China's Housing Bubble

The Chinese housing market appears to be in a bubble and that bubble appears to be bursting right before our eyes. On my recent trip to China it was impossible not to be impressed with the number of cranes that dotted the skyline of each city I visited. During my meetings and in subsequent meetings at my office, Chinese CEO's defended the housing market with the same answers. "In China owners have to put 30 percent down so banks are protected." "The Chinese economy is growing so fast that the demand for housing from over 1 billion people will support the housing market for a long time." "The Chinese government will never let a disaster like the US housing market happen in China."

While most of this is true it does not negate the two critical facts that China has overbuilt and that the affordability ratio is at an all time low. As with the US, housing bubbles take time to burst. First you have to have overbuilding, then you need prices that take the man in the street out of the market. Finally price increases slow while speculators toss the proverbial hot coal around, but once speculators realize that prices are softening they stampede for the exits and the market bursts.

Currently there are 64 million housing units that are empty and building continues on another 30 billion square feet. The Chinese government recently concluded stress tests at banks based on a 50% drop in the price of housing. A drop of this magnitude would clearly wipe out the home buyers 30% deposit and put the market into a crisis worse than the US.

Why would it be worse? If this were to happen a significant portion of the construction projects underway would be placed into mothballs resulting in millions laid off from work. This could result in the type of social unrest that the Chinese government has feared for years. Furthermore the Chinese government would be forced to implement a massive stimulus program targeting the laid off workers. In other words massive infrastructure projects would be undertaken. Where would all this money come from? More than likely a massive withdrawal from US government bonds.

If this theory works out correctly, expect the global repercussions to be severe as rising interest rates would drag the US economy once more into a recession and this time Bernanke and his Federal Reserve cohorts will have no ammunition left to fight off the collapse.