs or uses any of it.[1]
* The New South China Mall, in Guangdong Province. With nearly 10 million square feet of retail space, it's by far the world's largest mall. Opened in 2005, almost no one ever visits it, and only around 1% of the retail space has been leased -- it just sits empty. A lot of money went into building it, but no one needs or uses it.[2]
* A well-known hedge fund manager recently reported that China is building "2.8 billion square metres of Class A office space over the following couple of years... That’s basically a five-foot by five-foot office cubicle for every man, woman and child in China.” A lot of money is going into building a new cubicle for everyone, but what's the economic rationale?[3]
[1] Here's a recent BBC article on it: http://www.bbc.co.uk/news/magazine-17390729 and a great photo essay in Time: http://www.time.com/time/photogallery/0,29307,1975397,00.htm...
[2] Here's a recent video of the mall on a Saturday: http://www.youtube.com/watch?v=Eel1r1nm1lU and here's an article about it: http://www.dailymail.co.uk/news/article-1223747/Ghost-mall-T...
[3] For example, see http://www.theglobeandmail.com/report-on-business/rob-magazi...
- China's construction industry is a force unto itself - important economically and a huge employer. Its hard to say 'stop'.
- As it said in the OP - property seems the simplest way to invest money. After all, can prices go down when they are already so low compared to the west?
- In the west we built in the 1960s at (what seemed then) a ridiculous pace, with new building typologies that were often terribly designed. Like us, they will be living with (or in) the consequences for the next 50 years.
- Various levels of govt are already trying to put the brakes on the worse kinds of speculative development, with some success. Aside from the already clear examples of 'bad investment' (like the ones you point out) - the brakes are already coming from other directions too.
Unlike Chinese workers, a Chinese apartment is never going to compete against a western apartment
Did you know Ordos has higher GDP per captica than HongKong?
The same logic applies to the entire country's GDP, BTW: take out spending on construction, and China's GDP growth looks a lot less impressive.
http://en.wikipedia.org/wiki/Ordos_City#Economy
I think it's comparable to Dubai.
http://en.wikipedia.org/wiki/Kangbashi_New_Area
Ordos City itself apparently has close to 2 million people, but there's a fully developed urban housing district designed for 300,000 which has only reached 10% occupancy since 2010.
> There are a lot of things I don't understand about
> China's economy
http://asiavalueinvesting.blogspot.com/2011/09/chinese-banks...
Often, the economic rationale is simply the desire to create jobs (on the part of the government to stave on social unrest) and the desire to create profit (on the part of private enterprises that couldn't figure out how to be more innovative and so jumped on the bandwagon of the construction boom without seeing the risks).
As another comment notes, the government has realized this is a bad situation, and they're trying to put the breaks on it, but it's hard to do that and also enable a soft landing so that there's little or no social unrest. They're trying to shift from an infrastructure investment-driven economy to a consumption economy and an innovation economy, and the big debate is whether or not they have the right horses to be able to compete in that race.
Basically, if you look at an asset breakdown of personal wealth, real estate will account for 65% of all investments in China, while in other countries like the US or in the EU, that number is close to 20% (source: World Bank & Citibank's Investment Research and Analysis). Other than that, because of a reform on the tax sharing mechanism (in 1994), local governments are highly dependent on the real estate market, as 40-55% of their direct income comes from land sales and property-related taxes. That gives the government a very high incentive to keep property prices up and the real estate market booming.
I can email the report to anyone interested in it (sorry, can't just upload to the public here, I worked at Citibank once, could get me into trouble), just send an email to me (rafaelcamera@gmail.com) and remember to put HN on the subject.
Note, the central government doesn't want high prices, but the Chinese government is not entirely monolithic. "Heaven is high, and the Emperor is far away", is a common Chinese saying - people bend the rules when they can get away with it.
But yes, local governments get a lot of their revenue from land scales. If they are anything like Western local governments, they also get most of their bribes from developments (there are opportunities for zoning bribes, development approval bribes, building inspection bribes, waste disposal bribes, infrastructure connection bribes, and so on, depending on how corrupt they are).
Do you think that is valid comparison? (NB In many ways I hope it isn't as a crash like Ireland's on the scale of China would presumably be disastrous).
You can also see that with their investments in Australian real estate (where I now live). A lot of the apartments now being built are investment properties for Chinese buyers. In a lot of cases, the building is nearly sold out even before construction begins!
That sounds quite ominous - reminiscent of the property bubble here in the UK prior to 2008 (which was completely insane, but very tame compared to Ireland).
How is the rental market holding up there?
Luckily I don't work in the Sydney CBD, so my commute is pretty easy. :)
An oddly familiar pattern, and one that should give us pause.
Sydney in particular has a very tight housing market due to lots of people moving in but not nearly enough apartments and houses being built. This has kept prices up, but there will have to be a drop at some point. The only question is when, not if, and how much.
For example, a large force behind the housing bubble is the drive to increase local GDP, which is a vital promotion metric for local officials; another force is local bank executives' desire to pretty-up their promotion metric by pushing for more "safe" yet profitable loans. Construction companies are mostly just there to ride the train.
Also top party men are rotated from region to region regularly, so they only care about the local economy for as long as they are in tenure, typically 5 years. Whatever happens after that isn't their problem.
The guys who built those empty cities and super-malls moved onwards and upwards. You can always blame the guy who took over after you for dropping the ball, or the guy you took over from for passing you a dud.
People forget that China is a command economy. The government tells you where to live and what to do. If you want to live somewhere else or do something else you need to apply for permission from the government.
Cities like Ordos shouldn't make anyone blink. Once the government knows what it wants to do it will be filled overnight.
People in China are not told where to live, or what job to do. The government makes use of various macro-economic tools to steer the economy much more forcefully than in Europe perhaps, and perversely, the market forces (w/ Chinese characteristics!) are also fairly brutal and fast-changing, but people mostly choose their own professions and locations and in many respects, society behaves pretty similarly to the US/Europe.
Not directly, no, but the hukou system still exists, and the choice of living location is in some circumstances still heavily restricted.
I am in China right now. I lived in a ghost city just last year.
In a similar vein, I remember how weird it sounded to me when an american friend told me in texas there are such big malls that people go there for working out (running) indoors.
Every tidbit you state is fully explained in the article's explanation of the lack of investment vehicles for middle and low income Chinese. When your bank account has a negative real interest rate, then real estate becomes a great vehicle for it, provided there is no crash. I suspect that the lack of non-government media in China causes many of the investors in these properties to have no idea that they sit dormant.
They've also built one of the longest bridge that only save like 20 minute of traffic...
http://www.autoblog.com/2011/07/01/china-opens-26-mile-long-...
But even so the alarmism doesn't make any sense. If we multiply the amount of state-acknowledged NPLs at the largest five Chinese banks (~300 billion RMB) by an order of magnitude and we still only have 500 billion USD in bad assets. Sure this is a lot of money, but the Chinese government has previously dealt with the NPL issue by dumping cash into the banking sector and will doubtless continue to do so if necessary to maintain the status quo. 500 billion dollars still pales in comparison to China's more than 3 trillion in foreign currency reserves, so who cares? In reality, this system is actually sort of preferable since no-one can effectively loot state currency reserves yet, so bailing out the banks gets the money back into play.
To the extent there are stresses in the system, its that real estate development has been on the rocks since 2008 and prices are getting past the point where people can throw themselves into practical servitude in order to buy property. If you follow the Chinese media, right now it looks like the bubble will play out with local governments buying properties from cash-strapped developers at inflated prices (bonus question: guess who will issue the loans to finance this?) in order to turn them into social housing projects (bonus question two: guess who you need to be related to in order to get apportioned these assets?). Since it seems likely the poor are going to get screwed regardless, the real losers in the coming years are Chinese citizens locked into 30 or 40 year mortgages on underwhelming properties who will soon find themselves doubly-screwed as cash-strapped localities who can no longer charge real estate developers such inflated prices for real estate switch to issuing property taxes instead.
And the reason I said "smells bad" instead of "wrong" is that China is complex and some things that seem wrong on first pass might actually be right. As far as I know, for instance, the blogger is also wrong when he implies that the big four are holding significant amounts of Treasuries on their balance sheets. The reason I believe this is because the People's Bank of China sterilizes currency inflows and monopolizes currency exchange. So the banks which are the most exposed to non-performing SOE debt should not have the USD to invest in US Treasuries and it should mostly be the PBOC which handles Treasury purchases. Googling for terms like "ICBC" and "US Treasury Bonds" suggests this is in fact the case since it doesn't pull up any documents suggesting ICBC is buying Treasuries. But maybe the bank is awash in them and the blogger knows something other people don't? China is strange. It could happen.
What? Where? The only mention of "big four" in his text is about big audit firms being silent about evidence of fraud perpetrated by big Chinese companies.
[1] http://en.wikipedia.org/wiki/Banking_in_the_Peoples_Republic...
A mistake of this magnitude doesn't automatically discount the rest of the original post, but it does make me suspicious.
Where you get the boom/bust is when increased investment and loans creates a feedback loop with the money multiplier causing prices of assets to increase in value even as the supply of those goods increases. Production is encouraged to become wasteful and inefficient because inflation and production taking place over time takes care of the profit margin. When the credit runs out, interest drags the prices back to their non-inflated money supply value and you get debt deflation and doom and gloom covers on The Economist.
China fixes debt deflation by printing the money and handing it to the banks in exchange for their bad loans. In the west, the way things are set up, for better or for worse, we have to borrow it into existence and pay it back with interest, further burdening the tax payer and forcing government austerity. China can take care of the moral hazard that comes with printed money bank bailouts because the government has political control of the financial sector. The government routinely tells banks to stop lending to certain sectors and slaps very specific regulations on to what kind of people and on what terms bank can lend to borrowers. In the west, we like to let the "free market" run things which is why we got rid of Glass/Stegal, etc.
But a forced, regressive negative real savings rate? I cannot think of a moral justification for that.
Plain English: Theft-level interest rates are OK, as long as you have deflation.
China is not experiencing deflation, so it is not OK.
> China fixes debt deflation by printing the money and handing it to the banks in exchange for their bad loans.
To make sure that inflation occurs, yes, China prints money. This is a fine balancing act, as the article implies.
Print too little, deflation takes place and all the SOEs collapse. Panic + revolution. Print too much, you get a high inflation rate. Also panic + revolution.
Not only is this opinion not right, it's not even wrong. When you say "we", are you talking about the Fed? Banks? Consumer debt and credit? Since you're talking about "burdening the tax payer and forcing government austerity", I'll suppose you're taking about Treasury-backed Federal Reserve currency. Now, the Fed remands almost all of its profit back to the Treasury, so we're actually talking about the opposite--Federal Reserve printed currency is seignorage, it's very close free money to the government. The taxpayer pays almost nothing for as long as the debt-backed money exists.
A lot of this narrative seems to depend on popular, but bad, memes of armchair economics, so I'm just picking out the worst one.
The government is running a deficit, but the law (treaties in Europe) forbid it to fund itself by printing money. So it needs to reduce expenses and/or increase taxes, but in the meantime it has to borrow from the market (whether that happens through the central bank like in the US is irrelevant). Borrowed money is not free at all as you say, it comes with an interest that is paid to the private lender, not to the Fed. The interest adds to the deficit, increasing the drive for higher taxes (hence the burdening of the tax payer) and lower expenses (hence the austerity).
This mode of funding often amounts to a tax on the poor (through spending cuts in social programs for example) and to a lesser extent a tax on the rich (through tax hikes). A government funded directly through printed money is more of a tax on the rich, due to the loss of value of their savings and assets. It also makes it much easier to run an irresponsible budget.
The United States is a bit of a special case; the dollar is the world's reserve currency. For starters, as a large business you have a big need to stash your money into some kind of ultra-safe vehicle with lots of liquidity. Lots of companies sink their payroll into Treasuries because a) they know they can sell them when the time comes and b) they're basically guaranteed to never lose value.
Secondly, It's the currency of international trade; if I live in Brazil and want to sell my coffee to Russians, we will exchange dollars. As a result, there is a constant demand for lots of dollars.
Finally, US Treasuries are currently set at negative real interest rates. If I were to buy a Treasury today, after inflation, I am paying the US Government for the privilege of lending it money. See for yourself: http://www.treasury.gov/resource-center/data-chart-center/in... (As for today, a 5 yr bond is going for -1%).
This is to say, no one is getting paid an enormous amount of risk-free interest. You only invest in Treasuries if you have absolutely nowhere else to put your money. No one likes having their money in Treasuries, because while the nominal value is basically guarantee, you lose money by holding them.
Edit: as a final aside, some commentators have gone as far to say that the current crisis in Europe stems from German hatred of inflation; they could easily solve the problem by having the ECB guarantee EU sovereign bonds, but that would probably cause the inflation rate to rise above 2%.
Another big complication in the relationship between printing money and inflation is expectations. If the Fed gave everyone in the US $1000 but said that anyone who didn't return it in a month would go to jail, then inflation would go up very little because most people would save the money. Conversely, if people were absolutely convinced they were going to get $1000 in a month inflation would go up a bit right now as people made purchases in expectation of their future windfall.
This makes printing money as a way to finance the government very dangerous, though. If the government is printing money to finance its spending, people know the money is going to keep coming into the economy, so prices go up even in advance of the money arriving. But this inflation forces the government to print even more to match the increased prices, and you've got a positive feedback loop and then you get hyper-inflation. Which really sucks for the economy. So though you want a central bank that can print money to do macro-stabilisation, you don't want to have the people in charge of the budget able to print money to make ends meet.
[1] The governments numbers on inflation take months to calculate, inflation was already crashing at this point but the Fed Open Market Commission didn't know it.
Well… It depends, is what I hear.
If you use debt to finance economic stimulus (i.e. World War 2) then you're making a bet that the amount of money you spend now will be offset by the jumpstart in economic growth you're creating. A crazy amount of things affect the economy.
Boom/bust economics don't apply to China because there isn't a free capital market (legitimately anyway, there is a shadow underground financial system in some parts, not sure how big).
It's not really a market economy, it's selective application of market principles in a primarily top-down government-run economy.
Government directs SEOs to build apartments, high-speed rail etc., banks to lend for it, and bails everyone out if it doesn't make money. Result is massive resource misallocation. (Not that the West doesn't misallocate resources, build see-through buildings, Pets.com, etc.)
Another good read on China is here - http://www.ritholtz.com/blog/2012/05/a-different-way-of-look...
The article makes some very insightful points, but I'm not convinced that Chinese SOEs are more evil than any other centers of power (just one manifestion of growing inequality). One casualty overlooked here are Chinese SMEs: "The real problem is the limited presence of other financial intermediaries and the rudimentary nature of bond and equity markets, both of which poorly serve the needs of small private companies and local governments."[3],[4]
The author is right about deflation as the sandtrap up ahead, but that's just the consequence of a decelerating economy and we're still to see how soft/hard China lands. In doing a root cause analysis, one can chase down endless trails corruption. But if you want to find a problem which can be solved with a technological solution (as opposed to a social solution), it comes down to a distinct lack of progress in energy tech. Productivity gains in IT just haven't been enough to offset the rising cost of energy (as argued by Peter Thiel)[5]. Sure, the rising cost of energy is tempered a bit during deflationary cycles. But its a lose-lose, because so is economic growth (harmed both by too much inflation and deflation).
1. http://yro.slashdot.org/story/12/05/31/1953210/comptroller-a...
2. http://www.nytimes.com/2012/06/10/business/banks-could-retur...
3. http://www.bloomberg.com/news/2012-06-05/tall-tales-about-ch...
4. http://www.bloomberg.com/news/2011-11-06/china-credit-squeez...
Ref: http://www.cbc.ca/news/world/story/2009/10/28/f-rfa-germain....
The local gov'ts expropriate the land from peasants and sell is for housing development. In the absense of substantial tax income, this is the one important source of income for cities and towns. There is often no legal way for people to fight the expropriation, because executive and judicative powers are all in the local party's hand.
That said - I'm not really for predicting the future in narrative form like this because it is very one eyed. There's plenty of signs pointing in other directions as well.
First, a very large percentage (maybe 40-50%) of Chinese companies going public on Western and developed Asian exchanges have turned out to be complete frauds. There have of course been some very large companies that have been very successful and they are likely completely honest, but there are also many, many often smaller companies who's financial statements are pure fiction.
It turns out that the biggest beneficiaries of the frauds were politically connected families, yet none has been prosecuted. The Chinese had decided to open things up a little bit, essentially taking baby steps towards the Western model and require companies to file at least a minimal amount of information domestically and to make some this information theoretically publicly available. Furthermore when a company goes publicly in most markets outside China, it has to file a whole smorgasbord of financial information.
Most of these frauds were uncovered by a careful examination of financial statements companies going public were required to file. A number of the frauds were in fact discovered by this blogger himself (see his earlier posts). In many cases the financial statements were just ludicrously implausible. In other cases they were listing facilities which did not exist etc. Very few were in anything other than plain view.
Remember that this really hurts honest Chinese companies (and there are many high quality Chinese companies that do things by the book) because you are going to have to do far more due diligence on a Chinese company because you can't really rely on the financial statements. Even after you do due diligence you are going to demand a discount. While there is a mania for anything Chinese by naive retail investors everything seems fine if you are a small company with a limited float but for a huge company trying to raise a lot of capital, you have to raise money from well informed institutions.
While companies that only list domestically are harder to do due diligence on, it seems, based on work done by the blogger and others, that the percentage of frauds listing on the Shanghai exchange is at least as high as the percentage of frauds listing on foreign exchanges.
Imagine if 40-50% of US companies going public over a period of time were frauds and this was discovered through their public filings. Legislators and regulators would be lining up to require more disclosure. Instead the Chinese have now changed the law so Chinese companies have to file less information and the information they do file is practically a state secret. This is somewhat akin to companies trading on the NYSE filing absolutely NO financial statements and the SEC and Congress preventing anyone from seeing what they did file.
Especially given that in the few cases where it is possible to trace the ultimate beneficiary of the frauds, it has been a politically connected family member, none of whom have been prosecuted, it is hard to ascribe any reason to pass rules restricting access to company financial information other than a desire by the elites to steal as much as they can through stock fraud.
By "see-through" I assume the author refers to (mostly motel style) apartment buildings that are completely unoccupied or even unfinished and hence they lack blinds, drapes, furniture, (and sometimes walls). Thus, you can completely "see-through" them from street level.
You can---by the way---see the same phenomena in the American South where gulf-relief zones made building (or to start building) new apartments/condos in some areas practically a tax-dodge but where the natives in those areas don't have the means to buy them at even a quarter (sometimes eighth) the cost.
There are streets where you can see two or three streets over "through" these empty parking lots.
sounds like sour grapes to me...