December 13, 2011 8:19 pm

Chinese property: a lofty ceiling

A roadside advertisement for a luxury housing development in Beijing
A roadside advertisement for a luxury housing development in Beijing. Home prices in the capital have risen by about 150 per cent in the past four years

In a showroom built to resemble an ancien régime palace, a platoon of salespeople stands idle on the frontline of a looming Chinese property bust.

The luxury apartments of Versailles Residentiel de Luxe La Grand Maison, located next to a polluted river in the third-tier coastal city of Wenzhou, have not yet been built but are already on sale for as much as Rmb70,000 ($11,000) a square metre. That is more than double the annual income of the average Wenzhou resident, who would have to save every penny for 350 years to buy a 150 sq m home in this development.

But even the few who can afford it seem to be having second thoughts. “We have been told to say publicly that everything is going very well and our apartments are selling even though none of the other developments in the city can sell theirs,” says one sales assistant who asks not to be named for fear of losing his job.

Prospective owners have paid deposits on only a dozen or so of the 198 apartments on sale at La Grand Maison.Prices are dropping fast and everyone is waiting for them to fall further before they think about buying,” says the sales assistant.

Across the country, from the big cities of Beijing and Shanghai to the smallest regional towns, countless such complexes have sprung up in recent years as developers and local governments have rushed to capitalise on the frenzy for property. But now, following a decade-long boom and nearly two years of attempts by the central government to cool the overheated sector, the market appears to have turned. Sales volumes have slid and prices are falling as developers try to tempt reluctant buyers with discounts.

China’s property bubble is bursting,” says Andy Xie, an independent economist. From their current elevated levels, “prices may fall by as much as 25 per cent soon and by another similar amount in the following two to three years”.

The downturn comes just as the market expects a wave of new supply, particularly in smaller cities such as Wenzhou, on China’s prosperous eastern seaboard. The country’s 80,000 property developers own enough land to build nearly 100m apartments. Add this to vacant apartments for sale, according to estimates by Credit Suisse analysts, and China already has the capacity to satisfy housing demand for up to 20 years.

The consequences of a crash would be dire for the wider Chinese economy and for the economies of many other countries that rely on China to fuel their own growth.

Last year, property construction accounted for 13 per cent of gross domestic product, and for more than one-quarter of all investment in what is the most investment-dependent economy in history. Property directly accounts for 40 per cent of Chinese steel use; the country itself produces more steel than the next 10 producing countries combined, making it by far the most important buyer of inputs such as iron ore.

Construction in China is also important for a host of other industries, from copper, cement and coal to power generation equipment. The sectormatters to an extraordinary degree for overall Chinese growth, for commodity demand, household expenditures, external trade and underlying heavy industrial profitability,” says Jonathan Anderson of UBS. He calls it “the single most important sector in the entire global economy, in terms of its impact on the rest of the world”.

The increasing prospect that this sector could come to a screeching halt has serious implications for the global economy at a time of deepening gloom and uncertainty. It is especially important for commodity exporters that have seen their economies boom on the back of Chinese demand for raw materials.

“The growth model China has followed for the last few years, which has involved a whole lot of property construction, is running out of steam,” says Mark Williams of Capital Economics. People have not priced in the coming rebalancing of China away from commodity-intensive development and this has to be bad for economies like Australia, Brazil and Chile.”

Chinese housing prices have soared so high and so fast that the dream of owning an apartment is now out of reach for almost anyone who does not already have one. Growing public dissatisfaction prompted the government early last year to start introducing increasingly tough restrictions, such as higher deposit requirements and outright bans in some cities on the purchase of more than one apartment. But the measures have started to work only in recent months.

. . .

According to government figures, which most analysts believe understate the reality, average housing prices more than doubled in the last four years nationwide, while in Beijing and some other regions the price increase was more like 150 per cent. Data are incomplete but analysts say the price of an average apartment in a Chinese city is now about 8-10 times the average annual income nationwide; in cities like Beijing and Shanghai the ratio is closer to 30 times.

Even at the height of the US real estate bubble in 2005, the price-to-income ratio for the whole of America peaked at about 5.1, while cities such as Las Vegas, where the bubble was biggest, saw the ratio reach 5.6, according to Zillow, a real estate information company. Historically, US home prices have tended to be about three times average annual incomes and they are close to that level again now, six years after the bubble burst. In the UK, the ratio peaked at about 5.8 in 2007, according to Halifax, the mortgage lender.

Government policy over the last decade set up perverse incentives that almost seem designed to create a bubble, say Chinese analysts and economists. To start with, all land belongs to the state and local government officials have monopoly power over its supply. In an autocratic, opaque and corrupt system, that gives them enormous authority to decide who gets to use that land and how.

Faced with chronic revenue shortfalls but forbidden to run deficits, local governments have come to rely on land sales (the “sales” are actually only of land-use rights of up to 70 years) for up to 40 per cent of their income. Analysts say the tax system encourages real estate speculation by wealthy Chinese who have few other investment alternatives and face negative real interest rates if they deposit their money in the bank.

Apart from pilot projects in Shanghai and in Chongqing to the west of the country, nowhere is an annual property tax levied and the property transaction tax that exists is derisory.

Right now the high housing price is not due to limited supply – it is because of endemic speculation but the government doesn’t combat speculation because high prices keep GDP growth and revenues high,” says Yi Xianrong, a professor at China Academy of Social Sciences, a government think-tank. China’s real estate bubble is undeniably the biggest in history but our property taxes are lower than Zimbabwe’s; the situation is laughable.”

China’s domestic financial system, which sailed through the global financial crisis mostly unscathed, is also vulnerable. When Beijing unleashed an enormous stimulus package in late 2008 to combat the effects of the crisis, much of the money went into construction.

The government says developers and mortgage borrowers account for about 20 per cent of all loans but senior regulatory officials admit that figure probably significantly understates the true exposure of the broader financial system to a downturn in the sector.

A banking stress test conducted this year by China’s biggest banks concluded that non-performing loans would tick up only slightly if real estate prices halved. But analysts say the test did not take into account a steep fall in transaction volumes that has already hit much of the country or recognise how falling prices would affect the wider economy when construction inevitably slowed down. Nor did the test try to estimate how falling land sales and prices would affect the value of bank collateral, even though the vast majority of collateral in the system is land or property.

In Wenzhou, often seen as a bellwether for the wider economy, house prices fell 5.2 per cent in October from the same time a year earlier and dropped 4.6 per cent from a month earlier. Prices have not yet fallen as much elsewhere – but transactions across the country were down 11.6 per cent from a year earlier in October, compared with a 7 per cent fall in September, and in the 15 largest cities the drop was 39 per cent.

“The volume of land transactions has also dropped sharply as developers hold off on new projects and will probably continue to weaken as homebuyer sentiment falls further,” says Du Jinsong, China property analyst at Credit Suisse.

. . .

So far, the government has stood firm on its commitment to bring down property prices and has refused to roll back any of its restrictions. This year it unveiled a plan to build 36m subsidised housing units for low-income families in just three years, in the hope that this would make up for the slowdown in commercial housebuilding.

But there is some evidence this plan is already faltering, because of opposition from developers and local governments who are expected to build and pay for units on land they would have otherwise been able to earn big profits from.

“The subsidised housing is all very poor quality and in terrible locations,” says Cao Jianhai, a real estate expert at the China Academy of Social Sciences.Local governments are not willing to build affordable housing that can compete with commercial residential developments.”

Given the importance of the sector to the overall economy, most analysts believe that if prices drop too far, Beijing will step in to save the market by lifting purchase restrictions and pumping more credit into the economy.

But others warn that saving the property sector would require another flood of liquidity into the system and would only re-inflate the bubble, leading to higher inflation and an even bigger crash in the future.

“The government is in a very difficult position,” says Tao Ran, an economics professor at Renmin university in Beijing. “If they relax macro­economic policy the bubble will get worse. But if they don’t relax policy then the bubble will pop and the economy will stall.”

It is an eventuality that may already be confronting the backers of the faux French development in Wenzhou.

Housing history

In 1996, when Li Fuan was asked by his bosses at China’s central bank to translate an American banking examination manual into Chinese, he stumbled on a problem in chapter 17.

“I couldn’t find a translation for ‘mortgage loan; we just didn’t have a word for it in any of the dictionaries,” says Mr Li, now a senior official in the China Banking Regulatory Commission.

Eventually he tracked down an English-Chinese dictionary printed outside the People’s Republic and used the word he found thereanjie – to describe a personal bank loan for the purpose of buying a house.

“At the time there was no such thing as a mortgage loan in China and some of my superiors thought we should just leave that chapter out of the book altogether,” Mr Li says. “In the end we kept it in but clearly marked it as ‘reference only.”

Before 1998 China did not have a residential real estate market to speak of and there was no need for such exotic financial products. In urban areas, all housing was built and allocated by the state through the ubiquitouswork unit”. In the countryside, peasant farmers built their own homes on land allotted to them by the state or the collective.

The real estate market that now plays such an important part in China’s overall economy was born when the Communist party decided in the late 1990s to begin transferring ownership of the vast majority of housing to individuals. The first home mortgages were extended soon after that.

It is easy to forget that the market is just over a decade old and, apart from a brief dip in the midst of the 2008 financial crisis when transactions dried up, most Chinese have only seen prices double every couple of years and never seen them fall.

Many regulators believe that the sector’s short history and a lack of other investment options has led to irrational exuberance. And that in a country where speculative bubbles have been a constant phenomenon since market-based reforms picked up pace in the 1980s.

Copyright The Financial Times Limited 2011

The ECB Fear Factor

Philippe Legrain


BRUSSELS – Panic is beginning to overwhelm the eurozone. Italy and Spain are caught in the maelstrom. Belgium is slipping into the danger zone. As France is dragged down, the widening gap between its bond yields and Germany’s is severely testing the political partnership that has driven six decades of European integration.

Even strong swimmers such as Finland and the Netherlands are straining against the undertow. Banks are struggling to stay afloat – their capital providing little buoyancy as funds drain away – while businesses that rely on credit are in trouble, too. All signs point to a eurozone recession.

Left unchecked, this panic about sovereign solvency will prove self-fulfilling: just as a healthy bank can fail if it suffers a run, even the most creditworthy government is at risk if the market refuses to refinance its debt. One can scarcely bear imagining the consequences: cascading bank and sovereign defaults, a devastating depression, the collapse of the euro (and perhaps even that of the European Union), global contagion, and potentially tragic political turmoil. So why aren’t policymakers doing whatever it takes to avoid catastrophe?

Ever since Italian bond yields first spiked in early August, I have believed that only an open-ended commitment by the European Central Bank to keep solvent governments’ bond yields at sustainable rates could calm the panic and create the breathing space needed to implement confidence-boosting reforms. Everything that has happened since then has only confirmed this view.

Now that the crisis has reached the “core” of the eurozone, the resources needed to backstop weaker sovereigns exceed the limited fiscal capacity of stronger ones. Financial wizardry cannot disguise that, while throwing a bigger lifeline risks dragging everyone down. Piling everyone on to the same life raftthrough Eurobonds backed by joint and several guarantees – is not legally feasible for now, and would be politically toxic if attempted prematurely. Nor can a systemic crisis be resolved by individual governments’ actionsnot least because the panic is outpacing politicians’ ability to respond. Only the ECB has the unlimited wherewithal to save Europe from the abyss now.

The ECB has a strong rationale to act: to ensure the smooth transmission of monetary policy, to prevent a depression that would lead to deflation, and to avoid the breakup of the euro. Yet it has so far refused to do so, hiding behind a legal fig leaf.

Granted, Article 123 of the Lisbon Treaty prohibits the ECB from purchasing bonds directly from public bodies, but intervening in the secondary market is permitted. The ECB has long been doing so through its Securities Market Program. Where in the treaty does it say that extending the SMP is prohibited? Indeed, a credible open-ended commitment to contain interest-rate spreads would actually require fewer purchases than the ECB’s current limited and temporary program does.

Unfortunately, many Germans, notably at the Bundesbank, loathe the idea of central-bank intervention, because it conjures up memories of 1923, when the Reichsbank printed money to fund government borrowing, the resulting hyperinflation destroyed middle-class savings, and a decade later Hitler came to power. Yet Germans ought to remember that it was in fact the financial panic provoked by the collapse of the Austrian bank Creditanstalt, the resulting slump, and misjudgment by the German political establishment that cleared the Nazis’ path.

Far from precluding action, history justifies it. Besides, there is no reason to panic about inflation when monetary growth is low, bank credit is contracting, and people are hoarding money rather than spending it. Moreover, any ECB purchases could continue to be sterilized.

Another objection is that ECB intervention would ease the pressure on the new governments in Italy and Spain to reform. Yet, as it is, reformers have no time to establish their credentials, and if the eurozone collapses, the door will be open to populist extremists. So why doesn’t the ECB strike a bargain with solvent governments to keep rates down as long as they stick to their reform programs?

Eurozone leaders could also set out a roadmap towards Eurobonds, subject to strict conditionality, and tied to a credible mechanism for ensuring fiscal prudence. This would provide an additional incentive for governments that wish to qualify to introduce the necessary reforms, while reassuring the ECB and markets that governments remain committed to making the euro work.

Exceptional times demand exceptional measures – and I believe that the ECB will feel obliged to act if the eurozone is pushed to the brink. But the longer the ECB delays, the greater the hit to people’s jobs and savings, the deeper the enduring damage to investors' confidence in the eurozone financial system, and the bigger the risk of a catastrophic mishap. The time to act is now.

Philippe Legrain is an independent economic adviser to the European Commission.


Precious Metals, Equities & Oil Long Term Outlook Part II

December 14th, 2011 at 1:35 pm

It’s that time of year again and I’m not talking about the holiday season. What I am talking about is another major market correction which has been starting to unfold over the past couple weeks.

I have a much different outlook on the markets than everyone else and likely you as well. However, before you stop reading what I have to say hear me out. My outlook and opinion is based strictly on price, volume, inter-market analysis, and crowd behavior and you should put some thought as to what I am saying into your current positions.

Two weeks ago I sent my big picture outlook to my subscribers, followers, and financial websites warning of a major pullback. You can take a quick look at what the charts looked like 2 weeks ago:

Since my warning we have seen the financial markets fall:

SP500 down 2.6%
Crude Oil down 4.4%
Gold down 9.6%
and Silver down 12.2%

If you applied any leverage to these then you could double or triple these returns through the use of leveraged exchange traded funds. The amount of followers cashing in on these pullbacks has been very exciting to hear. The exciting part about trading is the fact that moves like this happen all the time so if you missed this one, don’t worry because there is another opportunity just around the corner.

While my negative view on stocks and precious metals will rub the gold and silver bugs the wrong way, I just want to point out what is unfolding so everyone sees both sides of the trade. I also would like to mention that this analysis can, and likely will change on a weekly basis as the financial markets and global economy evolves over time. The point I am trying to get across is that I am not aGloom and Doomkind of guy and I don’t always favor the down side. Rather, I am a technical trader simply providing my analysis and odds for what to expect next.

Let’s take a look at some charts and dig right in.

Dollar Index Daily Chart:

SP500 Futures Index Daily Chart:

Silver Futures Daily Chart:

Gold Futures Daily Chart:

Crude Oil Futures Daily Chart:


Mid-Week Market Madness Trend Analysis Conclusion:

In short, stocks and commodities are under pressure from the rising dollar. We have already seen a sizable pullback but there may be more to come in the next few trading sessions.

Overall, the charts are starting to look very negative which the majority of traders/investors around the world are starting to notice. With any luck they will fuel the market with more selling pressure pushing positions that my subscribers and I are holding deeper into the money.

Now that the masses are starting to get nervous and are beginning to sell out of their positions, I am on high alert for a panic washout selling day. This occurs when everyone around the world panics at the same time and bails out of their long positions. Prices drop sharply, volume shoots through the roof, and my custom indicators for spotting extreme sentiment levels sends me an alert to start covering my shorts and tightening our stops.

Hold on tight as this could be a crazy few trading sessions.

December 14, 2011 3:34 pm

Europe needs a firewall to stabilise markets

The European sovereign credit markets are in a danger zone. Italy and Spain need to borrow a combined €590bn in 2012, their yields remain above sustainable levels, and the European Central Bank’s efforts at buying debt in the secondary markets have so far been ineffective in holding yields down.

Drawing on our experience restructuring companies along with lessons learned in the US following the bankruptcy of Lehman Brothers, we suggest the ECB consider a sovereign debt guarantee programme as a solution to the European sovereign debt crisis. Such a scheme would be similar to the successful Temporary Liquidity Guarantee Program adopted by the US’s Federal Deposit Insurance Corp to stem the financial crisis after the failure of Lehman by enabling financial institutions to refinance their maturing debt and avoid a default.

It is clear that existing, piecemeal efforts by European leaders have been ineffective. Even after the ECB bought €208bn of European debt, Greece, Portugal and Ireland all still required bail-outs. Italian and Spanish yields, meanwhile, remain stubbornly high.


The European Financial Stability Facility, the eurozone rescue fund, is proving impractical – the recent sale of €3bn of bonds met only tepid demand, casting doubt on its ability to raise its full €440bn target, never mind the €1tn needed for the credit enhancement insurance scheme. A €200bn capital boost to the International Monetary Fund was a step in the right direction, but the amount is still not sufficient to alleviate market concerns. Direct purchases of new issues of sovereign debt by the ECB have been ruled out owing to their potential inflationary effects.

Last week’s statement from European leaders should go a long way towards fiscal consolidation, a necessary step towards the long-term viability of the euro. But it did not provide the “firewall” to address the short-term liquidity needs that the markets wanted.

Italian and Spanish bond yields have subsequently risen casting doubt on their ability to meet their funding needs. The market also remains vulnerable to a downgrade by Standard & Poor’s or Moody’s of either France or the eurozone – which could push yields even higher.

The European banking sector also remains under pressure in large part owing to its exposure to European sovereign credit. A firewall is needed now to stabilise the markets, bring yields down, allow for sovereign refinancings, reduce stress in the banking sector and provide protection against likely future credit events. Acting now would be more effective and cost-efficient than waiting for a crisis that forces such action at a later date.

An ECB sovereign guarantee programme would immediately calm the credit markets. It would be non-inflationary and would allow Italy and Spain (and other countries, if necessary) to refinance their maturing debt at reasonable rates. It would also ease pressure on banks as concerns about their sovereign credit exposure would subside.

The sovereign guarantee programme would work as follows: in return for a 1 per cent annual guarantee fee, and compliance with the ECB and/or IMF on implementation of structural reform programmes, Italy and Spain would be able to refinance all maturing debt with an ECB guarantee. This would probably cause their “all-in-financing costs” to fall to the 4 per cent range. The programme would be open for two years for maturities of up to 10 years, giving Italy and Spain time to implement their structural reforms.

The benefits to this programme are many: it would immediately stabilise the sovereign credit market, it would not expand the ECB’s balance sheet, it would not cause inflation, it would keep interest costs low, and negate the need for the ECB to buy debt in the primary or secondary market. Since Italy and Spain are facing liquidity, not solvency issues, the guarantee would probably never be used, and the ECB would collect fees for its service.

The ECB is the only institution in Europe that has sufficient resources to guarantee European sovereigns. With ECB backing and subsequent debt spreads about 1 per cent above the German Bund, Italy and Spain would have time for new austerity measures and growth initiatives to take hold. There may be a need for a technical adjustment to the ECB’s mandate to implement the guarantee programme but there are various options available. Time is running out for the euro. 

A comprehensive firewall is needed now, before the crisis gets worse. The sovereign guarantee programme would provide the firewall to stabilise the market and provide a temporary umbrella to allow the EU and members states to implement their fiscal plans.

The writer is president of Paulson & Co, the investment management firm

Copyright The Financial Times Limited 2011