Today I had the pleasure of hearing Shaun Rein speak at a meeting of the Shanghai Foreign Correspondents Club, and considering that Shaun is known as one of China’s most outspoken bulls, he was surprising pessimistic about the country’s prospects in the near to medium-term future.
In particular, Shaun was concerned with the growing rich-poor gap in China and his feeling is that the relaxation of bank reserve ratio requirements last week was likely to fuel this problem. His feelings were expressed quite clearly in his own blog post on Monday.
China’s good times, however, might end after a major policy mistake by the central bank last week that could spur rampant inflation and trigger a speculative and very dangerous bubble in the real estate sector. The central bank dropped the reserve ratio requirement for banks by 50 basis points, signaling an end to the tight monetary policies needed to stave off inflation.
At first glance it is understandable why China’s economic planners took such a step. Faced with a contracting factory sector — the PMI index dipped below 50 last month for the first time since February 2009 —, rising fears of a euro zone collapse, and a cooling real estate sector, the central bank felt it had to ease its tight monetary policy. But, it should not have.
Essentially, the central bank signaled to the market that real estate is a one-way bet up because as soon as prices soften, the government will basically bail out developers who have unwisely taken on too much debt. Until last week for the first time in a decade, developers, companies and everyday Chinese realized real estate prices could drop and were beginning to be more cautious when investing.
Before then, as soon as people had a little money, they funneled it into real estate with seemingly little thought. If you look at the bottom lines of Chinese companies traded on the A-share market, much of their profits came not from selling widgets but real estate investments. Everyone and his aunt became real estate speculators. Shoe companies became real estate developers. Letting a major developer go bankrupt would have forced investors to be more cautious.
Fears of a real estate bubble in China have been exaggerated. A drop of 20 percent does not threaten a systemic risk. For years, there has been little debt on the residential side so there would not (and has not been) panic selling when prices softened. Strict regulations on mortgages the last two years have also kept homebuyers out of the market but created massive pent up demand.
Ironically enough, this viewpoint is considerably more downbeat than last month’s presentation at the Correspondents Club by noted bear Andy Xie. For me, count me firmly in the wishy-washy, we’ll muddle through camp.
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