This bubble is unmatched in history

Bad news for Chinese real estate market is constantly coming out these days. Western economists and analysts mostly think about the issue in the normal context of a free market economy. But the Chinese economy is not a free market economy, especially in the property market.

There is no doubt that the early development of the property market in the 90s and the first decade of 21st century long with the whole development of the economy brought millions of Chinese people out of poverty. However, because the Chinese government is the sole owner of all land in mainland China and has complete control of banks, law and media, to say that the Chinese government has the monopoly power over the property market is an understatement.

Based on analysis of the financial reports of developers in China, the government takes away 40%-45% of the revenue of a project. The government is the biggest winner for sure. Land has been the magic treasury box with endless cash flow for the governments since the beginning of commercial property development.

However, at the beginning of 2010’s, the return on investment of residential property at good location with reputable school was at 2% in 1st tier city, such as Shanghai, while the interest rate for one-year fixed deposit was at 3%.  The residential property price was already out of reach of ordinary people in China. But Chinese people was still pouring money into the property market in strong believing that the government wouldn’t allow the property price to drop and the price of property would keep going up.  With a stock market of disappointing performance and bad reputation, they believe that buying property was the only way for investment. To be sure, with capital control for overseas transaction and a casino like stock market, the only valid way for Chinese people to invest was buying property.

Moreover, home ownership is not a dream, but a necessity in Chinese culture. It was not uncommon for a marrying couple to buy an apartment for the new family with the help from their parents from both sides. This further made an impact the consumption of other items from these 3 families.

Meanwhile, although the government already realized that the property market at such price level was not sustainable, they cannot afford to lose the magic treasure box. They tried their best to stop people from speculating the market using policy tools and propaganda machine on one hand, while made all the efforts to block any reports or comments pointing out potential property market crisis using censorship tools, and even to order the property developers not to drop the selling prices on the other hand.

Chinese property prices kept going up for almost another decade. The most recent available statistics showed that it took 20 to 43.5 years of median income to buy an apartment unit in 1st and 2nd tier cities in China. Meanwhile, Banks did not stop lending even they sense the risk, because the government owns banks. In addition, based on the relevant Chinese law, the banks are actually not bearing any direct risk for the mortgage, because in the great People’s Republic of China, once the buyer stop paying the mortgage, the bank will get the property, but it’s not the end of the contract, unlike in any other country. In the case of the selling price of the property cannot cover the rest of the mortgage owed by the buyer, the unfortunate buyer still has to pay the difference! These people not only lost their home, but most likely would carry the debt in the rest of their life. It’s happening now and more will come.

When I travelled and saw concrete jungles of high-rise buildings in China in recent years, I saw craziness of people from buyers, developers, bankers and government officials and wondered how ugly this would end up.

High Speed Crash

The recent Crash of 2 high speed trains in China is not only a reminder of the danger of building a high-speed railway network in high speed without proper management, but also a reflection of vulnerable situation of Chinese economy and the corresponding political system.

One of the lessons learned from the crash is that when the speed is close to the limit, it’s dangerous. In addition, paying the high price for that kind of speed is also not worth it. Having learned the lesson, the Chinese government adjusted the speed limit of the high-speed train and the corresponding prices lower. However, many investors or speculators of the stock market in China don’t seem to learn the same reasoning behind.

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Burning Tough

2010 is the most difficult year I had went through as an investor. The only certain thing about the economy in 2010 is uncertainty. As I mentioned in my last article “Is this party time again?” China is still facing the same economic problem and the share market performance after the National Day is well reflecting such dilemma. Fortunately, I had invested mostly in US companies in last year and still got a 19% return on my portfolio.

At this very beginning of 2011, it’s again very difficult to predict the economic picture of the whole world. The key issue now is not US unemployment, neither government debt in certain European countries. It is China’s run-away inflation and “burning” (hot is not the right word now) property market having the potential power to suck everyone into another crisis. Why?

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Is This Party Time Again?

The share prices in worldwide stock market went up in the past 2 weeks. As an investor, I should be very happy with the capital under my management fully invested in US and HK markets. However, it’s China again. Although we only allocate a small portion of our capital to invest in the China A shares, we had only invested even much smaller portion before October.

Have we missed the party? Many people may regret for not plunging into the market earlier, or at least feel itchy to get into it now. I don’t think so. The Chinese economy is still in serious uncertainty at best, considering the huge property bubble and lacking of purchasing power in ordinary Chinese people. The fundamentals have not changed over the so called National Day. The bubble popped up by the inflation and speculation on the RMB exchange rate will bust at any time. However, it seems that the governments around world are all determined to print more money and a worldwide inflation is almost inevitable, especially if the Chinese government keeps the interest at such low level. Investing in natural resources should be a good idea under such circumstance, as many investors have been doing. I personally don’t like the idea because the commodity prices are largely decided by the world economy, while the economy is very hard to predict. Investing in good business is always a good idea, no matter in good or bad economy. A good business can not only survive a recession, but also grow stronger in a recovery.

Not Be Fooled by Viagra

There are many professional investors talking about the low valuation about the Chinese A shares recently. They even compared the price of H share or B share of the same company with its price of A share, and discovered that the A shares of certain companies are cheaper than their counter part in H or B share market. Therefore, the pros declared that A shares are cheap and the Chinese investors are again immature. It seems that they are right with the surge in the A share market on the 2nd day today.

Well, you can not just rely on the economy figures from the Chinese government to make your judgment on Chinese economy. If you had friends living and working as a slave of their properties, or you had taken a ride recently on the very new high speed train and realized that the train had been transporting chairs instead of passengers, or you were receiving promotion materials selling properties desperately located in some ghost town in your email box on weekly basis, you would not agree with these professionals.

China economy was sick even before the financial crisis from the US. And it’s now in a more sever condition now due to last year’s government policies. The policies and money were mostly aimed at creating an instant surge on the GDP, not on the health of the over all economy and well-being of its people. It was like a very sick man being given a Viagra and suddenly he’s up. And ladies desperately missing an orgasm were all cheering. However, a sick man shouldn’t have such erotic actions based on our common sense. It only made his health worse! Now, the effect of Viagra is over. He looks like shit!

With these in mind, the prices of A shares in general are still not cheap enough to cover risks of a property market crash, very likely defaults of local government loans, a possible banking system melt down and some unexpected skeleton in the cupboard.

Greece Is No Big Deal

All investors have Greek crisis in their mind now. But Greece is a small economy. The serious impact to the world economy will come from China. And this time it will be serious and real, because China economy took the wrong medicine in 2009, which made the desease worse. It will be a world full of uncertainties in the next 2 years. Well, there will be still opportunities to invest. Focus on business!

Chinese Property Bubble

The rental yield in Shanghai is about 2% now, a serious bubble! It’s close to the return of 1 year fix deposite. Considering the most recent CPI figure was over 2%, the rental yield is actually negative. This will affect the Chinese economy in many aspects, if not a pending crash in the economy. Be very cautious at investing in any assets in China now.

If you want to know more about the property bubble, look at the following link.