The Big Bubble

During all the summer the first pages of almost every newspaper were reserved for the clashes between the US president Donald Trump and Xi Jinping, the Chinese general secretary of the communist party, leader of the Asian giant country, and the tariff battle among them. However, even if the tariff dispute continues to struggle their economies, for China this isn’t the only problem to face, and inside the country there are still big troubles that threaten the economic predominance of the most powerful country of the region and the second one in the world.

During the past few years, a lot of film makers have decided to focus their attention on a strange phenomenon: ghost cities. Like Ordos, in Inner Mongolia, a city built for thousands of people that is most of the time completely empty. Many buildings are unoccupied, unfinished, and many investors have decided to leave their investments there. Moreover, is not an isolated case. Looking at the prices of new homes during the past few years, the values of commercial and residential constructions have boomed, and they are expected to rise of 3.3% in the first quarter of 2019, after a 5% increase during this year. The government knows the importance of the real estate sector and have decided to invest 990 billion yuan (more or less 143.63 billion US$) to push the sector around the country through the PSL (Pledged Supplementary Lending) plan, based on demolishing old constructions (concentrated usually in rural areas) to move workers inside whole new cities, to stay near new offices and factories.

However, it is also true that in many developed parts of the country, like the Zhenjiang and Shenzhen provinces, prices have reached levels that are way too high for common workers and employees; this problem is known also in the new big cities, where for the rural residents the prices of the new flats are high too.

A part of the problem has been identified in the speculations of big companies, that have decided to exploit the increasing prices in the market to invest and buy big residential areas just as a common asset in their portfolio. The government is trying to limit the speculation, with controls on the residence of the buyers and by limiting the number of houses you can own in some districts. Also, they have tried to limit the convenience of these speculative investment through taxation and higher fiscal expenses on second homes.

Anyway, this doesn’t seem to be enough, and the prices are continuing to grow, reaching levels that are completely dissociated to the real value of the constructions sometimes. For some analysts it seems to be not so far from the sub-prime scenario that has invested the US market just 10 years ago.






And as in the US case, the problem is still strictly associated with the financial sector, in particular with credits and mortgages on real estates. From recently data provided by the Bank of International Settlements, the total value of credit to the non-financial sector has reached the level equal to 261.2% the annual GDP, too high for a country that is still classified as developing. And the rate is expected to grow at even higher values in the next few years. And together with the increase in the value of loans granted, it is booming also the value of NPL, that have reached an unofficial level of 15% of the total credit positions still pending. We consider the unofficial value, because the official data are surely underestimating the entire situation. In fact, in China the phenomenon of shadow banking is widely spread across urban and rural areas. Useful for people who cannot have access to regular mortgages and credit to banks (usually for a mix of bad credit history and no guarantees in general), they are not under the control of the central bank and very difficult to estimate precisely the figures of this market. But it is also true that the highest percentage of NPL are registered on the loans issued inside this shadow system. And if the total amount of NPL will continue to increase, more and more apartments and offices used inside real-estate backed loans will enter inside the balance sheets of banks and financial institutions, that sooner or later will try to sell in the market, causing a decline in the prices of houses and a situation that will worsen very fast, with a scenario similar to the real estate crises of 2008 in the US.

A big role is played by the People’s Bank of China (the central bank of the Chinese republic), that is continuing to manage and control the value of the interest rates, still kept at a very low value. This allows to many people to have access to a large and cheap quantity of cash that is financing also the real estate market. But for how long this process could last? If the interest rates will start to increase, the value of NPL will increase dramatically all over the country, determining huge losses and the decline in the prices of buildings, often used as bank guarantees. It is also true that for some analysts all those forecasts are way too catastrophic, and the authorities will have the possibility to manage correctly the interest rate, avoiding the market to collapse. China, rather than many other countries, is strictly managed by the authorities and under the actual policy given by the leader Xi Jinping, promoter of a wide control over many aspects of its people, the decline on the process could be managed in order to avoid a new recession. That, looking at the exposure and the position of the Chinese, would spread widely and very fast.

The key point is how this entire credit bubble will be managed by the authorities: it is a big responsibility, that will directly affect the future position of this economical giant, with huge effects on the entire financial market. There are clear signals that this process, as it actually seems to be, cannot last too long. But the future evolution of the situation is still unknown.




Matteo Mamprin