A Chinese national with the username HITOMI lays out the case in two fantastic comments on this Foreign Policy article discussing "both sides" of the issue:
http://www.foreignpolicy.com/articles/2010/05/13/bubble_bubble_china_in_trouble
HITOMI 12:00pm EST May 14, 2010
This bubble will likely be catastrophic.
I find many of the arguments for why China's property bubble is not, in fact, a bubble systemically flawed on at least two counts. Typically, as occurs in the article referenced by the "overstated" link toward the end of your work above, economists trot out statistics on how leveraged households are in the PRC (the statistics indicating that they are minimally leveraged) to determine that many if not most large scale purchases are being paid up-front, in cash, and that this imputes a degree of stability to the system. To a certain minor extent, this is true; however, such an account fails to take into consideration the peculiar status of PRC citizens' "savings" by which such purchases are funded.
Simply put, PRC citizens' savings aren’t what they appear to be. They are almost entirely an aggregate of *already directed future purchases*, necessities really--in the domain of property expenditure for descendents who are unable to buy their own apartment, massive health care and education costs--in lieu of a sufficiently supportive welfare network. They are not by definition surplus capital laid aside for potential “disposable” consumption. The operative difference between the two is that when such savings are spent on a large investment, such as an apartment or a child's overseas education, the family absolutely requires the investment to generate a significant return in order to sustain family finances, and resupply the retirement nest egg. If it fails to do so, say if one's child salary fails to match the expediture on his/her education after graduating from an overseas program or if property values fall after an investment, it has the potential to bankrupt the family. It would seem the ramifications of viewing “savings” differently in China’s unique environment hasn’t really penetrated most economic analyses as of yet.
HITOMI 12:04pm EST May 14, 2010
The second systematic flaw concerns how these "savings" are generated. Those who have garnered a network of friends and acquaintances in on the mainland may be aware that family “savings” of a couple million RMB (which is essentially the amount necessary to place down-payments on apartments in major cities) rarely come from incremental deposits of income over time—unless, of course, the members of said families were in the upper-income bracket of mainland Chinese a generation ago. The frugality of previous generations, while significant, was fiscally limited by depressed (relative to today’s figures) wages and salaries. Thus a middle-aged salesman for an industrial organization on the mainland 15 years ago may have considered himself very fortunate for earning 8000 RMB/ month, but the amount of disposable income that would have yielded would likely amount to no more than 5000 RMB after taxes and basic costs of living were removed. Assuming he could average that amount of savings each and every month, it would take 20 years to accumulate enough money (more than 1.2 million RMB) to put even the most basic level of down-payment on an apartment at today’s rates in major cities.
Of course there are all kinds of other factors playing into this. Rising salaries may play a role, but I’m already starting with an example of a person earning generous income in the previous decade. There is the further factor of households borrowing not from the banks, but from their extended families and friends (a frequent occurrence in China) and thus masking their down-payments as a form of official savings (at least negatively, by not registering in mortgages). This factor has yet to receive sufficient attention from those invoking the household leverage statistics, massive though it may be. Many Chinese families are indeed leveraged to others, just not to official lending organizations. But surely the one factor which particularly stands out, and bears significantly on the current real estate market, is that of resettlement compensation. The individual in my example above likely did not wait till now to purchase a home; he rather bought one at a much lower price decades ago and has since sold it, or his family was resettled and compensated for the value of their previous apartment. Savings are often “instantly” generated through windfalls in this manner. Most private (property) speculators on the Mainland got their start in the market through an initial government purchase of their home.
Now this is where things get interesting. The only economist I’ve seen who deals with generation of savings through windfalls on the mainland is Andy Xie, whose work is remarkably trenchant. Xie notes that “The overwhelming majority of end-user purchases [in real estate] probably came from resettled residents who used their compensation cash for down payments. Resettlement compensation is the biggest transfer of wealth from the government to the household sector since the privatization of low-cost public housing a decade ago. It is probably the most important government action supporting today's economy.” That is, people receive windfall amounts as compensation for homes that are demolished by the government and then apply that compensation to down-payments on further apartments, generating more demand and industry, driving growth. But one can’t understand the full impact of this situation until one considers what that means for the argument that Chinese property purchases are normally financed through “savings”. If “savings” are generated in such a manner, they have a rather odd status. In order to compensate home owners through resettlement, local governments must take out *institutional loans* and use the land as collateral. Thus, in effect, Chinese “savings” for the purchase of new homes undertaken in such a manner are actually reprised forms of debt, not household debt but government debt, which is now heavily involved in the property market [state-reported statistics for the first quarter of 2010 show that the government was responsible for 42% (!) of all property purchases in Beijing]. Xie makes the point frighteningly clear: “[Resettlement compensation] uses a form of leverage to support demand. Local governments borrow to pay compensation packages, using land as collateral. Resettled residents use compensation cash as down payments for mortgages. In this way, *government debt becomes equity for mortgage debt; there is no real equity in the financing chain.*”
Xie has shown elsewhere why this tactic is self-defeating (and least with regards to social and fiscal stability, though it certainly is effective for long-term kleptocracy) and potentially disastrous. The government must thus keep property values from falling, or it cannot even begin to balance its books—nor can the state banks, who supply the institutional loans. And this basic depraved structure comes on top of all the aberrant and wasteful investments made by Local Government Investment Vehicles.
We need to treat this run-up and nearly guaranteed future crash as a risk to the stability of the US and the world economy. If you're worried about the public debt problem in Greece ($339B GDP(PPP)) being "contagious", you should worry a whole lot more about a public debt disaster in the Chinese economy ($8.77T GDP(PPP)) at 25 times the size and a lot more involvement with US companies and consumers.
