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Nicely done video, but I think it gets the story wrong. The bubble is not illogical to start with. Thanks to currency controls most people have no way to invest

Nicely done video, but I think it gets the story wrong. The bubble is not illogical to start with. Thanks to currency controls most people have no way to invest outside China. The Shanghai stock market meanwhile has huge problems with adverse selection (bad companies pay to list -- successful companies list in Hong Kong or the United States). There are no property taxes in most of China, so people with money park it in real estate. And developers keep building these assets because they're insulated from loss in any case. If you're connected you can get zero/low cost loans. And local governments are complicit because they make money "selling" the land and don't have alternate income sources. So no-one really cares if someone builds a massive complex and it doesn't sell: the government and developers are covered by the bank, and the bank is covered by the Central Government. This is just a distributional game in which China pays for infrastructure by using public policy to inflate bank earnings and then banks approve questionable local projects. And sometimes these things make a lot of money, so it isn't as if they're taking a hit on every single complex.

yaix 15y ago
This is mostly what happens. Additionally, these new apartment complexes are often build in "new areas" of the bigger cities, to grow the city. China is trying hard to reach a level of urbanization comparable to the west, so they need to "grow their cities" somewhat aggressively. I have lived in two of those newly build complexes myself. First there is not much around, roads, maybe a supermarket and a few stores. The local gov't or the developer offer the shop owners rent-free for a year or two to get them to set up their stores in the new area, because there are almost no people yet. But two or three years later, the apartments are mostly filled (either rented or sold) and the shops are paying rent too, new supermarket have arrived, and suddenly the area has become part of the city center. Same goes for big roads. In the southern part of the town I live in, there is a huge road grid (6 lane roads, etc) already build, but there is only grassland. Come back in five to ten years, and it will be inner city area. Smart to finish the roads before it is crowded.
- j2d2j2d2 15y ago
  Everything you've said assumes these cities are going to explode with 1) enough people to buy the apartments and 2) enough people who can afford them. Could you clarify your view on those two issues?
  - jhancock 15y ago
    Why does the price on failed buildings have to stay high? Why couldn't the government (through a bank, likely) reclaim a bankrupt project, restructure its books and basically "give away" the units? China certainly has its share of problems. Having lots of extra housing for people to eventually move into is far from the top 10. Something related that is a bigger deal is the energy of heating and cooling housing built without 21st century insulation. I think its useful to _not_ compare how the U.S. and EU have handled bailing out its financial institutions. China does not have to bail out its financial institutions in the same way if and when it comes to that. They could simply just let the rich take a haircut and give away a bunch of empty apartments to cool the angry masses.
    - trevelyan 15y ago
      Hey Jon, What is Shanghai like these days? In Beijing there is a ton of vacant commercial real estate, but most of it seems to be owned by organizations with no need to lease (else why not lower prices?). Where developments like SOHO are competing is by selling rather than leasing smaller condo-style units. And while the market for apartments has slowed down, there are still people buying. Fifth ring road near Echo's place is 30,000 RMB per square meter. I wonder more what the actual cost structure is for the complexes cited in these videos. They should be the lowest of all since they're being built on satellite territories. That said, even in a worst case scenario of total default, I wouldn't expect banks to seize the property of people they've been pressured to lend money to. And I wouldn't expect the property to remain "unowned" if it seemed like that would happen. The developers would just sell the assets to a property management company and go nominally bankrupt. Agree about the differences between China, US and EU too, but my guess is that banks are safe, and that as individual markets get overdeveloped local governments will start adopting property taxes to raise revenue. This is NOT going to be popular with people who've already taken out a 30-year mortgage to buy a 60 square meter apartment, but that coupled with price stagnation should curtail people's tendencies to treat real estate as assets for investment instead of places to live, and push prices to whatever is logical given demographic and migration trends. Soft landing?
joe_the_user 15y ago
The bubble is not illogical to start with. Thanks to currency controls most people have no way to invest outside China. Now wait a sec. The bubble is illogical. That it involves individuals making rational choices in a distorted market doesn't exempt it at all. In fact, it is a fine illustration of how distorted, artificial markets produce irrational results despite each person making choices that are logical for them.
- stretchwithme 15y ago
  Yep, its the artificial markets. People have no way of investing outside of Earth either, but that doesn't mean investment bubbles have to happen. Instead of building things people don't need, in a natural market, things are made that people are willing to pay for with their own money. The building boom in China has been directed by government. Banks were told to loan. The government also created the housing boom in the US, through cheap money and loosening lending standards. In both cases, the government created incentives to do stupid things. And the markets responded as markets do to incentives.
  - wisty 15y ago
    I dunno. The government incentives aren't that big, and people do stupid stuff with and without government help. There's no doubt that the government (and neo-liberal mainstream economists) failed to prevent the bubbles. But there's other factors at play. Housing takes a long time to reach an equilibrium. It can take decades for people to move out of a house that's too big for them. The market just doesn't respond quickly, which is a recipe for instability and chaos (just ask anyone who's studied control theory, or chaos theory). There might be a few players who are smart enough to see this, but the average real estate investor isn't a Wall Street quant, or even a trader. They are a 20-or-30-something year old, with no financial nous at all. They see 10 years of solid growth (due to demographic changes, income growth, and government intervention), jump on the wagon, and that creates a little more impetus. Do you really think that the government is entirely pro-cyclical? That they choke supply, and give out free money while prices are rising; and increase supply and curtail loans while prices are falling? I doubt it. And if the Chinese government is to blame, why is it so damn regional? The Shenzhen bubble is nothing like the Beijing one, which is nothing like the Shanghai one, which is nothing like the Inner Mongolia one. Some of that is local government actions, but I dont't think it is in most places.
westiseast 15y ago
I'm pretty sure that fundamental economics are the same the world around - if there's no end consumer for your product, then there's a loss somewhere. It doesn't matter who covers the loss, but there's still a loss and it's not correct to say that no-one cares. The biggest fallacy I've heard recently about this housing situation is the oft' repeated "things are different in China" - you can't argue with basic maths like this. Surely the 2008 economic crisis was triggered by a similar situation, with western banks and investors ignoring fundamental economic equations?
westiseast 15y ago
oh, and another thing - people have no way to invest outside of China? What? Any quick google search will tell you about the hundreds of millions of government money being embezzled by officials outside of China, not to mention rich Chinese citizens legitimately taking American citizenship and investing their money overseas...

yaix 15y ago

This is mostly what happens. Additionally, these new apartment complexes are often build in "new areas" of the bigger cities, to grow the city. China is trying hard to reach a level of urbanization comparable to the west, so they need to "grow their cities" somewhat aggressively. I have lived in two of those newly build complexes myself. First there is not much around, roads, maybe a supermarket and a few stores. The local gov't or the developer offer the shop owners rent-free for a year or two to get them to set up their stores in the new area, because there are almost no people yet. But two or three years later, the apartments are mostly filled (either rented or sold) and the shops are paying rent too, new supermarket have arrived, and suddenly the area has become part of the city center. Same goes for big roads. In the southern part of the town I live in, there is a huge road grid (6 lane roads, etc) already build, but there is only grassland. Come back in five to ten years, and it will be inner city area. Smart to finish the roads before it is crowded.

j2d2j2d2 15y ago
Everything you've said assumes these cities are going to explode with 1) enough people to buy the apartments and 2) enough people who can afford them. Could you clarify your view on those two issues?
- jhancock 15y ago
  Why does the price on failed buildings have to stay high? Why couldn't the government (through a bank, likely) reclaim a bankrupt project, restructure its books and basically "give away" the units? China certainly has its share of problems. Having lots of extra housing for people to eventually move into is far from the top 10. Something related that is a bigger deal is the energy of heating and cooling housing built without 21st century insulation. I think its useful to _not_ compare how the U.S. and EU have handled bailing out its financial institutions. China does not have to bail out its financial institutions in the same way if and when it comes to that. They could simply just let the rich take a haircut and give away a bunch of empty apartments to cool the angry masses.
  - trevelyan 15y ago
    Hey Jon, What is Shanghai like these days? In Beijing there is a ton of vacant commercial real estate, but most of it seems to be owned by organizations with no need to lease (else why not lower prices?). Where developments like SOHO are competing is by selling rather than leasing smaller condo-style units. And while the market for apartments has slowed down, there are still people buying. Fifth ring road near Echo's place is 30,000 RMB per square meter. I wonder more what the actual cost structure is for the complexes cited in these videos. They should be the lowest of all since they're being built on satellite territories. That said, even in a worst case scenario of total default, I wouldn't expect banks to seize the property of people they've been pressured to lend money to. And I wouldn't expect the property to remain "unowned" if it seemed like that would happen. The developers would just sell the assets to a property management company and go nominally bankrupt. Agree about the differences between China, US and EU too, but my guess is that banks are safe, and that as individual markets get overdeveloped local governments will start adopting property taxes to raise revenue. This is NOT going to be popular with people who've already taken out a 30-year mortgage to buy a 60 square meter apartment, but that coupled with price stagnation should curtail people's tendencies to treat real estate as assets for investment instead of places to live, and push prices to whatever is logical given demographic and migration trends. Soft landing?

joe_the_user 15y ago

The bubble is not illogical to start with. Thanks to currency controls most people have no way to invest outside China. Now wait a sec. The bubble is illogical. That it involves individuals making rational choices in a distorted market doesn't exempt it at all. In fact, it is a fine illustration of how distorted, artificial markets produce irrational results despite each person making choices that are logical for them.

stretchwithme 15y ago
Yep, its the artificial markets. People have no way of investing outside of Earth either, but that doesn't mean investment bubbles have to happen. Instead of building things people don't need, in a natural market, things are made that people are willing to pay for with their own money. The building boom in China has been directed by government. Banks were told to loan. The government also created the housing boom in the US, through cheap money and loosening lending standards. In both cases, the government created incentives to do stupid things. And the markets responded as markets do to incentives.
- wisty 15y ago
  I dunno. The government incentives aren't that big, and people do stupid stuff with and without government help. There's no doubt that the government (and neo-liberal mainstream economists) failed to prevent the bubbles. But there's other factors at play. Housing takes a long time to reach an equilibrium. It can take decades for people to move out of a house that's too big for them. The market just doesn't respond quickly, which is a recipe for instability and chaos (just ask anyone who's studied control theory, or chaos theory). There might be a few players who are smart enough to see this, but the average real estate investor isn't a Wall Street quant, or even a trader. They are a 20-or-30-something year old, with no financial nous at all. They see 10 years of solid growth (due to demographic changes, income growth, and government intervention), jump on the wagon, and that creates a little more impetus. Do you really think that the government is entirely pro-cyclical? That they choke supply, and give out free money while prices are rising; and increase supply and curtail loans while prices are falling? I doubt it. And if the Chinese government is to blame, why is it so damn regional? The Shenzhen bubble is nothing like the Beijing one, which is nothing like the Shanghai one, which is nothing like the Inner Mongolia one. Some of that is local government actions, but I dont't think it is in most places.

westiseast 15y ago

I'm pretty sure that fundamental economics are the same the world around - if there's no end consumer for your product, then there's a loss somewhere. It doesn't matter who covers the loss, but there's still a loss and it's not correct to say that no-one cares. The biggest fallacy I've heard recently about this housing situation is the oft' repeated "things are different in China" - you can't argue with basic maths like this. Surely the 2008 economic crisis was triggered by a similar situation, with western banks and investors ignoring fundamental economic equations?

westiseast 15y ago

oh, and another thing - people have no way to invest outside of China? What? Any quick google search will tell you about the hundreds of millions of government money being embezzled by officials outside of China, not to mention rich Chinese citizens legitimately taking American citizenship and investing their money overseas...