From NZZ's The Market.ch, October 11:
Beijing-based economist Michael Pettis sees the looming collapse of real estate developer Evergrande as a signal that China needs to fundamentally shift away from its investment-based growth model.
Few Western observers know the Chinese economic and financial system as well as Michael Pettis. The American has lived in Beijing for twenty years and teaches financial theory at the renowned Guanghua School of Management at Peking University.
In his view, the crisis of the property developer Evergrande confirms a thesis he has been advocating for years: China's economic growth was based far too heavily on investment. «There is a lot of fictional growth at play in China, overinvestment in all kinds of construction projects has inflated growth for years», he says.
Pettis does not expect a financial crisis; nevertheless, he says, China's economy is facing major upheavals that will affect the rest of the world. In an in-depth conversation with The Market NZZ, he explains what's at stake.
How dangerous is the looming bankruptcy of Evergrande for China’s financial system?
We have to see Evergrande not as one major event, but as one of a series of events that express the unsustainability of China’s growth model. I would argue that the latest series began in May 2019 with the government intervention in Baoshang Bank. Since then we’ve had a number of interventions, the most important of them being Huarong, where the regulators had Citic take over the obligations of Huarong. Another important crisis company was HNA. And now the rumors are very strong that Ping An would be the next one, which would be much bigger than Evergrande.
Within that sequence, what’s the importance of Evergrande?
Its importance, besides the fact that Evergrande is the most indebted property developer in the world, is that this company represents the excesses in the property sector. Most estimates put the contribution of the property sector to China’s GDP at between 25 and 30%, that’s two to three times what it is in other countries. Property investment alone is about 13 to 14% of GDP. In the US, it’s about 5%. The most worrying statistic of all is that homes represent about 80% of household wealth in China. In Japan, during the property bubble of the 1980s, it peaked at 65%. In most countries, it’s about 30 to 40%.
What does that tell us?
It tells us a couple of things. One, that property prices are very high in China; it’s probably the most overvalued property market in the world. Two, more importantly, it tells us that if property prices go down, there will be a significant wealth effect on households. If your wealth goes down, the way you react is that you spend less and save more.
Just to be clear: Are we talking about a speculative bubble here?
Yes. Because economically, it’s very hard to justify an economy that is two thirds of the size of the US, with having property that is worth twice as much as US property is worth. It’s not as if US property is cheap. It’s probably too expensive in the US too, which means it’s incredibly expensive in China. The amount of income it takes to buy an ordinary apartment in China is several times what it would take even in Switzerland.
You recently tweeted that a speculative bubble never corrects by going sideways. It has to keep growing, or it will collapse.
When you are in a fundamentally sound market, you buy an asset because it has a value to you, and that value is greater than the price you pay. But when you are in a speculative market, you buy an asset because you think its price will be higher tomorrow. In China, the market is extremely speculative. I have students that are 19 or 20 years old, whose parents buy them apartments, because by the time these students are 25, their parents fear they won’t be able to afford an apartment. That is the essence of speculative buying: You’re only buying because you know prices are going up.
What will happen when they stop going up?
When prices no longer go up, two things happen: One, a lot of the demand disappears, because the only reason people bought was because of ever rising prices. Two, many people have borrowed money to buy apartments, which they are not renting out, because rental yields are very low. Don’t forget: nearly a quarter of all apartments in China are empty. So when prices are not going up anymore, these people are losing money on their apartment. What would you do in that situation? You would probably sell it. So you’ll have less buying and more selling, and of course that drives prices down. You know, I was a bond trader before I moved to China, and that was one of my fundamental learnings: Once the market enters a speculative stage, it either goes up or it goes down, but it does not go sideways.
Baoshang, Huarong, HNA: These bankruptcies were all digested rather smoothly within China’s financial system, without triggering a crisis. Is that a blueprint the regulators will be able to repeat with Evergrande?....
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