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This Time is Different Syndrome in China

Jim Chanos stated recently that he thought China was Dubai times 1,000. Many people have argued whether he is right or wrong since his comment. I noticed that the arguments on both sides seemed to have more of personal bias, and most articles on the matter provide little statistics to support their argument. I thought the best way to see if Chanos is right is to examine his argument in a rational way. The best way to accomplish this is to look at some numbers in China and compare them with the United States at the peak of its housing bubble.

I originally planned on writing this article with extensive data on housing metrics, loan metrics and other numbers to judge the validity of the argument. I wanted to compare China’s numbers with the numbers the United States had at the peak of the housing bubble. However it is very hard to get these numbers for China so I had to piece together a few numbers that I got.

The average home to income ratio in Bejing is 27-1, while the national average might be lower, this statistic clearly indicates a bubble at least in Bejing. In the United States at the peak of the bubble the ratio was below 5%, five times less than the ratio in Bejing. In other major cities in China" Price to income ratios have reached 15-20 times in major cities and around 10 times in regional cities (Pivot Capital)." This trend is clearly unsustainable and home prices will have to decrease to revert to a normal mean.

Another similar statistic that indicates a bubble is that home prices have been outpacing income rises. In the past six years “housing price hikes have outpaced income rises by 30 percentage points in Shanghai and 80 percentage points in Beijing” according to Business Insider. If wages do not increase at the same pace as home prices than property prices cannot continue increasing.

I recently read This Time is Different by Kenneth Rogoff and Carmen Reinhart. They argue that every bubble is accompanied by a thinking this time is different, and a financial crisis is impossible. This thinking was very common in the United States only three or four years ago. People were convinced that housing prices would continuously increase. Whitney Tilson writes that the rating agencies had various risk models for CDOs, however every scenario assumed home prices would continue to rise! I think this thinking is currently how many investors feel about China.

The “this time is different” crowd has two main arguments as to why China will not experience a real estate crash and/or a financial crisis.

The first argument is that China has huge foreign currency reserves and this will prevent a bubble. Thomas Friedman cited China’s two trillion dollar foreign currency reserves as a reason not to short the country. This argument makes little sense; Russia has one of the largest foreign currency reserves in the world, and has been severely affected by the global financial crisis. Russia’s GDP contracted 9.87% in the first three quarters 2009, and its stock market declined over 85% from peak to trough.

Some numbers below:

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russia-real-gdp.jpg

Furthermore, spending money will not help much in economic contraction. In the United States the Government has flooded the economy with trillions of dollars and the economy is still losing jobs a year later. In addition one of the causes of the bubble was China’s huge spending and flooding the economy, so how will spending more stop the bubble?

The second point the “this time is different” people will make is that China requires large down payments for homes. This is a valid point, however if home prices decline severely even with large down payments many home owners will be under water. According to Bloomberg, housing prices in Dubai have decreased by 52% over the past year. If China’s real estate is a bubble this decline could also happen in China, and many homeowners will be underwater. Therefore, even if down payments are a prudent policy to prevent bubbles there is only so much they could do.

I am not arguing that China’s economy will crash, I am only stating that people arguing that it cannot happen in China, beware!

disclosure: none

About the author:

Jacob Wolinsky
My investment ideas have been inspired by many of value investors including Benjamin Graham, Charles Royce, John Neff, Joel Greenblatt, Peter Lynch, Seth Klarman,Martin Whitman and Bruce Greenwald. .I live with my wife and daughter in Monsey, NY. I can be contacted jacobwolinsky(AT)gmail.com and my blog is www.valuewalk.com

Visit Jacob Wolinsky's Website


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Comments

DaveinHackensack
DaveinHackensack - 4 years ago
The main question regarding China, as I see it, is the one I mentioned in the footnote to this post:

We presented the positive view on China this post back in September, "China's new self-propelled economy", and the editors of the FT presented the scary view in this editorial last month, "The cost of China’s excess capacity". In a nutshell, the positive scenario: China's big stimulus this year has helped transition its economy to one fueled more by internal demand, in which case there should be continued growing demand for industrial commodities to build infrastructure in underdeveloped parts of China, manufacture first refrigerators for rural Chinese, etc. And the negative scenario: China's stimulus has been mainly hair of the dog, propping up an unsustainable status quo relying on massive trade surpluses that over-extended Western consumers can no longer support.


Since my largest stock holding (Alloy Steel International) profits from China's iron ore demand, in that post I discussed an idea I had to quasi-hedge against the risk of a fall-off in Chinese demand.
yswolinsky
Yswolinsky - 4 years ago
Here is a comment someone sent me:

Let's put some numbers to it.

i will take your average 27-1 ratio of home to income.

Let's take a 50% downpayment number.

so....we can conclude that on a $100K house in Bejing......that roughly $50K is put down on the house.

Mortgage size is $50K.

The income of the individual is going to be on average $3,700/yr?

I am guessing that the house to income ratio is a ratio of house to income per year right.

So the income per month is roughly $308/month.

I don't know there interest rates over there....but using a 7% rate, the mortgage on the house is roughly $332.65 for a 30 yr mortgage.

Now.....its obvious that this will not work....so they are living with multiple incomes.....and possibly many individuals in one home. Or they are in a bubble. If they truely have $50K to put down......it would take them 33 years to save that up if they saved 50% of their income.

Stuff isn't adding up....I think multiple people are putting savings together and buying....OR wealthy people are buying up the city. Because the numbers aren't adding up. You can't use the average income if 90% of the homes are being bought by wealthy individuals....I dunno....anyone else have more info?
yswolinsky
Yswolinsky - 4 years ago
Kenneth Rogoff said on Bloomberg this morning that there is a lot of this time is different thinking with China now. And even if you put 50% down houses could crash a lot more than 50%.

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