Is There a Real Estate Bubble in China?

On CBS, 60 Minutes ran a piece about China's real estate bubble.  You can watch it here.  While I'm not a big fan of watching news programs on regular television, I do find that 60 Minutes tends to be more educational than most.

I have been talking about a real estate bubble in China for a few years now.  I suppose this makes it the perfect bubble, because it lasts longer than what seems possible.

I am impressed by the growth of China's economy over the last three decades.  It is remarkable what a little liberalization will do.  A crack in the door for the free market has led to hundreds of millions of people finding their way out of poverty.

With that said, China cannot escape the Austrian Business Cycle Theory.  A loose money policy and artificially low interest rates have led to an artificial boom.  It will eventually result in a bust.  China will experience its first modern day recession and it will be a bad one.

I have known for a while that the Chinese real estate market is out of control.  Watching the segment on 60 Minutes, I was still surprised.  I had no idea it was this bad.  There have been cities built for millions of people which are virtually vacant right now.  Most people in China are still too poor to afford the housing that has been built.  The only way to solve this problem will be for a dramatic drop in prices.  But this will be really painful for a lot of people.

The Chinese real estate bubble will make the U.S. real estate bubble look benign.

There are objections to my predictions of a Chinese real estate bust.  Some people say that we can't be in a bubble because there are too many people talking about a bubble.  When the U.S. housing bubble popped, there weren't that many people predicting it.

But just because some people see a Chinese real estate bubble now, it doesn't mean it can't be a bubble. 60 Minutes is an American program.  It is often easier to see from the outside.  If you talk to the average Chinese guy on the street, you will probably get a different sense.  The average Chinese guy will probably sound more like the average American did in 2005.

Another objection is that there is less leverage being used in China.  They aren't taking out these creative mortgages that we saw in America.  Many properties in China are bought with 50% down payments.  Chinese people tend to be quite frugal and save a lot of money.  Real estate is a place that people have found to try to protect their savings.

So while this might ease the burden on banks and even the property owners (except that it makes it harder to walk away), it doesn't mean there can't be a bubble.  There was a gold bubble in 1980, but it was not all due to leverage.  The tech stock bubble in the late 1990's was mostly through people buying stocks with saved money.  There was not a huge amount of leverage involved, at least relatively speaking.

People can drive up the price of an asset without using a lot of leverage.  If it is being driven up due to false signals from the central bank's monetary policy, then we should expect a bust.

I fully expect a real estate bust is coming in China.  It will be very painful for people living there.  It will have its effects on the American economy.  The question is not so much if, but when.

Similar to the U.S. and elsewhere, there is a giant misallocation of resources that has taken place in China.  It needs to be corrected through a deep recession.  Maybe then China can try true free market capitalism.