“Preparing for the (Possible) China Crash”

Continuing the string of posts about the Chinese economy, this one from Business Weekly about what might trigger a crash here:

“A lot of people in the broader market are now asking these questions that they weren’t asking before,” says Patrick Chovanec, a business professor at Tsinghua University. “Before, the China story was so powerful that it overcame all doubt. Now there has been a big shift in sentiment.”

If a crash or slowdown occurs—which most analysts define as growth below 7 percent—it will be brought about either by inflation or a reversal in real estate. The Chinese Communist Party is loath to allow high inflation, says Chovanec. In the 1940s, hyperinflation turned ordinary Chinese into Communists. Inflation of around 20 percent was one reason protesters took to Tiananmen Square in 1989. Should inflation exceed 10 percent for long, “they pull a Volcker,” says Chovanec. Paul Volcker, the former U.S. Federal Reserve chairman, defeated high inflation in the U.S. with rates so steep they plunged the country into severe recession.

In real estate, the party has gone on too long. As Nicholas Lardy of the Peterson Institute for International Economics points out, inflation in China is outstripping the one-year savings deposit rate of 3.5 percent. That prompted many Chinese to pour parts of their savings into apartments. Already, 9 percent of economic output comes from residential housing investment. It was 3.4 percent in 2003. With the building boom well under way, supply is finally outstripping demand. The unsold inventory of apartments has gone from zero last summer to about three months’ worth now, according to Standard Chartered Bank.

If apartment prices fall steeply, ordinary Chinese could lose their savings, and local governments will be unable to pay off the loans they took out to invest in residential and commercial projects. Local governments also rely on land sales for over 60 percent of their revenues in some cases, says City University of Hong Kong political scientist Joseph Cheng. In a property bust, few will be buying land. A real estate reversal would drag down local makers of steel, cement, and household furnishings.

Again, this is just one possibility. It’s one worth keeping in mind, though, as we try to figure out if China will remain stable over the years to come.

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