He Who Bloweth the Bubble With Wet Lips ...

By: Reggie Middleton | Thu, Jan 7, 2010
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... Should Stand Back Lest Spittle and Saliva Spray Upon Ye Face

Just the other day I stated "Why does everyone confuse a bubble with economic progress" in a post about a very probable bubble in China (see "It Doesn't Take a Genius to Figure Out How This Will End" then get your chuckles on with "Goldman Seems to Trust the Chinese Economic Reporting a Tad Bit More Than I Do!"). Well, as if on cue, Stocks, Metals Decline Around World After China Curbs Lending; Yen Weakens:

Jan. 7 (Bloomberg) -- Stocks fell around the world, driving the MSCI Emerging Markets Index down the most in three weeks, and metals declined after China moved to curb lending. The yen dropped after Japan's new finance minister said he would welcome a weaker currency.

The MSCI emerging markets gauge slipped 0.7 percent at 9:45 a.m. in London, led by China as the Shanghai Composite Index plunged 1.9 percent, the biggest decline among benchmark indexes tracked by Bloomberg. Futures on the Standard & Poor's 500 Index lost 0.3 percent. Copper retreated from a 16-month high and oil snapped an 11-day rally. The yen weakened against all 16 most- traded currencies.

Central bankers in China, the engine of the global economic bubble recovery, sold three-month bills at a higher interest rate for the first time in 19 weeks after saying their 2010 focus is controlling record loan growth. The Federal Reserve said in the minutes of its latest meeting that the U.S. economic recovery might require additional stimulus measures to be sustained.

"Bubble Blowing Growth will probably reverse slow this year as tight credit will damp the artificially derived and probably outright lied about demand side," said Zhang Ling, who helps oversee $7.2 billion at ICBC Credit Suisse Asset Management Co. in Beijing. "That will dash investors' hope of another year of fast bubble blowing growth."

Why would China want to raise rates? Well from the afore-linked post:

Some local officials are even building towns from scratch in the desert, certain that demand won't flag. Straight out of the Dubai make money now and pay for it later handbook of bubblistic speculation! And if families can swing it, they buy two apartments: one to live in, one to flip when prices jump further. Imported speculators from Miami, LA and downtown Brooklyn!

And jump they have. In Shanghai, prices for high-end real estate were up 54 percent through September, to $500 per square foot. In November alone, housing prices in 70 major cities rose 5.7 percent, while housing starts nationwide rose a staggering 194 percent. The real estate rush is fueling fears of a bubble that could burst later in 2010, devastating homeowners, banks, developers, stock markets, and local governments. Let's get this straight. "Fears of a bubble"!!! A 54% gain in 9 months does not confirm a bubble???!! What is the long term historical average in China. Probably 2% to 4% annually, or on pace with inflation, give or take. So, if pundits are not sure a 25x increase is a bubble, what would it take to convince them?


"Once the bubble pops, our economic growth will stop," warns Yi Xianrong, a researcher at the Chinese Academy of Social Sciences' Finance Research Center. On Dec. 27, China Premier Wen Jiabao told news agency Xinhua that "property prices have risen too quickly." He pledged a crackdown on speculators. Actually, once the bubble pops, their economic growth will collapse, and trend in reverse. That's what happens when bubbles pop. If the growth just stopped, then it would make sense to encourage bubbles, wouldn't it? You can just reignite another bubble when the previous one pops and start the cycle over again. It appears as if this is the playbook some of our central bankers are following. Unfortunately, they are called boom/bust cycles, not boom/stop cycles. Bubbles are not indicative or true organic growth, they are a sign of growth borrowed from future time periods that MUST be paid back with hard money interest. The bigger the bubble, the bigger the "vig".

Although parallels with other bubble markets, the China bubble is not quite so easy to understand. In some places, demand for upper middle class housing is so hot it can't be satisfied. In others, speculators keep driving up prices for land, luxury apartments, and villas even though local rents are actually dropping because tenants are scarce. What's clear is that the bubble is inflating at the rich end, while little low- cost housing gets built for middle and low-income Chinese. This is not hard to parallel. This is exactly what happened in NYC, particularly Manhattan and Downtown Brooklyn. See "Who are ya gonna believe, the pundits or your lying eyes?" (for pictures) and "Who are you going to believe, the pundits or your lying eyes, part 2" (for numbers and a very shaky video), I illustrated a trip from Chelsea Piers in Manhattan to Prospect Park in Brooklyn, capturing the rampant supply of residential, office and commercial space that is STILL being put up despite the extreme glut currently in this rapidly declining market. As you look through all of this visual material, remember banks have supplied the capital for building all of these empty edifices, at no less than 10x leverage. None of this inventory was targeted at the middle and lower classes. As ironic as it may sound, this activity ultimately ends up causing downward social mobility as asset values collapse under mounting debt. See Super Brokers form to push Super Broken products to make those with High Net Worth Super Broke for my take on social mobility, downwards style).

In Beijing's Chaoyang district, which represents a third of all residential property deals in the capital, homes now sell for an average of almost $300 per square foot. That means a typical 1,000-square-foot apartment costs about 80 times the average annual income of the city's residents. I'll give this until the end of 2010 to blow up!


Koyo Ozeki, an analyst at U.S. investment manager Pimco, estimates that only 10 percent of residential sales in China are for the mass market. Developers find the margins in high-end housing much fatter than returns from building ordinary homes.

How did this bubble get going? Low interest rates, official encouragement of bank lending, and then Beijing's half-trillion- dollar stimulus plan all made funds readily available. City and provincial governments have been gladly cooperating with developers: Economists estimate that half of all local government revenue comes from selling state-owned land. "Nuff said!

Chinese consumers, fearing inflation will return and outstrip the tiny interest they earn on their savings, have pursued property ever more aggressively. Companies in the chemical, steel, textile, and shoe industries have started up property divisions too: The chance of a quick return is much higher than in their primary business. Oh my!

Built on Sand

"When you sit down with a table of businessmen, the story is usually how they got lucky from a piece of land," says Andy Xie, an independent economist who once worked in Hong Kong as Morgan Stanley's top Asia analyst. "No one talks about their factories making money these days."

Like I said in the original post, "It Doesn't Take a Genius to Figure Out How This Will End." See the following for my historical opinion on the subject: China Macro Update, (also of interest is the HSBC opinion and 2H08 update).Then My view of the China hype bears additional fruit and All of my warnings about China are starting to look rather prescient.



Reggie Middleton

Author: Reggie Middleton

Reggie Middleton

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