Vanguard's Chief Economist
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In the Chinese city of Ordos, empty skyscrapers loom over largely empty roads, empty town plazas, and empty schools. It’s China’s best-known ghost town. The empty buildings in Ordos and other places—started as part of an ambitious government plan to build hundreds of new cities—are monuments to inefficient allocation of capital.
Chinese GDP growth likely to slow
These idle properties may invoke memories of the semivacant suburban tracts that symbolized the U.S. housing crisis, but the similarities largely end there. As our recent Global Macro Matters research concluded, problems in the Chinese real estate market are not likely to ignite another global financial crisis.
That’s not to say that China’s economy is entirely healthy.In the first nine months of this year, new-home sales fell 10.8% there, and in September, new-home prices dropped in all but one of the 70 cities that the government monitors. The inventory buildup in small- to medium-sized cities likely will prolong this downturn, curbing GDP growth.
How much? We estimate that every 1-percentage-point increase in residential investment adds 0.15 percentage point to China’s GDP growth. So, as this chart shows, if the current growth rate of housing investment were to shrink from the current level of 15%to –5%, GDP growth would drop by 3 percentage points to 4.3%, which qualifies as a hard landing given that the Chinese economy has been growing at more than 7% yearly.
When China sneezes …
A slowdown in China would hit the country’s closest trading partners hardest. If housing investment in China fell by just 1 percentage point, it could decrease GDP growth by 0.9 percentage point in Taiwan and by 0.6 percentage point in Malaysia and Korea, according to research published by the International Monetary Fund (IMF), 4 Countries that export commodities would suffer, too. Growth in Chile and Saudi Arabia could drop by 0.3 percentage point, and in Australia by 0.2 percentage point.
So why aren’t I more worried? One reason is that China has over invested in housing in part because investors lack few alternatives. China has begun relaxing investment restrictions. Over the long run, that will create more outlets for investors, reducing pressure to invest in housing. The country also is making it easier for rural workers to move to cities, where those new residents will soak up excess inventory. Think of it as China bringing forward its housing investment today at the expense of growth in later years.
It’s also possible that growth many not suffer as much as some economists expect. As China moves toward a more consumer-driven economy, a newly empowered middle class will spend money, compensating for reduced housing investment in the GDP equation.
But that transition will take time, and the collapse of the U.S. housing market understandably looms large in investors’ minds.Fortunately, there are key differences between the U.S. and Chinese housing booms, as this chart shows.
In the United States, many investors took out speculative loans on houses they could not afford. In China, lending standards have not loosened. Sub prime mortgage loans with minimal down payments do not exist there. Chinese home buyers must put down at least 30%—and often more than that for a second home. They also can’t walk away from their debts easily because they lack the no-recourse loans that allowed underwater U.S. borrowers to wash their hands of their housing debt. Mortgage securitization, a major factor in the global financial crisis, is also less prevalent in China than in the United States. Overall, the Chinese housing boom is missing the leverage that accelerated the housing bonfire here.
Furthermore, compared with the housing market in the United States, China’s housing market is relatively young and represents a smaller part of the economy. Home ownership took root only in 1998, when Chinese officials began eliminating the state-run housing system.
Finally, the key difference in China is that most of the risk lies with real estate developers and local governments, who have borrowed excessively and left many cities with an oversupply of housing. In fact,revenue from land sales is about one-third of local government revenues, and many local government funding vehicles use land as collateral for their borrowing. Bad loans could emerge in the future if banks tighten lending, and housing and land demand slows.
Nonetheless, with the central government trying to engineer a gradual slowdown of leverage growth and cutting rates to lower the debt-service burden, a systemic crisis is still unlikely.
Joe Davis, Vanguard’s Chief Economist
© 2014 The Vanguard Group, Inc. All rights reserved. Used with permission.