Tuesday, November 8, 2011

Chinese Housing Market is in trouble

A Construction bubble has fuelled the economic growth in China over the last 15 years in the same way it has in Ireland and Spain since the Euro and as it did in Japan in the eighties. When the bubble bursts, it will hurt.

The prices of houses in China have already reached a peak and have now started to go down. In response buyers will delay purchasing in the expectation that prices will go down further. This will become a self-fulfilling prophecy if sellers cannot pay the cost anymore and have to reduce prices to find buyers.

Dropping prices will be a strong incentive for construction companies to stop building, also because there already is a large reservoir of unsold houses in China. Construction is 10% of the Chinese economy (acc Mr. Wei Yao of Societe Generale). In addition, following a dip in construction all supplying industries will loose turnover (for many a substantial part of their existence). Especially the upstream companies, at the beginning of the supply chains, will see a significant dip because the whole chain will de-stock. This supplying industry is a much bigger part of the economy than the 10% mentioned by SG.

Dropping prices will also give strain on the banking system if the value of the houses drops lower than the mortgages. A Chinese banking crisis will be felt throughout the world. And dropping housing prices will reduce Chinese end market consumption, affecting all other industries as well.

The Chinese government might want to keep their trillion in the pocket to solve these problems, in stead of investing it in Greece or Italy.

The only consolation is that housing prices in China have gone so high that many ordinary people cannot afford a house. So if the prices drop 50%, a whole new market may emerge.


Newspapers are writing about the German recovery as if it concerns a new Wirtschaftswunder. Nonsense. Germany has gone deeper in the crisis than most other West-European countries because they have such deep supply chains, with a lot of capital goods that are very cyclic because they fluctuate around demand in other busineses. Another reason for their strong dip is their large automotive sector, with deep supply chains.

The long German chains have responded to the crisis by active and reactive de-stocking, and when the de-stocking was over, by an elastic response in re-stocking, which I have called the Lehman Wave. The Lehman Wave is causing the steep recovery that is mistakenly seen as Wirtschafstwunder.
The strong recovery of the automotive sales has helped here too, and caused another, this time upward bullwhip effect in the chains.

We can be optimistic about the German economy: when the whole Lehman Wave is behind, and the curve is down again, the Germany industry will be at a higher production level than the industry in many other countries due to the particular situation of construction in this country. In Germany, construction has been declining slowly but steadily since 1990 and therefore it completely avoided the bubble that took place in countries like Spain and Ireland and to a lesser extent in UK and the Netherlands. Construction is now more or less on the level it was in 2007 and stable. This will give a solid new base for the economy in the coming years.
Robert Peels