How China Economy Could Trigger a Problem

In 2010, the U.S. real estate market had a problem.

The 30% drop in the market caused roughly 25% of all homes with mortgages to dive underwater, meaning the homes were worth less than the mortgages outstanding on them.

Many of those homes were financed with subprime loans, meaning the borrower put down less than the conforming 20% down payment and/or had a spotty credit record.

As events unfolded, people blamed the banks for lending too much, the borrowers for borrowing too much, and almost any other scapegoat they could identify.

However, other than calling out the Community Reinvestment Act for prompting subprime lending, few people tagged the U.S. government as the one responsible for price movements. It’s a market-based economy, after all, which is what we have to keep in mind when trying to understand the Chinese markets.

They don’t do things the same way we do. They don’t look at things like us Westerners do. There’s a different sense of who’s responsible, and who must fix things.

For the Chinese, it is all about the government…

Last summer, the Southwestern University of Finance and Economics in Chengdu, China, surveyed 99,000 Chinese across 28,000 households. It found that Chinese consumers overwhelmingly put their savings into their homes.

Chinese homeowners typically put down 30% or more on their first home, and put down more on any second home they purchased.

With the dramatic rise in the country’s property values over the past few years, almost no homeowner is at risk of being underwater on their homes, even if the markets drop dramatically. According to the study, home prices could be cut in half and only 5% of homeowners would be underwater.

However, this situation does come with its drawbacks.

The high down-payment required, along with the phenomenal gains that have occurred, has led most Chinese to put almost all of their savings into the property market, with very little diversification into other assets.

Across China, households have 66% of their wealth in real estate, and in Beijing, the figure is 84%. In the U.S., households have 41% of their wealth in property.

With such a large amount of their personal net worth tied up in the value of real estate, this is a market that the Chinese watch very closely. No one wants to lose.

Recently, property developers in Hangzhou tried to cut the prices of their unsold inventory to move the units. When previous buyers — who’d paid higher prices — got wind of this, they were furious.

Selling those units at a discount would mean that previously sold units had dropped in value. So the current owners protested to stop the discounted sales. That’s just one developer in one city.

As China economy slows down, things are going to get interesting…

The government wants to curb lending so that a growing credit bubble doesn’t collapse on itself. This will mean fewer funds will be available for the next round of homeowners, which could cause a fall in home prices.

And about those next home buyers: The study found that 87% of city dwellers already own their homes, which means there aren’t many prospects left to buy property.

At the same time, urbanization is waning as the bulk of educated young people interested in moving to cities have already done so.

All of this points to a time when homeowners in China will feel the sting of a market retrenchment, but unlike U.S. consumers, they won’t complain they’ve been duped by scandalous lenders. Instead, as the survey points out, they’ll demand that the Chinese government do something to protect the interests of the little guy.

This point of view has already been expressed in the China Daily, which is basically the state run newspaper. A recent editorial warned that policy makers had to work to prevent dropping home prices creating financial instability, and had to take steps to deal with the social impact of falling prices.

It will be interesting to see what the Chinese will do.

In this area, they’re caught between a rock and a hard place. Will they keep the bubble going and risk a bigger crash, or will they constrict credit and cause some short-term pain that could lead to social unrest?

Who knows?

Either way, it looks like a bumpy ride ahead, which could trigger quite a sell-off in the countries that count on China to buy their stuff.


Rodney

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About Author

Rodney Johnson works closely with Harry Dent to study how people spend their money as they go through predictable stages of life, how that spending drives our economy and how you can use this information to invest successfully in any market. Rodney began his career in financial services on Wall Street in the 1980s with Thomson McKinnon and then Prudential Securities. He started working on projects with Harry in the mid-1990s. He’s a regular guest on several radio programs such as America’s Wealth Management, Savvy Investor Radio, and has been featured on CNBC, Fox News and Fox Business’s “America’s Nightly Scorecard, where he discusses economic trends ranging from the price of oil to the direction of the U.S. economy. He holds degrees from Georgetown University and Southern Methodist University.