The Most Important Economic Question in the World Today

Chinese and American flags flying together

Is when will the Chinese property bubble burst.

As RGE pointed out:

Urban property prices increased a record 11.7% y/y in March 2010, up from 10.7% y/y February 2010, according to the National Bureau of Statistics’ property price index. Prices rose y/y in all 70 cities in the index, with prices in some cities like Haikou on Hainan Island up more than 50% y/y. In m/m terms, prices accelerated as well, according to the index, rising 1.1% in March, up from 0.9% in February. Real-estate investment saw a 35% y/y jump in Q1 2010, partially due to base effects and potentially also due to developers pulling their projects forward to avoid regulatory restrictions.

The bubble has been going on for years.  Many cities have had 20% housing inflation since the 2000’s.  The bubble has been fueled by very easy credit, and a great deal of fraud.  Sound familiar?

Bubbles end when the last sucker buys.  At that point housing prices implode, and banks have tons of loans go bad on them.  They either write them off and probably go bankrupt, or they are allowed to keep them on the books as non-performing loans, which means they become zombie banks, unable to loan effectively.  Meanwhile local governments, highly reliant on the bubble, are forced to start cutting back services and employment.

The government at that point may choose to print a great deal of money (the Chinese are much less reluctant to do that than many Western governments), in which case they risk either inflation (if it gets into the real economy) or the Japanese disease, in which case China gets substandard growth.  Since growth is what the Communist party offers Chinese in exchange for staying in charge, low growth risks the Chinese communist party being overthrown. And by overthrown, I mean killed.  The Chinese are really big into mass violence, riots and so on.

The majority of the world’s growth, at this point, is coming from China, with Asia ex-Japan providing most of the rest of it. If China goes under, it takes the world with it.

And, from a longer perspective, if you’re worrying about a Great Depression and using the last one as your model, China is what you want to watch. Though not dominant in gross terms in the way the US was in the 1920’s, it is the major surplus nation in the world, just as the US was then.

I don’t know how this is going to play out, but there’s no question that China has a huge property bubble.  All bubbles pop eventually.  The question is when, and how that popping is handled.

China needs to tamp this down, keep building its internal economy, and get off the mercantalist treadmill.  The rest of the world is not going to buy enough Chinese goods to allow them to fully industrialize through mercantalist policies—they are going to have to switch to an internal consumer society.  A Japanese style status quo is not feasible for China, both for political reasons and for the simple reason that their population is just too large.