Chinese Housing and Australia…Big risk???

I am a believer in the China story I look at where it is in the sense of urbanisation and I look at where it is headed as the population shifts and as the economy shifts focus and I think “happy days – glad to be an Australian”. Now obviously my great joy at Chinese desire for our rocks and dirt is tempered by the RBA’s constantly wagging finger that we’ll all have to make way for the mining boom so that China can get their rocks and dirt and Australian households will just have to put up with higher rates and Australian  business a higher Aussie Dollar. But it will all be right in the end, apparently!

Now you can probably sense my disquiet at how this boom is impacting on Australia at the moment but this disquiet or frustration is born from our analysis of the economy and the fact that perhaps we just need to temper our enthusiasm for the pace of mining’s expansion and investment and take it a little slower because there are fundamental structural shifts in our economy at work at the moment and the over focus on the 8% of the economy that is mining is missing some very big elephants in the room. Thinks like the savings rate, household debt, who holds the debt, pressure from a high Aussie dollar and so on.

I’ll leave those for another blog because today I want to focus on where China is at and the risks that the Australian economy could face over the next year or so if we see a Chinese cyclical slowdown within its broader structural growth pattern.

First, how important is China to Australia? The RBA has told us many times over the past half decade just how important that Chinese growth is for Australia but a speech by RBA Assistant Governor Philip Lowe in September 2010 had a comment a chart that said it all,

These developments in China are being closely observed in Australia, including at the Reserve Bank. A decade or so ago, we spent a lot of time puzzling over why quarterly movements in Australian GDP were so highly correlated with quarterly movements in US GDP. We don’t puzzle over this anymore – not because we solved the puzzle, but because the correlation has fallen. At the same time, the correlation between quarterly movements in Australian and Chinese GDP has steadily increased. Clearly what happens in the Australian economy is now more dependent upon what happens in China than has been the case at any time in our past.

So the statistics tell us that China is now more important for Australia than the United States. That makes sense on two counts. First the baton as the epi-centre of global growth has been handed from the US to China and we know that China is a significant driver of demand for our resources, both directly and by inference.

So we then can say that the Chinese economy and leading indicators of the Chinese economy (there is a very strong correlation between Chinese LI and GDP outcomes) probably impart some interesting facts about where the Australian economy is headed. We’ve done a lot of work on this and the best representation we think is the following chart.

This chart shows the movements in RBA and standard variable rates (the weapon du jour for the economy) versus the Chinese Leading indicator of growth. We can see that the movements correlation picks up through time in line with the increase correlation above in the RBA chart. The big pullback in the leading indicators as the Chinese authorities wrestle with their economy and try to stop it from over heating informed at the margin our view that the Australian economy was probably going to slow its momentum from that which we saw around a year ago. Notwithstanding natural disasters it clearly has and when we add household restraint we get a multiplier effect.

Which brings me to the point of today’s piece. I can not claim to be an expert on Chinese property and I can not claim to have been on the ground recently enough to get a feel for how things are panning out but I do know through my study of market and economic history that there is a high likelihood that at some point Chinese supply will move to far ahead of demand and the market will need to readjust backwards.

Some call it a housing bubble I think it is just markets doing what markets do and at some point we’ll see a cyclical downturn within the structurally sound market. much like we are seeing here in Australia at the moment. But as the chart below shows there is little doubt that the Chinese authorities are trying to rein in the speculative fervour in some parts of the market by increasing the reserves that banks need to hold and thus rationing the available credit for housing. This reduces its availability and raises its price – and should slow down demand and speculative building


 So it was with some disquiet in the context of the potential impact on Australia that I saw an article overnight on one of the world’s best blog sites Naked Capitalism” about the “imploding” of the Chinese housing bubble.  The piece says,

China has accomplished the impressive feat of bringing literally hundreds of millions out of poverty in a comparatively short time frame. It has also studied the Japanese playbook and managed to avoid some of its pitfalls (of course, it has the advantage of not being a military protectorate of the US), in particular refusing to liberalize its financial markets (some accounts of the Japanese bubble and burst give considerable weight to overly rapid deregulation and the growth of what was then called zaitech, or financial speculation). is also hostile to neoclassical economists.

China escaped much of the impact of the global financial crisis by ramping up investment even higher than its pre-crisis level. It now has investment approaching 50% of GDP, an unheard of level on a sustained basis. A big chunk of that is housing related (housing is an estimated 13.5% of GDP), and prices have long been considerably out of line with incomes, a telltale sign of a bubble. In Beijing, admittedly one of the hottest markets, an average priced new apartment was equal to 57 years of average worker savings (and if you tried to pay for it with a super-long dated mortgage, you’d be in hock even longer, since you would also need to cover the interest charges).

Another warning sign is inventory overhang; the Wall Street Journal reports tonight that Standard Chartered forecasts that level of unsold apartments in secondary cities will amounts to roughly 20 months of sales by year end (and that’s before considering that many of the apartments are being acquired as investments rather than for use).

The Wall Street Journal article says that the foundation of Chinese growth is real estate and while we only agree up to a point any cracks in the wall of growth will have severe implications for Australia.

Now every one wants to call the bursting of so-called bubbles because they want to put it in their resume and while there is likely to have been over building and a correction is always on the cards, it’s what the Chinese Central Bank wants to slow things down, it could be anytime from now till 5 or more years out.

What this article and the actions of the Central Bank do highlight however is that forecasts of straight line Chinese Growth to drive Australian prosperity miss the point that economies cycle. China will have a weak spot which will impact Australia, lets hope it’s not too soon when Australian Households are already under pressure.

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