from Follow the Money

Trans-Pacific Real Estate Bubbles

March 25, 2005

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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If you think that speculation on real estate has replaced the stock market as the US national pastime, try visiting China.

I expected Beijing to be one large construction sites, and was not disappointed. Shanghai is being built up even faster. But I was surprised by all the real estate froth around Chongqing. New apartments are going up everywhere. Chongqing may not be a typical inland city, but, at least in some instances, China’s real estate boom clearly extends well beyond the coast.

I do not agree with all of Andy Xie’s analysis of China. I think he overstates, for example, the risk a renminbi revaluation will push China into a Japanese-style deflationary spiral -- and understates the risks associated with maintaining the current peg.

But he is no doubt right that low US interest rates have helped to fuel China’s real estate boom.

Last week, he laid out how rising property prices in the US have supported US consumption (a theme Calculated Risk also has explored). US consumption supports Chinese exports, and that, in turn, also helps to fuel China’s real estate boom.

Property bubbles support demand in the US and China. Until property prices begin to decline in New York and Shanghai, the game is not over.

Household real estate values in the US increased by $2 trillion or 13.4% in 2004 compared to $1.4 trillion or 10.5% in 2003. US personal consumption rose by $505 billion in 2004. On the surface, the balance sheet of the US household sector is much stronger than one year ago due to asset inflation. As long as property prices keep appreciating at the current pace, why should the US consumer stop spending and start saving?

Strong US consumption has kept China’s exports strong. Hot money continues to pour into China. China is not investing all the money that it has. The surplus liquidity in the banking system is very high. China’s property sector continues to expand rapidly. Over the past three years, property prices have doubled in major cities in the Yangtze Delta region and increased by 60% in most provincial capital cities. The sales of new properties reached 7.4% of GDP from 4.7% three years ago and 2.1% in 1997. New property projects have been growing at 15% per annum in square meters in the past three years. The properties under construction, when completed, are worth more than one-third of GDP at current prices. As most developers expect double-digit price increases, the inventory-carrying profit is expected to exceed 3% of GDP per annum. The profits of S&P 500 companies are only 3.5% of the US’s GDP. This is why the investment desire is so strong in China.

The consumption dynamic in the US or the investment dynamic in China won’t change until the property markets turn down in either or both.

The strong correlation between the US and China’s real estate market should not be all that much of a surprise: by pegging to the dollar, China tied its monetary policy to that of the US. Capital controls do give China a degree of monetary freedom, at least in principle. But China’s controls leak, and certainly do not seem to have given it much monetary autonomy. If it raised its interest rates, it would just attract more external capital. Indeed, China’s desire (so far) to maintain its peg has led its reserves to soar. China is selling renminbi to buy dollars -- and having trouble selling enough renminbi bonds to take all the money it is creating out of circulation (sterilization). China’s peg means it has trouble running a tighter monetary policy than the US -- but it seems to have no trouble running a looser policy, at least so long as it is willing to keep adding to its reserves.

There is another reason for China’s real estate boom. In China, you cannot own land (it is the property of the people in Communist China), but you can own an apartment. This seems to have turned China’s Communist party into a bunch of real estate mavens, at least at the local level. Anyone that wants to turn a rice paddy into a high rise does not need to convince the peasant currently working the land to sell; the peasant cannot sell land he or she does not own. The real estate developer just needs to convince the local party to let him (or her) put up the skyscraper or apartment tower. Rather than buying out the peasant; the developer pays off the local authorities. In political science terms, a classic Iron Triangle seems to link China’s local government (which controls the land), China’s state banks (which can supply the financing) and China’s real estate developers (who can grease a lot of palms with their profits).

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