• Richard Murff

The Dragon Blows a Bubble

What Will Come Down with a Chinese Real Estate Collapse?


In 2007, just before the financial meltdown, I wrote a piece for a now defunct publication called, The Dragon Blows a Bubble on how “Capitalism with Chinese characteristics” (or “Communism with Chinese characteristics” depending you was doing the explaining) was holding up in the global fracas. Then Chinese Premier Wen Jiahou had just given a gloomy press conference that China’s growth model had become “unsteady, unbalanced uncontrollable and unsustainable.” The article was duly ignored. The GNP has since fallen from 15% to 6%, the slowest in 30 years. The actual figures, factoring in opaqueness of book-keeping, government involvement, price rigging, currency-pegging and theft of intellectual property, is closer to “Who the hell knows?”


Now, it seems, that the great whacking bubble in which the dragon economy has been floating, is sinking, and looks set to explode. It has been a hell of a ride, though.

After Mao’s Cultural Revolution of the 1960’s and 70’s took the country to the brink of civil war, the communist party launched “reform and opening” policy in 1978. It didn’t do much for personal freedom, understand, but the global markets took to it. The multinationals came in, knocked senseless by the prospect of more than a billion people to sell stuff too. Although what they thought would happen when they got into bed with the same authoritarian regime responsible for the Great Leap Forward that destroyed the country’s agriculture industry in about the time it takes to make one of their famous eggs is worth asking.


By the mid 90’s, Shanghai was the market center of the country: modern, slick but, for the most part, empty. The government had started to encourage private enterprise, but there was still no middle class to speak of. According to an article in The Asian Wall Street Journal at the time “The city was, quite literally, ordered to be great.” On paper this seemed to work. Free markets, though, are generally sloppy, grass roots affairs, but with the help of central planning, between 1981 and 1995, according to the World Bank, the increase in China’s income inequality was “by far the largest of all countries for which comparable data are available.”


Then Chinese markets opened its side-door when the British passed Hong Kong back to the motherland and things really started to hop. It also highlighted one of the dangers of spending too much time playing with spreadsheets – double digit growth for years on end is impressive, but less so when you are starting from a baseline economy that needs the odd famine to make the numbers work. The numbers, however, did fly – until they didn’t.


Of course, I was playing in Collateralized Mortgage Obligations at the time, so I can’t sneer. Our numbers went boom in 2007. As I wrote back then, no one could keep a shell-game going forever, and the whole thing would have to collapse eventually.

Outlook not so good.

Evergrande, a Chinese real estate firm with fingers in a dozen other pies, is in debt to the tune of $300bl, and is currently in the 30-day grace period after missing a bond service payment on 24 September. Another $200bln in debt is spread around the industry, with two more firms – Fantasia and Sinic – in default. Overall, the real estate sector has contracted for the third quarter. To communists, I suppose, private property is something of an afterthought, so the country doesn’t have property taxes. Meaning that there is no cost in holding onto an apartment or property while waiting for prices to rise. The QED being that about 80% of household wealth is now sunk in real estate.


As of Friday, the Chinese central bank has finally weighed in and said, more or less, that any spillover into the financial system will be controllable. Well, boys, good luck with that. The US went full ‘moral hazard’ with our bailout and it still took down our economy and well as damn near everyone else’s. The concentration in China is even heavier: Real estate, property and related services account for some 29% of GNP – about the same as Ireland and Spain just before their real estate crises.


All of which puts Chinese president Xi Jinping between a socialist rock and the capitalist hard place. China – any communist country – is a state where order is maintained with benefits, not freedoms. As he’s gunning for an unprecedented third term as head of the party, Xi is touting his devotion to “common prosperity” and he’s had political success taking ultra-rich Chinese elite in both business and media down a peg or two. It’s also thrown cold water on investors.


The Chinese have a stronger sense of community that most of us in the West, but wiping out the savings of the newly created middle class that piled into speculative real estate is going to tax the anyone’s sense of community. If not their marxist beliefs. A major industry bail out avoids potential unrest but also creates the moral hazard of “guaranteed bubbles.” While the move would ensure home-owners and investors aren’t wiped out, it also encourages more bad behavior to benefit the billionaire elite.


Which normally wouldn’t move the needle with most American’s during football season save for what exactly, is going to happen when the world’s second largest economy blows up. The larger question is what the man is going to do with the world’s largest navy when it happens.