A bubble in Chinese Asset Prices?

The Yuan has actually come up sharply in recent years, more than what appears on paper, because of the elimination of the black-market currency. Yuan used to be much, much cheaper for businesses to have access to, and even the very slight rise on the surface betrays the fact that in reality, Yuan prices have gone up 2-3xs in the last decade.

A clear example of a bubble with Chinese assets is in the steel industry. China's stimulus package now has China reaching all time highs in steel production. With demand below 2007 levels and German industry analysts’ not expecting demand to be back at 2007 level until at least 2012, what is China going to do with all that steel? Should they dump the steel on other markets. The problem is that even with dumping on other markets, boat loads of steel are just waiting to be offloaded or are sitting in storage.

Luck for China they have the reserves, thanks to U.S. and other consumers, to fund the bubble. Unfortunately, China needs to maintain order and to do that they must keep people working. China is not inclining to allow the Yuan to rise, since it will reduce their income. They need the income to fund the bubble(s) to prevent unrest.

 If you have lived in Shanghai from 2000-2003 and even at that time there hadn't been a black market currency for years. At the time the exchange rate was 8.2:1 and today it's 6.8:1, which is certainly not a 2-3x difference, it is argued.   A 24x price earnings ratio for Chinese shares is not an average historical multiple. Years ago, before the madness encouraged by faucets of money from banks with tonnes of bad loans, PE’s were 6x or so. The Chinese bubble may be over-inflated.

Now Economist is at it again at a different angle, asking that: “Without an independent monetary policy China will eventually become a bubble economy. To avoid that fate, Beijing must let get down of the Yuan. When the Chinese currency RMB is already overvalued than being undervalued for a still developing economy with per capita GDP being only about one tenth of the West, particularly in view of China’s social and health safety net needs and its huge foreign exchange holding.

That is, until the living standards catering to its people are brought up with services and conveniences that are taken for granted in the developed economies, the RMB can ill afford any further major revaluation against the dollar (it has already risen more than 20% over past couple of years). Keeping RMB where it is at now is one major safeguard why China does not have dangerous bubbles so far, and is indeed a positive contribution to the good health of world economy.

In 1995, the exchange rate was 10:1 and in 1999, it was 9:1 in the black market (compare to the official 8.2), now probably below 6.8. I don't know earlier statistics, it could have been much higher, and there were tales of black market vendors becoming millionaires in the 1980s. The vendors are pretty much out of business now. Now exchange rate is even slightly lower than the official rate of 6.8.

 In this era of recession, the economy of few countries like China,India,Brazil is rising at the rate of 6%,4%,1%of GDP and all of these are developing ,while the economy of developed like America, Britain are falling. China’s exports are continuously increasing and its new business ties with America, India and other neighboring countries are getting healthier so Yuan is getting stronger. In the global talks on climate, economy china is moving towards the cat bird seat. China has also shown its keenness towards the climate change by funding on millions of dollars on climate change. China military is the second largest in the world and it spends a huge amount on it (almost 2.5times than India).These all are the strong signs of Beijing.

10. It seems there is going to be a bubble in asset creation by the Government of China. The stimulus packages initiated by China are going to create massive infrastructure in entire China. But the issue is how long this economic activity can be sustained. It seems the government is taking solace against its foreign exchange reserves with US government and not allowing its Yuan to rise.

 So China has to start seriously acting by the end of 2011 for controlling its pollution, freeing Tibet, making better products for exports by a 70% quality scrutiny wise and invest in an internal transport infrastructure. They then, will be, via international circles boycott and impenetrable geo political countries that will do their "made in" instead of their "made in China" (Turkey, Eastern Bloc countries, central America, North Africa), political alliances from Mediterranean countries, Western EU, and even Japan/Singapore/Australia point of business transactions for safety, backing off the international scene in a big way and their exports/investments will be reduced to about 25 to 35 %. They backed off big time. Why? Because cheap goods after a while did take over good quality ones?

  The world could have a new bubble economy? A rising chorus of foam-spotters believes so. Their argument is simple: to support demand, China’s government has created huge quantities of credit. That lending is leading to unsustainable asset-price inflation, while wasteful investment is producing noodles of excess capacity. As a result, China’s stimulus will inevitably be followed by a bust down the road.

Few things matter more for the global economy than whether this argument is right. With America and other economies in the English-speaking world weakened by their own asset busts, the pace of global growth over the next couple of years will depend heavily on China. A painful asset slump or banking collapse there would further slow the pace of global growth. No one doubts that credit has been growing dramatically in the Middle Kingdom.  Lending grew by 34% in the year to August, around four times faster than nominal GDP. Nonetheless, today’s fears are exaggerated—for four main reasons.

First, neither China’s Stock nor Property Markets looks dangerously overvalued. The average price/earnings multiple, at 24, is well below China’s long-run average. Property prices are rising smartly in Shanghai and other cities, but nationally House-Price Growth has only just turned positive. Next, even if China’s asset prices surge and then slump, the damage will be less grave than elsewhere, because China’s house and share prices have not led to too much debt-driven borrowing. Only around a quarter of middle-class homeowners have mortgages and the average loan-to-value is less than 50%.

Third, although there is much scope to improve the efficiency of capital allocation in China, the lending boost may not be as inefficient as some fear. Much has gone into infrastructure, which ought to improve the rate of productivity growth. Lastly, Chinese officials have long been more worried about excess credit growth and asset-price bubbles than many of their Western counterparts. Even now, regulators are tightening the rules—demanding bigger down-payments on second homes and higher provisioning from banks—even as Beijing’s politicians promise that monetary conditions will stay loose.

But even if immediate worries about a bubble are overdone, there are medium-term risks. Ample liquidity, low inflation and strong growth are the perfect ingredients for sustained Asset-Price Inflation. And China lacks one essential anti-bubble instrument: the ability to raise interest rates.

To support its exporters China has kept the Yuan stable against the dollar over the past year, in effect tying China’s monetary conditions to America’s. So far that has mattered little. Domestic deflation means China’s real interest rates are the highest of any big economy. But this monetary coupling will become increasingly dangerous. America’s weak economy means its monetary conditions are likely to stay ultra-loose for far longer than makes sense for China. Left in place too long, the currency alignment could swell an asset bubble.

Just as the rebalancing of China’s economy calls for a stronger Yuan, so the ability to avert bubbles requires a more flexible one. The transition will not be easy. The spectre of a stronger Yuan will, temporarily at least, worsens China’s asset-price bubbliness, as foreign capital floods into the country in anticipation of a stronger currency. But this argues for acting quickly and carefully, rather than doing nothing. The longer China shadows the dollar, the bigger the distortions and the risks from any currency adjustment. Without an independent monetary policy China may eventually become a bubble economy. 

Early this year, many China-watchers warned that the government’s stimulus was not enough to save the economy from a deep downturn. With indecent haste, they have now switched to worrying that overly lax policies have created a gigantic bubble in shares and house prices.

Figures due later this month are likely to show that China’s real GDP grew by around 9% in the year to the third quarter—a period over which output in most other economies probably fell. A recent flurry of bearish reports has warned that sooner or later the markets will crash, excessive borrowing and investment will cause banks’ bad loans to surge, and China’s growth will collapse.

If the government does not act soon to tighten liquidity, share and house prices will become seriously overvalued.  Start with China’s stock market, an independent economist, as a “giant Ponzi scheme”. Despite a recent slide, Shanghai’s A-share index is still up by over 60% since its trough last November. Yet this is only a fraction of the gain during China’s previous bubble in 2006-07, when the price/earnings ratio jumped to an eye-popping 70. Today the P/E ratio stands at 24. That is high compared with developed markets but well below China’s long-term average of 37 . China’s faster trend pace of growth also means that the outlook for corporate profits is rosier than elsewhere. They are already bouncing back: in the three months to August industrial profits were 7% higher than a year ago, after falling by 37% in the year to February.

Bubble suspect number two is the housing market. Average Chinese home prices are nine times average annual household income. In the rich world a ratio of more than four would sound alarm bells; in other Asian countries prices are typically 5-7 times income. The volume of property sales has surged by 85% over the past year and prices of new apartments in Shanghai have risen by nearly 30%. Some conclude that prices have been pumped up by imprudent bank lending and that the market is at risk of crashing.

However, average nationwide house prices have risen by only 2% over the past year, after falling in 2008. The official price index may understate the true average gain but figures for central Shanghai will overstate it. Either way, house prices are rising nowhere near as fast as they did during the previous boom in 2004-07 (see right-hand chart). And in relation to income, average house prices in China have fallen slightly over the past decade (although they have risen in some big cities)

Arthur Kroeber, an economist at Ergonomics, a research firm in Beijing, argues that the high level of prices relative to income is partly explained by hidden subsidies. A high proportion of households live in apartments purchased at a fraction of their value from the government a decade ago (when the housing market was privatized) or have upgraded to apartments financed by the sale of such properties.

The leap in property sales follows a deep slump last year after the government deliberately cooled the market. The level of transactions in August was less than half its level in 2005 or 2006. More important, China’s housing market is much less dependent on credit than those in places like America, so its economy would be less vulnerable to any sharp fall in prices. Andy Rothman, an economist at CLSA, a broker, estimates that only one-quarter of middle-class homeowners have a mortgage and their average loan is only 46% of the property’s value, compared with 76% in America. Homeowners have to put down a minimum deposit of 20%. Speculators buying property as an investment have to put down 40%.

Rising home prices are not an accidental consequence of government easing but one of its goals. The government needs a lively housing market to support the economy when its fiscal stimulus fades. It creates a lot of jobs, spurs private-sector investment in construction and encourages new homebuyers to spend more on furniture and electrical goods. Until recently China’s recovery was driven largely by state spending but thanks to a rebound in construction, private-sector investment rose by 30% in the year to August, double its growth rate in December.

But even if China’s stock markets and housing markets do not look particularly overvalued now, there is a clear risk that they could become so. Mingchun Sun, an economist at Nomura, points to some big differences between the recent sell-off in shares and the previous one in November 2007. Inflation was then 6.9% and rising, so policymakers were forced to slam on the monetary brakes. Today consumer prices are falling. In 2007 liquidity was tight, with the M2 measure of money supply growing more slowly than nominal GDP. Today excess liquidity (money growth minus GDP growth) is growing at its fastest pace on record. Low inflation, lashings of liquidity and strong growth are the ideal environment for asset-price inflation. Mr Sun concludes that equity and housing bubbles are inevitable and may grow even bigger than those in 2007.

The third alleged threat to China’s recovery is overinvestment. It is widely argued that the recent investment boom has simply exacerbated China’s overcapacity, which will reduce the return on capital and eventually drag down its growth rate. Yet analysis by BCA Research, a Canadian research firm, finds surprisingly little evidence of wasteful overinvestment to date.

One yardstick of the efficiency of capital is the incremental capital-output ratio (ICOR)—the investment needed to generate an additional unit of output (i.e., annual investment divided by the annual increase in GDP).  China’s ICOR has been fairly stable over the past three decades. This year it will shoot up because investment surged and growth slowed, but the ICOR is meaningless in a recession. America’s ICOR, for example, will be infinite because GDP fell. In general, BCA finds that China’s ICOR is lower than that in many other places, suggesting that its capital spending is more, not less, efficient.

But what about this year’s state-directed investment boom? The good news is that little new investment has gone into industries which already had excess supply, such as steel. Three-fifths of new lending this year went into infrastructure projects. Some of this money will inevitably be wasted and banks’ non-performing loans will rise in future years as payments come due. But much of the new infrastructure, especially railways and roads, should help improve future productivity.

As for bank lending, which grew by a thumping 34% in the year to August, the government has repeatedly signaled that it will maintain its easy monetary policy because it is still concerned about the sustainability of the recovery. But it is also trying to curb speculative excesses and to tighten bank supervision. The banking regulator strengthened the rules on mortgages for investment properties this summer, and has told banks to raise their capital ratios to 10% and to hold provisions equal to 150% of projected loan losses by the end of the year.

China does not yet have dangerous bubbles in housing and shares that could threaten its recovery. Indeed, rising asset prices will help boost consumer spending over the next year, which will in turn help broaden China’s recovery. But to minimize the risk that China is starting to inflate its biggest bubble ever, the government does need to curb excessive liquidity. That means allowing the Yuan to appreciate. With interest rates likely to remain close to zero in America for some time, China cannot significantly tighten its own rates unless it allows its currency to rise. If China’s growth has decoupled from America, then so must its monetary policy.

I have more confidence in the Chinese government than the US government when it comes to long term fiscal policies. It's ironic that the Communists are the real capitalists these days, while America who taught the world free market capitalism has become the socialist nanny state.

Perhaps that's the advantage of not having to worry about reelection. The government can afford to do what's good for the country longer term as opposed to what we have in the US, where everything is short term focused and must show results before the next election.

China is lucky that even though their top officials are not popularly elected, they are smart and by and large govern with the interest of the people at heart. The genius is in their term limit of 8 years at the top level. They should extend that to all lower level officials to reduce power abuse, corruption and cronyism.

Contrary to Economist postulation that [(If) China’s growth has decoupled from America, then so must its monetary policy], China’s growth is not decoupled but more closely interwoven with America and other nations.

The close coupling is not just in trades but in a slew of other instruments such as China’s increased holding of the U.S. treasury notes and foreign exchanges of EU.

That’s rather responsible act heroic for a developing economy indeed, a sort of repeat or mirror performance on the part of China by holding steady its currency to the benefit of other Asian economies during 1997 Asian financial crisis. And the macro environment of China today is poles apart from that of Japan years ago. Yet even as a developed economy then, Japan is still smarting today from the consequences of that Plaza accord. Some think the Chinese currency RMB is already overvalued than being undervalued for a still developing economy, particularly in view of China’s social and health safety net needs and its huge foreign exchange holding.

That is, until the living standards catering its people are brought up with services and conveniences that are taking for granted in the developed economies, the RMB can ill afford any further major revaluation against the dollar (it has already risen more than 20% over past couple of years).

Keeping RMB where it is at now is one major safeguard why China does not have dangerous bubbles in shares and housing—yet. Some don’t agree with what you said the government need to appreciate the RMB lower the interest rate to the level nearly as same as US, you know what, if the appreciation of RMB happen, the hot money would come in further due to the better expectation and speculation and people want to hold more of the currency and let alone the export industry. What is more, lower interest rate would boost further lending and housing and stocks market bubble would become bigger!! Right now, the housing price, in fact, is already sky-high compared with Chinese people income.  Houses are hardly 10% occupied, and 90% of apartment complex are empty and uninhabited.  China represents one of the three best investment opportunities over the next decade, along with Brazil and India. Over the long term, population and organization makes for strong economies, and they have both. It’s likely however that the short term will be rocky - Some expect a significant dip in the next few quarters, and will go long when the bottom is near.

 Well the elite Chinese leadership has its pros & cons. Never mind the label of Communism as an ideology  is much needed for a country of little religious beliefs like China and Chinese have learned that 'isms are the means but goals. Basically the party leadership has the historical task to revive the nation & improve living standards on their shoulder. So it's a bit like a family controlled firm with a wise head running the business. Capitalist American is becoming less free market oriented because its leaders have also realized they need state intervention whatever the label 'ism in order to compensate their current means - capitalism which has shown its flaws to maintain a sustainable good society. The election system to a nation's political leader is like the appointment of chairman/CEO of a shareholder-controlled listed company. Short term goals such as share price performance rather than company’s long term growth can prevail, which ultimately can harm shareholders themselves.  The biggest risk for an elite leadership is a wrong person in charge could cause disasters for long time while a democratic system could get rid of a bad one in a 4/5-year term.