Property prices are the hot topic in China right now.  With the average house price up 10.7% yoy in February and house prices in some areas of the country rising much faster, the government has promised to step in to control the market.  But action has been slow to follow words, and some netizens have evidently concluded that the government is dragging its feet.

One enterprising blogger has pasted together several pictures of Premier Wen Jiabao and added some comical text to capture the Premier’s thought process on how to control runaway property prices.  The pictures show Premier Wen holding up first one, then two, three, four, five and six fingers, presumably to enumerate the six points of an argument he is making.  Underneath the pictures, the blogger has Wen saying:

‘I’m very distressed, at CNY10,000 per square meter, how can ordinary people afford to buy a home?

Now there are even some areas where the price is CNY20,000 per square meter, that’s just unreasonable!

What?  Hangzhou prices have hit CNY30,000?

No! CNY40,000? House prices that high are not natural!

Wow!  Do we really have house prices at CNY50,000?

Well, if they are already that high, we’ll wait till they get to CNY60,000, then introduce some controls.’

I think there might be some cleaning up of this particular joke, but I found a copy of it here (you have to scroll down a bit to get to it)

Culture, Property

How serious a problem is China’s property bubble?  King of the China bears Andy Xie thinks its pretty serious, and on Friday I had the chance to hear him presenting his views.  The main points from the presentation are:

‘The Chinese response to the financial crisis has followed that of the US.  But where in the US a financial meltdown required near zero interest rates to keep the banking system solvent, in China there was no problem with the stability of the financial system.  Very low interest rates were inappropriate for the Chinese economy.  With the Chinese banks motivated to lend to appease their shareholders in Hong Kong, and the property sector motivated to borrow by very cheap rates, a year and a half of very relaxed monetary policy have made the Chinese property sector bubble bigger.

Property in China is a government business.  Many property sector developers are owned by local government.  For those that are not, the cost of land and taxes are so high that they are effectively just middle men for the government.  Property is the most important source of government revenue

The government is caught in a vicious cycle.  Property prices rise, which means that property developers demand more land to build on.  To meet that demand for land, local government has to clear residents away from more and more areas.  Residents see that to buy a new home, they will need large amounts of money.  They demand huge amounts of compensation - Xie mentioned a household in Shanghai that received CNY1mln compensation for being forced to leave a 10 metre square apartment.  The government is now massively in debt as a result of the high cost of compensation, and so needs to sell the land on at high prices to recoup its costs.  Property developers buy the land at high prices, and so can only turn a profit by selling high end property at high prices, and the cycle continues.

Land is now so expensive that only state owned enterprises, that face no real budget constraint, are willing to buy.  With state owned enterprises the only buyer, the property sector is just a series of transfers between different parts of the government.  State owned banks lend money to state owned enterprises who use it to buy land from the state. 

Local governments are waiting for private sector property developers to buy land.  Their attitude is that private property developers only exist with their approval, so their money is really government money, and can be extracted at will.  Private property developers might look big and powerful, but according to Xie they are being squeezed by the government, with profit margins of 50% a few years ago, 25% today, and non-existent if developers are forced to buy land at today’s high prices.

This state of affairs can’t continue for much longer.  In Hong Kong, property is expensive but other taxes are low.  In China, property is expensive and other taxes are high.  The middle class - grauates of the 1990s who are now earning CNY10-15K/month - are getting squeezed.  This is the most able and vocal of China’s social groups.  Xie pointed out that journalists are also in this group, which is why there is so much negative press attention on the housing issue.

Inflation will be the pin that pricks the bubble.  Xie believes that China is entering an age of high inflation.  Xie pointed out that in the 1950’s, Chaiman Mao encouraged families to have multiple children to boost the Chinese population.  ’Hero mothers’ that had 10 children could even meet Mao.  In the 1970s, the children of the resulting baby boom hit their teenage years.  The result was the cultural revolution.  In the 1990s, they entered the labour market and excess labour supply kept wages (and inflation) low.  Now they are leaving the labour market, wages will start to rise and with them inflation. When inflation returns, the Chinese government will be forced to raise interest rates.  When borrowing becomes more expensive, house prices at today’s high levels will not be sustainable, and there will be a sharp correction.  Xie’s intuition is that this will come in 2012.’

Interesting stuff.  I had not heard the argument about compensation for relocation before, and don’t think it is as important as an explanation for high land prices as local government’s need to close the gap in their finances.  But in general, a compelling account of the drivers and motivations of the key players in the most important sector of the Chinese economy.  Also fascinating argument about the role of demographics and Mao’s ‘hero mothers’ in China’s recent social and economic history.

Banking, Financial Crisis, Fiscal Policy, History, Labour markets, Monetary Policy, Property, Social Policy

On Tuesday, Premier Wen Jiabao met with foreign business leaders.  Top of the agenda, trade, of course.  But also in evidence, Premier Wen’s rhetorical flourishes.

Answering a question on cooperation between countries in response to the economic crisis, Premier Wen busted out with ‘when you’re in the same boat, you have to row together’ (同舟共济) - which incidentally is reminiscent of Secretary of State Clinton’s turn of phrase when she visited Beijing this time last year.

Then, in response to a question on whether China and the US would be able to find their way in the bilateral relationship, came:

‘In China we have a saying, sometimes when you’re lost in the wilderness, out of the shadows comes the light of a village’ (山重水复疑无路，柳暗花明又一村).

Here’s the complete text of Wen’s answer.

Culture, US-China Relations

I am currently ploughing through Brothers, Yu Hua’s tragi-comic epic of Chinese life from the cultural revolution to the reform era.  A translation of Brother’s into English has already been published.  But for those who might not have picked up a copy, here is my translation of the first couple of pages:

‘Our town’s richest man, Liu Guangtou, prone to wild flights of fancy, planned to spend $20m to travel to Russia and take a tour into space.  Sitting on his famous gold plated toilet seat, Li Guangtou’s mind had already drifted into orbit, from where he looked down on the world.  Then, unbidden, tears started to well up in his eyes, as he realised for the first time that he had no friends or family in the world.

One upon a time he had a brother, Song Gang.  Older than him by one year and taller by him than a head, kind, honest and stubborn, Song Gang had left this world three years ago, and his ashes now resided in a little wooden box.  Thinking of how few the ashes of his brother were, Li Guangtou was deeply moved, reflecting on how the ashes of a tree were greater in number than the ashes of his brother.

When Li Guangtou’s mother had still been alive, she was fond of saying to her son: ‘different fathers produce different sons.’  With these words, she referred to Song Gang, honest, sincere, and kind, from the same mould as his father, like two melon’s from the same vine.  When she was talking about Li Guangtou, she didn’t use these words, but would just shake her head and say that he and his father had walked different roads.  At least that was what she said till a fourteen year old Li Guangtou was caught peeping at women’s bottoms in the public lavatory.  At that point, his mother finally knew that Li Guangtou and his father were also melons from the same vine.  Li Guangtou clearly remembered his mother averting her eyes in horror, wiping the tears from her eyes, saying: ‘with that kind of father, you are bound to have that kind of son.’

Li Guangtou had never seen his flesh and blood father.  On the day of Li Guangtou’s birth, his father had made his stinking and notorious exit from the world.  His mother had said that his father had died from drowning.  Li Guangtou had asked how he had downed, in a lake, or a pond, or a well?  Later on, after he had been caught peeping in the public toilet, the scandal had spread round the town, and his notoriety was widespread, only then did he discover the real reason for the death of his papa: drowned in shit after himself attempting to sneak a peek at women’s bottoms in the public lavatory.’

For anyone confused about the mechanics of peeping in pre-reform era toilets, I believe the public toilet was essentially a plank with holes in suspended over a sewage pit, with men’s and women’s sections separated by a divide.  Instead of sticking their posterior into the holes too make use of the facilities, Li Guangtou and his less fortunate father appear to have stuck their heads through to peer at the women’s bottoms protuding through the plank on the other side of the divide.  Li Guangtou’s father evidently lowered himself down too far into the hole, lost his grip, and fell into the sewage pit below.

The opening paragraphs capture the bawdy physical humour with which Yu Hua deals with the extremely sensitive, and occassionally horrific, subject matter of life during the cultural revolution.

Culture, History

Local government debt is back in the headlines.  Today, I attended a presentation by Prof Victor Shih, who has just finished some fairly extensive research on the debt taken on by local government investment entities.

The starting point for Prof Shih’s argument is that last year’s massive economic stimulus was massively underfunded by the central government.  Local governments were left with colossal spending obligations but no obvious way to pay for them.  The solution for many local governments was to set up local government investment entities to borrow the money on their behalf.

The process is quite simple.  Local governments set up a financial company and give it some land.  Using the land as collateral, the financial company, which is wholly owned by the local government, borrows money form the banks.  That money is used to fund local government’s investment projects.

Prof Shih’s calculations suggest that money owed by these finance vehicles now adds up to around CNY11trln - or about 1/3 of Chinese GDP.

This money will now have to be paid back.  If, as seems likely, the revenue stream from the projects in which it has been invested are not sufficient, some other way will have to be found.  Land sales, higher taxes, or reliance on a bail out from the central government are the most likely options.

The government might have kept the majority of economic stimulus spending off balance sheet, but the bill will still have to paid.

Chinese economists are also alive to the problem of local government debt.  These are the main points from a recent blog post by Guo Tianyong:

‘Many of the projects funded through local investment vehicles are not commercially viable.  A visit to local areas revealed projects that will not generate revenue for 5 or even 10 years.

That will mean that responsibility for repayment falls back at the door of local government, which has acted as guarantor of the loans.

If the real estate market wobbles and land prices fall, the repayment ability of local government will also come into question.

Properly understood, local government finance risk and bank credit risk are now two sides of the same coin.

A more sensible approach for the future would be for local government to invite bids from the private sector to build local infrastructure.  If projects are commercially viable, there should be no problem.  If the project fails, the private sector is left with the debt, and its no burden for the government.’

You can see Guo Tianyong’s blog post here.  Prof Shih’s research has been getting a lot of play and you can see a summary of it here.

Banking, Financial Crisis, Fiscal Policy, Infrastructure, Property, Regional

Guo Tianyong is a professor of finance at the Central University of Finance and Economics and an expert on China’s banking industry.  He also used to work for the People’s Bank of China’s Yantai branch.  This is my translation of the main points from his recent blog post on the question of capital adequacy ratios (CARs) at China’s banks:

‘Very high levels of lending by China’s banks in 2009 was an essential part of the stimulus, but they also meant that CARs have taken a hit.  Continue lending at elevated levels in the first few months of this year has made the problem more severe.

To ensure the stability of the banking system, the banking regulators require that small banks maintain a CAR of 10% and large banks a ratio of 11%.  The regulator also moved to control the purchases of banks’ subordinated debt by other banks.  This raised the cost of capital for banks and made it harder for them to meet their CAR.

The CAR puts pressure on banks’ ability to make new loans.  With banks’ business model built around profits from lending, and bank loans the main source of finance for most businesses, this is a serious issue.  There are various routes banks can take to control their CAR.  They can use their own profits, sell shares, bring in new strategic investors, or issue subordinated debt to increase the numerator of the ratio.  They can also take steps to reduce their loans - for example securitising loans - which would reduce the denominator.

First, let’s consider ways to increase capital - or raise the numerator of the CAR.  Issuing shares is often a preferred method of raising capital, but the cost of capital raised in this way is rather high.  Issuing debt has also been a preferred method, but the clamp down on the issuance of subordinated debt has raised the cost.  With high costs to selling shares or issuing bods, bringing in strategic investors seems like an attractive option.  Bringing in strategic investors keeps the cost of capital down, strategic investors can bring in new ideas and expertise, and with the government’s controlling share in many banks still close to 70%, there is considerable scope to bring in new investors without even coming close to losing majority control.

Second, banks can improve the management of their loan books - reducing the denominator of the CAR.  Loan transfers and securitisation are important routes to managing the CAR.  But because currently only other banks participate in the market for loan transfers, and because of lack of transparency in transactions, the credit risk in loan transfers can only shift within the banking system.  Securitisation of loans has greater potential to help banks optimise their loan books, meet their CAR, and bring greater stability to the banking system.

In the final analysis, however, neither raising more capital nor optimising loan structure gets at the heart of the problem.  Chinese banks’ profit model is based on issuing ever increasing quantities of loans. Inevitably this leads to an erosion of the capital base.  Issuing more loans and then raising more capital to bring the CAR back to the required level is not a sustainable business model.  China’s banks need to move toward a business model that does not rely on ‘eating capital’.

Banks need to develop intermediary services as a source of revenue.  Foreign banks get 40% of their revenue from intermediary services, for domestic banks that number is just 15-20%.  Individual banks need to develop and compete on the basis of their own unique competences, competences that meet needs in the market.  Finally, banks should develop a model of capital replenishment that is counter-cyclical, using profits from the good times to build up their capital base so that they have a buffer for the bad times.’

You can see the blog posting here.

Banking, Monetary Policy

‘Safety first’ (anquan di yi 安全第一）is one of the phrases you hear and see most often in China.  Whether it’s walking past a building site with workers suspended precariously from bamboo scaffolding, or queuing to have your bag scanned by bored adolescent security guards on the metro, billboards will remind you of the priority given to safety in China’s public life.

But if safety is first, what is second?  Following a conversation with a taxi driver skidding across a snow covered road in Beijing this morning, China Translated can exclusively reveal that priority number two for the Chinese people is making money, with relaxing coming in at number three.

Safety first (anquan diyi  安全第一)

Making money second (zhengqian dier 挣钱第二)

Third, relax (xiuxi disan 休息第三)

Culture

I have an article in today’s South China Morning Post on where China is investing its USD2.4trln in FX reserves.

SCMP subscribers can read the article here and I’ve also pasted it below.

The USD2.4trln mystery

Where exactly is China investing its US$2.4 trillion in foreign exchange reserves? Most economists agree that a substantial chunk, and perhaps the majority, of those reserves are invested in US Treasuries - debt issued by the US government to finance its spending.

Until quite recently, monthly data published by the US Treasury supported that thesis. The Treasury International Capital System (TIC) - a massive data collection effort by the bean counters in Washington - showed a steady increase in China’s holdings of US Treasuries. Holdings did not increase by as much as the increase in China’s foreign exchange reserves, but they did grow steadily enough to confirm that China’s State Administration of Foreign Exchange remained the US Treasury’s best customer.

But, in the second quarter of last year, that relationship started to break down. China’s foreign exchange reserves continued to grow at a rapid pace, but the Treasury data picked up little if any increase in China’s holdings of US Treasuries.

Data from the People’s Bank of China shows that between April and December last year, China added a whopping US$441 billion to its foreign exchange reserves. But according to purchases picked up by the monthly TIC data over the same period, China’s total holdings of US Treasuries fell by US$12 billion.

That discrepancy flies in the face of common sense. China has continued to run a substantial trade surplus with the US. If Beijing’s foreign exchange managers were not reinvesting that surplus in US dollars, the brutal logic of supply and demand in international currency markets would force the yuan to appreciate against the dollar. But it has not, suggesting that China continues to park its reserves in US dollar debt.

Enter the Treasury’s annual survey of foreign holdings of US securities, which pieces together who is really buying US Treasuries. The results of the latest survey show China’s purchases of US Treasuries continued unabated. The results propel China back into first place as the biggest holder of US Treasury debt, with US$894 billion.

What the annual survey captures, that the monthly data misses, is a bias in the monthly data that attributes Treasury purchases to the place they are purchased, not the country of ownership.

Beijing’s foreign exchange managers appear to be taking advantage of flaws in the system to hide their purchases - deliberately channelling purchases through London and other centres to hide the increase in their holdings.

The motivation is probably partly domestic public opinion, which is decidedly averse to financing the profligate US government. At the same time, signalling intentions to the markets makes little sense.

For Beijing, hiding its purchases of US Treasuries plays to the nationalist gallery by hiding the fact that China continues to fork out its cash to finance the US deficit. And it keeps the financial markets guessing on where China is investing its money. If that means the rest of us also stay in the dark, that’s just too bad.

Exchange rate, International Relations, Monetary Policy, US-China Relations

China’s National Bureau of Statistics (NBS) gets a lot of stick, but in the last year they have actually acquitted themselves rather well.

First, movements in the official GDP data seem to have been a fair representation of the state of the economy - with little evidence of the political manipulation that was feared at the beginning of 2009.

Second, where there were oddities - like a mismatch between electricity output and GDP in the second quarter, the NBS did their best to explain them.

Now, the NBS is promising to publish wage data which disaggregates high and low wage earners - responding to the widespread criticism that the average wage data is biased upward by a few high earners.

This is my translation of the main points of a recent news article on the planned revisions to the wage data:

‘On the 23rd February, the head of the NBS bureau of population and employment Ping Nailin revealed that the way wage data is produced by the NBS will be revised, including showing the composition of wages and difference between high and low wage earners.

Ping said that the current approach to publishing average wage levels did not well reflect the situation in the labour market.  The NBS will conduct experiments with the new approach in 2010, with a view to a wider roll out at a later date.

Responding to questions about the popular belief that the NBS data overstates wage increases, Ping acknowledged that there were weaknesses in the wage data system, including failure to capture wage data from workers in private enterprises, and problems with the average wage level being dragged up by a few high wage earners.

Ping said that wages for employees in private sector firms have already enterered the NBS calculation.

Responding to concerns raised by netizens about wage growth in relation to GDP and the CPI, Ping noted that in almost all years since 1990 wage growth has outpaced GDP growth, and it has outpaced increases in the CPI in every year.’

We covered the popular criticism of NBS wage data in our post on New Words for 2009.

You can see the news article with Ping’s comments here.

Labour markets, Statistics

The National People’s Congress - China’s annual two week policy talking shop - kicks off this Friday.  Last year’s NPC set the course for a year of extraordinary economic stimulus.  This year, it is possible that the government will use the meeting to build consensus around support for a normalisation of economic policy.

The Economic Observer reports the outcome of an pre-meeting press conference where an official spokesman spelled out the main thirteen issues for discussion.  It’s the usual laundry list of refining macro-economic controls, expanding domestic demand, giving priority to education and health, fighting corruption, and so on.

One of the Economic Observer’s readers hits the nail on the head with a comment posted on the article:

‘Every year its the same, there’s nothing new here.  But the question is not whether these problems are old or new.  The question is when will the solutions be delivered.

We hear these problems so often that we are numb, everybody is numb.

Today a meeting, tomorrow a meeting, but when will there be a solution?’

Here’s a link to the Economic Observer article.

Communist Party