The Spectre of Asia’s Property Bubbles
Peter is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
If you listen to some financial commentators, they will describe the situation in China’s iShares FTSE China 25 Index Fund (NYSEMKT: FXI) real estate market in terms that make it seem like the next Asian financial crisis is right around the corner. While many of these cries are coming from the same corners that are also claiming the U.S. property market has turned the corner, they do nothing to build credibility in my mind. No one is denying that there is not a contraction going on in China’s real estate market. The same type of situation exists in Vietnam Market Vectors Vietnam ETF (NYSEMKT: VNM) as well with those watching that market prognosticating a similar catastrophic outcome. Both were fueled by the rapid inflow of capital and economic expansion mixed liberally with, accommodative monetary policy that encouraged an over-investment and speculation in real estate.
The response in both countries has been to apply very tight monetary policy and other legislative controls on the market, some more elegant than others, in order to first stop the speculation and then ease the market down without causing the dreaded hard landing that modern economists are terrified of. Jim Rogers thinks the worst is behind China while Marc Faber sees nothing but disaster ahead; two men with similar economic philosophies, more Austrian than Keynesian, and excellent investing track records, saying completely different things about the medium term prospects for China’s property markets. They can’t both be right.
The questions that have to be answered are as follows then:
1) Where are China and Vietnam in terms of the cycle?
2) How bad will the fallout be?
The Near Now for China
The IMF recently has cited the lack of property taxes in China as a contributing factor to the property problem as it encourages speculators to sit on their investments longer than they would without them. While the institution of a property tax would, indeed, light a fire under the most over-leveraged of developers it is also a very crude tool that will cause further problems; more perverse incentives as capital attempts to avoid the tax. Adding the complexity of property tax will not solve anything.
If we compare the price rise in China to the other modern housing busts of the last 40 years, China’s is more comparable to the early stages of Japan’s. Housing prices never went fully parabolic like they did in the other three countries and therefore it is very likely that China has forestalled the worst of the potential excesses by putting on capital controls in a timely manner as opposed to ‘saving’ the banks by lowering interest rates further and pumping up the markets with liquidity, a la the U.S. and, before them, Japan.
The current data suggests strongly that the worst is past. The People’s Bank of China (PBOC) began loosening credit controls as well as the reserve requirement for the banks from 21% by 50 basis points recently, but not the benchmark lending rate, still 6.56%. We have seen loans expand faster than central bank credit. They have struggled with negative interest rates for three years, but with recent CPI data coming in at 3.2% it looks like they have turned that corner, which will allow them to continue working through the excesses in real estate without having to completely crash the market. China’s current account surplus has come down to a more manageable 2.7% of GDP; allowing them to make a couple of significant changes to the Yuan which underscores the point that the hard landing scenario is off the table:
1) Last week the Yuan’s daily trading range was doubled from 0.5% to 1% telling the world that the PBoC was comfortable with the value of the Yuan
2) Increasing the quotas for Yuan available for foreign listed investment products, like ETFs, to $50 billion USD.
These moves are designed to encourage foreign investment into the Yuan at a time when confidence in the world’s financial markets is at low ebb. The target for a hard landing in China is also completely dependent on who is speaking with some suggesting GDP growth below 7% meeting the criteria. The Claymore ETF Trust (NYSEMKT: TAO) which tracks the AlphaShares China Real Estate Index has risen from a low of $12.37 in October when the worst of the news surrounding China’s property markets was coming out to $17.92 at the April 20th close, a 44.9% gain.
The Shadow of Paul Volcker on Vietnam
In Vietnam, the situation is similar while the policy controls have had to be more extreme. Instead of dealing with CPI inflation of 6.5% in 2011, Vietnam was dealing with a high of 24%. Since their markets have shallower pockets and debt to GDP ratios (both public and private) that were far higher, the State Bank of Vietnam (SBV) had to raise interest rates to 16% as well as begin wringing the use of the U.S. Dollar and Gold out of their day-to-day economy. Vietnam is still a three currency economy. It took nearly two years of Volcker-esque interest rates to finally tame inflation and force the liquidation and restructuring of a number of sectors of the economy.
In March, CPI inflation came in at 0.16% and April looks to be a similar number and that is after a 5-15% price hike in petroleum prices in March which was expected to cause the CPI to rise by as much as 0.4%. The SBV successfully removed more than $6.3 billion in foreign exchange from the Vietnamese economy creating a far more stable environment for the Dong to operate in. This also allowed the SBV to inject liquidity to the loan market selectively to stabilize the interbank loan markets among the largest banks as well as create a stronger demand for government debt. Bond yields have dropped more than 1.6% on 5 year debt year-to-date though the yield curve remains essentially flat.
Vietnam posted a trade surplus of 0.7% of GDP in the 1st quarter of 2012 for the first time in three years, while foreign exchange reserves have risen more than 50% in the past nine months.
The Future of Ghosts Past
In both countries there will be after-shocks of their property bubbles for a long time. As a result there is little doubt as banks and real estate companies complain bitterly in the press for more to be done. The banking sectors are still fragile and prices for real estate are still falling which will put a damper on the earnings of those banks and real estate developers that survive, but the economic data is signaling that the expansions have begun. There may be another quarter of slower GDP growth in both countries but the widening inter-regional trade for Vietnam and the flexibility of China’s currency policy and increasing domestic consumption are the drivers of a story that, unlike the U.S. and Europe, will likely see them grow their way out of their respective property busts.
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