Opinion & Commentary
Haunted by China's ghost cities
When Glenn Stevens admitted last month that the Reserve Bank had consistently underestimated the China-fuelled surge in commodity prices over the past five years, most analysts assumed that this was even more evidence that China will shield Australia from the worse effects of the ‘Dutch disease’. History suggests that the story of economies becoming too reliant on commodities for growth rarely ends well. But the common wisdom is that China’s seemingly insatiable appetite for commodities is driven by the unprecedented rate of urbanisation in China and the subsequent rise of a middle class demanding modern housing, roads and other infrastructure.
According to this narrative, Australia is uniquely placed to benefit for several generations. So should we worry that a small but increasing number of notable investors such as Jim Chanos and Garry Shilling are shorting China? Australian mining executives say ‘no’ but the facts say otherwise. As last SBS' Dateline program on the country’s ‘ghost cities’ suggests, construction in China too often bears little relation to demand for buildings and infrastructure, or profit from doing so. No one knows when the hard landing will come, or severe it will be. But even the most bullish Chinese economists conclude that it is coming.
Let’s look at the argument that urbanisation is the primary driver of growth in Chinese demand for commodities such as iron ore. We often hear the mind-boggling figure that around 15 million rural Chinese are moving to cities every year. But the urbanisation rate is only slightly above 1 per cent each year. Yet, Chinese consumption of iron ore has increased by 80 per cent since 2003. China’s own economic and social planners estimate that they can reduce steel production by one third and still meet demand resulting from ongoing industrialisation and urbanisation.
More broadly, fixed-asset investment which is driving increases in demand for commodities has been increasing by around 20-40 per cent per year over the past decade. Such investment now constitutes around 55 per cent of GDP which is way above the 25-30 per cent levels that occurred in East Asian countries such as Japan and South Korea when they were rapidly industrialising in the 1960s and 1970s. Once again, even the most ardent China-bulls do not believe that these levels of fixed investment growth are sustainable. In this light, it seems irresponsible if Australian forecasters assume differently.
Digging deeper into the Chinese economy, the country’s property market is indicative of the dangerous distortions throughout its model.
Bank lending, which facilitates the bulk of domestic fixed-asset investment, expanded from $US750 billion in 2008 to $US1.4 trillion in 2009, before falling slightly to $US1.2 trillion in 2010. The 2011 target is $US1.1 trillion, even though Chinese banks lent an estimated $US220 billion in January alone.
Three quarters of the capital go to state-owned-enterprises (SOEs). Overseen by the thousands of local bank branches, the vast majority of domestic capital is destined for the 120,000 locally owned SOEs and their countless subsidiaries. Why is this relevant to China’s property market?
Local governments are prohibited from borrowing from banks or issuing bonds. To get around these restrictions, they create state-owned commercial entities. These entities receive the lion share of loans from local bank branches with much of it ploughed into the local property market through the process of (often illegally) acquiring land, re-classifying the land as commercial or urban, and then working with developers to sell the buildings to both state-owned and private buyers. Indeed, about 50 per cent of local government revenues come from the property market. In other words, the tax revenue function for local governments in China is largely based on the perpetuation of a fluid and forever rising property market.
We can see why SOEs cannot exit the property game. But why do private investors enter it in the first place? The simple reason is that they have few alternatives. One option is putting money into a bank savings account. But interest rates in China are kept low in order to perpetually stimulate the economy through state-owned banks issuing cheap loans. Therefore, Chinese citizens who put their money into savings accounts will receive negative real returns.
This leaves two other options: the stock market and the property market. So far, listed equities have provided good but volatile returns. In contrast, valuations for property appear to consistently rise. Subsequently, property has been the ‘flavour of the month’ for the last two to three years.
Let’s return to the urbanisation issue. If the rise in construction is simply the result of rapid urbanisation, then there is little to worry about. Yet, some strange facts are emerging out of booming property markets.
For example, in the first half of 2010, a Chinese report revealed that 64.6 million urban electricity meters registered no electricity usage. This amounts to unused housing that could accommodate 200 million people. Andy Xie, the former chief economist for Asia at Morgan Stanley, crunched his own numbers and estimated that residential vacancies for commercial housing is around 30 per cent. Speak to Chinese middle class property investors and they will tell you that they buy property not to rent but to hoard as assets – in the same way one buys gold. In other words, the rise in property prices has little to do with demand and therefore yield.
No one knows where this will end. But if Australia thinks it can avoid the ‘Dutch disease’ by relying on the relentless construction of empty Chinese shopping malls, ghost cities and unused infrastructure, then we too could be in for a hard landing.
Dr. John Lee is a research fellow at the Centre for Independent Studies in Sydney and the Hudson Institute in Washington DC. He is author of Will China Fail?
