Economics is complicated, but at least in certain respects it’s not that complicated. Chart almost any market-sensitive variable and what emerges is a wave pattern, varying in amplitude, frequency, and trend, but clearly conforming to a general pattern, mixing an irregular rhythm with a random walk.
The irregularity and randomness are predicated by elementary economic theory, since determinism and regularity are strictly equivalent to bank notes lying on the street, no sooner glimpsed than seized. Zero-risk speculative opportunities – of the kind any intelligible pattern presents – are quickly arbitraged back to noise, the equilibrium state, in which all significant information is absorbed into price.
The residual rhythm is more unexpected, and attests to an irrational factor, stimulating intellectual and practical controversy. Regardless of such disputes, it is possible to be confident about two indefinite points. Firstly, market rhythms are (almost) never easy to accurately predict, and thus exploit. Secondly, off-trend deviations will eventually be corrected, unless – very rarely – the trend itself changes shape. The qualification of the second point deserves special examination, because unrealistic expectations concerning trend-line transformations lie at the root of the most notorious error in practical economic reasoning – the belief (typically hardening in direct proportion to the inflation of a bubble) that “this time is different.” This slogan, which encapsulates the stubborn and disastrously expensive syndrome of downwards correction denial, should be written on the shirts of those who will soon be losing them.
Any market wave of sufficient amplitude crests in a bubble, which ‘pops’ in a crash. Unless this time is different – and it won’t be – China will inevitably experience such an event. Speculative commentary on the nature and timing of this event has increased markedly in volume as the global economic environment has deteriorated. Yet prediction is especially difficult in this case. China’s market economy is just a little over three decades old, with only occasional rough patches interrupting near-continuous, rapid growth. Disentangling the unsustainable component or rhythmic upswing from the underlying development path involves unusually hazy estimation, given the incompleteness of the pattern perceived.
In an article published in Caixin and Marketwatch (via), Andy Xie makes a substantial contribution to this discussion. He identifies China’s financial vulnerability with a massive asset bubble in the property market, but remains sanguine about its ultimate consequences. He argues persuasively that a very substantial write-down of real estate values, although inevitably disruptive, would have a tonic effect on the Chinese economy almost immediately, with fast recovery to follow.
Because China’s market economy does not yet have an identifiable long-term trend, Xie estimates the scale of the country’s property bubble by comparing the appreciation of real estate prices to wage growth:
China has experienced rapid increase in land prices in the past decade. Some of it can be justified by income and productivity growth due to the country joining the World Trade Organization. Most of the increase is a bubble phenomenon.
While household income may have tripled in a decade, the average land price has risen by over thirty times. Whatever income growth is to come cannot justify the current price of land. Nor can a supply shortage.
China has no shortage of land. High-rise urbanization makes demand for land quite low relative to the population. The sustainable land value is probably 70% to 80% below current levels.
The role of the property market in contemporary Chinese social life is a topic of widespread interest, both inside and outside the country. Because marriage prospects (for men) are tightly bound to their ability to provide a home, some very deeply-rooted Darwinian forces are harnessed to the appreciation of property values, making them an overwhelmingly dominant factor in economic life. For this reason, among others, a real estate crash that brought prices down to somewhere between a third and a fifth of their current level promises to be traumatizing and liberating in equal measure.
Xie recommends that China push through the pain, as quickly as realistically possible:
Some argue that the property bubble is essential to China’s economic prosperity. This is utter nonsense. While the property industry has become bigger relative to the economy over the past decade, it mostly consumes resources and doesn’t enhance overall productivity.
It is the main driver for China’s inflation. If it shrinks, the economy may suffer temporarily. However, overall productivity will rise. The resulting income growth will bring back more sustainable economic prosperity.
Also, a bubble bursts sooner or later. Government help merely prolongs it, as the Chinese government did in 2008. And the longer a bubble lasts, the more damage it inflicts upon bursting. The economy is suffering because of what happened in 2008.
The country has sufficient capacity to absorb whatever non-performing loans may come out of this bubble bursting. It could be 20 trillion to 30 trillion yuan ($3.26 trillion-$4.89 trillion). But the waste in the bubble economy could have been 5 trillion yuan.
China could overcome the legacy of the bubble in four to five years. Further, better productivity from post-bubble reforms could add another 2 trillion to 3 trillion yuan per annum. The post-bubble recovery could happen in three years.
Japan couldn’t get its economy growing after its property bubble burst. The main reason is that its per capita income was already among the highest in the world.
China is still a middle-income economy. Improving productivity is not that difficult. Reaching per capita income of $20,000 by 2030, excluding inflation, is quite possible, which would make China the largest economy in the world.