Originally, I wanted to bang my head against a wall upon reading this. Matt Yglesias asks the question:
But here’s what I don’t get: Housing. Investment, you’ll recall, includes “residential investment” (i.e. houses) and I don’t understand why it would be the case that China is oversatured with residential investment. Now yesterday someone showed me this photo slideshow of the Chinese ghost city of Chenggong and it took me about five minutes to realize that this was actually a different ghost city from the ghost city of Ordos. Whole brand new cities full of vacant buildings certainly seems like good evidence that China is oversatured with residential investment. But why would that be?
I immediately thought Yglesias again doesn’t have access to basic economic information, but quickly I realized I am being uncharitable. Not everyone devotedly reads Gordon Chang, from whose insightful New Asia blog I believe was where I came across a link to the answer to Ygelsias’s question last year:
Chinese people have very few savings mechanisms. The major ones (bank deposits and their life-insurance contract twins) have sharp and consistently negative real returns.
Beyond that they have property.
Bank deposits have sometimes 5 percent negative returns. If you got 1 percent negative returns from property – well – you would be doing well. Buying an empty apartment and leaving it empty will do fine provided you can sell the property at some stage in the future.
It is commonplace amongst Western investors to view the see-through apartment buildings of China as insane. And they may be a poor use of capital. But from the perspective of the investors – well they look better than bank deposits.
But John Hempton also includes a warning:
The more serious threat is deflation – or even inflation at rates of 1-3 percent. If inflation is too low then the SOEs – the center of the Chinese kleptocratic establishment will not generate enough real profit to sustain the level of looting. These businesses can be looted at a negative real funding rate of 5 percent. A positive real funding rate – well that is a completely different story.
The real threat to the Chinese establishment is that the inflation rate is falling – getting very near to the 1-3 percent range.
Low Chinese inflation rates will mean reasonable returns on savings for Chinese lower and middle income savers. Good news for peasants perhaps.
But that changing division of the spoils of economic progress will destroy the Chinese establishment (an establishment that relies on a peculiar and arguably unfair division of the spoils). The SOEs will not be able to pay positive real returns to support that new division of spoils. The peasants can only receive positive real returns if the SOEs can pay them – and paying them is inconsistent with looting.
If the SOEs cannot pay then the banks are in deep trouble too.
All because the inflation rate is dropping. Maybe they can stop it dropping. The Chinese establishment has a vested interest in getting the inflation rate up in China. Because if they don’t all hell will break loose.
Unless the Chinese can get the inflation rate up expect a revolution.
Uh-oh. Henson’s post is from June 2012. How has the Chinese economy progressed until now? I turn back to Gordon Chang:
The Producer Price Index fell 2.9%. Factory-gate prices have now declined for 15 straight months. Because manufacturing is still the largest sector of the economy, the decrease in input prices indicates China is mired in deflation. Make that accelerating deflation. This year, the index fell 1.6% in January, 1.6% in February, 1.9% in March, and 2.6% in April.
I’m beginning to think Jim Chanos called it….