News Analysis
The Chinese phrase, “surrounded by Chu songs” is probably the best way to express the current state of mainland China’s real estate market. It derives from the battle of Gaixia where the 100-thousand-strong army of the prominent Chu warlord, Xiang Yu in the late Qin Dynasty (221-206 B.C.) was trapped and besieged by Liu Bang, the King of Han’s army, six times the size of Xiang’s.
As the last strategic move towards victory, Liu Bang ordered his soldiers to sing folk songs in the middle of the night so as to make the Chu army believe that Chu had fallen and that its people had been captured.
Hearing the songs made the Chu soldiers homesick, spurring many of them to run away. Xiang Yu attempted to break away with only 26 soldiers left. He mistakenly ran into a marsh by the Wu River. Surrounded by 5000 enemies and failing to board a boat to return to the Chu Kingdom, he committed suicide. The Chinese phrase, also translated as “Chu songs on all four sides,” has since been used to refer to encountering crises on many fronts.
Like Xiang Yu’s downfall, the Chinese economy today is collapsing on all fronts. With a frozen real estate market, a manufacturing industry on the edge of collapse, a chain of financial defaults (in banks and in private funds), deteriorating relations with surrounding countries, and foreign divestment, China is already “hearing the Chu songs” everywhere.
Public Confidence
The Chinese economy ran into significant trouble in 2011 when bad debts exploded—often referred to as the “capital chain rupture.” Today China’s entire economy has been segmented into many silos. The way the failing economy is spreading geographically and across industries resembles the way booths in a market go out of business one after another.
As the country is confronted by many economic and social crises, the majority of Chinese people have either failed to notice, or don’t want to give it any serious consideration. They remain hopeful that the power of the “system” will solve problems.
On the one hand, being immersed in government propaganda and seeing people around them getting rich, they believe that the economy is soaring, that it will surpass the United States in no time, and that they will benefit from the growth. On the other hand, most people are preoccupied with their own wellbeing, and turn a blind eye to the suffering of others. It’s the narrow thinking of the majority. One day they may wake up to the reality of being trapped in the economic mire.
On the surface the Chinese economy appears to be stable. Under the regime’s propaganda, unpleasant news is either censored or published only in remote corners.
In the meantime, the regime sings its “China dream” propaganda louder each day. People are enraptured by false national pride as regime leaders act like saviors and show off their wealth. State-run media has bombarded people with gossip, talent shows, and sex scandals, and TV programs show nothing but absurd stories about Communist heroes using ’superpowers’ to defeat Japanese invaders.
Believing that confidence is more important than gold, people happily offered their own savings, which supported the economy and slowed down the imminent collapse to a certain degree. As a result, the majority of the Chinese people remain very confident in the economy, except for those who have fallen victim to it.
Beginning of the End
The “Chu songs” got even louder by late 2014. As more segments of society collapsed, other segments are starting to feel the pain. The public realizes that the economy is problematic, and is concerned about the situation. But instead of trying to see the big picture to make informed decisions, many just hope that other segments of society will perform worse and will fall faster, and that they can survive alone.
Those who are familiar with businesses in malls especially know that such hopes are false: when over a third of the stores in a mall close, other stores will go out of business one after another, and it is almost impossible for the mall to survive. The Chinese public continues to support the economy only because they choose to ignore the reality of the situation.
As public funds are eventually drained, economic failure will explode and expand to all realms of society. Therefore, once news of the economic crisis breaks out into the wide public, China will experience a rapid and massive economic downfall, which will trigger more social crises.
In the past, the regime supported public confidence by supporting the most visible and representative parts of the national economy. The failure of the state-supported economic bodies will smash public confidence.
The beginning of the end is the deep freeze in the real estate market, which has been a main pillar of the Chinese economy, and of public confidence. Since the regime injected four trillion yuan into the market in 2008 in response to the global economic crisis, real estate and infrastructure sectors (including railroad, highway, transportation, energy, etc.) have added up to be over 50 percent of the nation’s GDP.
In addition, the mammoth investment in infrastructure has been supported by real estate. For example, a large portion of the investment in the railroad or subway system needs to be recovered through increased real estate value in surrounding areas.
The real estate market has been large and highly profitable. The vast fortune flowing out of the real estate market also pushed up consumption among those who are in or close to the regime, and industries appealing to their needs, such as the automotive industry, premium retail and food services, and tourism saw tremendous growth.
From the public’s perspective, although housing prices and other costs of living have soared, the increase in the net worth of their real estate assets has outweighed the impact of inflation. As housing prices continued to increase rapidly, people held a religious-like belief that the housing prices would never drop, and considered it as a token of financial security.
Even when some areas already witnessed plummeting real estate prices, idle housing, and emerging ghost towns, people in other areas still refuse to believe that the housing prices in their areas could possibly drop. Furthermore, the more the regime implements macro controls to prevent housing prices from going up too quickly, the more people believe that the prices can only increase.
People believe the economy is improving as long as they see the housing prices increasing, the automobile market flourishing, and see packed restaurants, regardless of the accelerating deterioration of the environment, food safety, income disparity and price inflation.
The banks have been raising deposit interest rates to attract customers. That has resulted in a tighter control over real estate-related loans, which has an immediate impact on real estate sales. Some have realized that it is difficult to sell their homes, and there is barely any way to further increase prices.
Over time, the popularity of the real estate market has been dropping. The stagnant market also sank China’s local governments deeper into debt, since most of them rely heavily on real estate (from selling land and from real estate taxes) for revenue.
Compared to the loss of income from the lowered real estate sector, the money saved from the regime’s anti-corruption campaigns (otherwise corrupted)—as propagandized as they are—is just a joke. Many local governments would have gone bankrupt had the central government not been aiding them by over issuing money. But such aid cannot solve the debt problem. Currently most local governments have stopped paying debts, including bank loans and supplier bills. They are in effect already bankrupt.
Local Governments Desperate
By the second half of 2014, local governments, desperate for revenue, had lifted limits on real estate purchases to stimulate the real estate market. But the regime soon learned that no administrative measures could significantly drive up real estate sales due to the tightened control on loans. The local governments then urged the banks to loosen loan policies, but could not change their minds.
At the end of Q3, 2014, under the pressure of local governments, the Central Bank of China published guidelines to support more relaxed real estate loan policies. Despite cheers and hopes to revive the real estate market, such guidelines provide no actual constraint on commercial banks.
On the contrary, the banks used the guidelines to collect mortgages, instead of granting more loans. After October 2014, more people have given up hope that the real estate market will ever recover, as it did in 2008 and 2009. With no additional funds to stimulate housing sales and to bring in tax income, the local governments are now in despair.
What the real estate tycoons are doing is a good indicator of today’s real estate market in China. At the end of the 20th century, the regime was determined to use the real estate market as a major economic pillar and as a main source of income. But due to a much smaller monetary supply in the country at the time, the policy only created real estate hot spots in a few areas.
At that time, the best-known Hong Kong real estate businessmen, Li Ka-shing, entered Mainland China’s market to hoard land. Later on, Chinese business people who became rich—thanks to the increase of exportation after China joined the WTO—started to form groups to make speculative investment in the real estate market (examples include merchants from Wenzhou City, and coal bosses from Shanxi Province).
In the meantime, foreign capital flooded into the Chinese real estate market due to a series of favorable policies. Shanghai and other governments promised foreign investors high returns and risk protection on real estate investments, and allowed them to receive large amounts of loans with little capital.
On top of the high profit rate, the government stimulus of 4 billion yuan (US$640 million) in 2008 attracted even more foreign capital into China’s real estate market. As housing prices sky-rocketed and land sales soared, early investors like Li Ka-shing found the value of the land they had purchased over a decade ago multiplied hundreds of times. With seemingly unlimited capital from all those sources, numerous residential and commercial properties were built all over the country.
But investors are holding back now. Since 2012, newly entering foreign capital has been switching away from real estate. Local real estate bosses such as Wang Shi and Pan Shiyi are also systematically reallocating their capital as they see the high risk in today’s real estate market.
Vanke Corp, the largest residential real estate developer, is moving capital abroad by developing and selling property in other countries. Hong Kong developers, like Li Ka-shing, are also fleeing Mainland China by trying to sell property unnoticed, while still praising China’s real estate market. But since they have hoarded so much property, most of them have to sell at a very low price in hopes of selling faster. This shows that investors who entered China early are eagerly looking for ways out.
To make things worse, since less new capital is entering the market, buying power has plummeted. Against a backdrop of overall economic slowdown and increasing cannibalization from virtual businesses, demand for commercial property and office buildings are declining. The market has become stagnant.
Low-income Targets
Rigidly relying on the demand for housing reflects an unpromising future of the market. Real estate has always been dominated by the rich. From ancient China to Europe, land has been centralized in the hands of big landlords or aristocrats, who hire farmers to work on the land. The value of farm land depreciated after the first Industrial Revolution, while urban land appreciated.
When society moved into a highly industrialized era, a house on 0.1 acre of land could be priced higher than 100-acres of farmland in a rural area. The capital market then came into shape in industrialized societies whereby social wealth is relatively evenly spread and people’s interests are more tightly tied together. Real estate became a major part of the financial market as a result of real estate securitization.
Since China joined the WTO, foreign investment funds, often amounting to hundreds of millions of dollars per project, entered the Chinese market. Such funds, coupled with bank loans, became the main force in the real estate market and attracted smaller private funds to follow suit. The large amounts of capital quickly pushed up housing prices, and drastically expanded the previously very small housing market. Since 2009, real estate speculation became a popular investment method in China, and almost everyone who could afford it joined in the game.
After 2012, the so-called “rigid buyer demand” was widely propagandized as a key market driver. However, those who have a “rigid demand” are mostly lower income people who have to borrow from friends and family to make the down payment. At that point, the large funds had either already been retrieved, or had been stranded.
Most of the private funds from smaller investors were also locked down. Though more lower-income people who believe in the propaganda are still entering the market, there’s increasingly less new money coming in. By the second half of 2014, there was hardly any large real estate investment.
Experienced investors know that the market’s good times are coming to an end when low income people become the key target buyers. Unlike the U.S. mortgage crisis that resulted from government- and financial institute-backed home purchases by the lower income groups, the disaster for the Chinese real estate market comes from over exploiting private assets.
Unable to Sell
The deeper people are involved in today’s Chinese real estate market, the less confident they are. Many people think of housing prices as an indicator of the health of the market. That is why the rising housing prices keep some consumers optimistic about the market even when transactions have become stagnant. But the volume of actual transactions is in fact the true measure of a healthy market, given the high price and low liquidity of the housing market. The price itself means nothing, if no actual sales happen.
In some first-tier cities, those who own multiple properties have sensed the problem and have tried to sell at the market price. But when the properties are listed, no inquiries are received at all, even after they lower the price significantly.
In the meantime, because the banks now grant few loans for existing properties, most buyers have to use commercial loans with a high down payment and high interest rate to purchase houses. As banks further tighten loans, buyers in many areas will need to purchase with full payment, which is unlikely in most cases.
Most owners are not sure how they should price their properties. To make things even worse, the local governments set high “reference prices” for the houses and charge taxes based on those prices. So although owners are willing to lower prices, it is still hard to sell.
Private sellers are starting to realize that their assets, however high their value looks on paper, have no liquidity. Unfortunately such a realization usually comes too late. Those who bet all or most of their assets on real estate are panicking, because they are about to lose their source of post-retirement income. That will be especially difficult for older people.
At this point, except for some lower income and economically uninformed people who are still considering purchasing for their own use, many have seen how bad the market is. Confidence is dropping, dragging purchases down with it.
Local Government Pain
But the local governments are even more fearful. The halt in real estate transactions means government revenue is flowing out. Soon the governments will be confronted with all the pains of bankruptcy, like defaulting on salaries, pensions, and healthcare payments.
As a result, on the one hand local governments have thrown out all kinds of market-stimulus policies—not so much to revive the market as to lure in purchases; on the other hand, they urge the regime’s central government and the central bank to print more money like they did in 2008.
From the local governments’ perspective, only another large scale over-issuing can help sell the houses and bring in revenue. Though Beijing expressed willingness to support the real estate industry, the chances of printing large amounts of money are minimal, to the despair of the local governments.
The collapse of the real estate market will no doubt accelerate the demise of the system, because officials on all levels have raked in additional “grey” income from real estate. Now that such income will decrease sharply, the mid-low level officials will notice a significant cut in their income and welfare, and will lose motivation. Therefore, the regime will find it more difficult to keep the system running.
A side effect of this is that the local governments will take every opportunity to exploit people in order to solve their imminent crisis and maintain the regime’s operation. As a result, more frequent and more violent conflicts between the government and the people will ensue, especially over land related disputes.
Local governments will have a hard time getting funds to repay loans and bills of construction projects. In places where the financial situation is relatively better, officials will spend as much as they can in order to make money for themselves before the government revenue drains out. The officials will also transfer their family and personal assets out of the country more actively, so that they can leave as soon as possible before the situation becomes even worse.
Society Disintegrating
Simply put, the freeze in the real estate market will lead to the disintegration of interest groups in China’s society. The nature of the Chinese economy is a communist totalitarian economy, supported by central Communist Party control, local support, and social followers (private and foreign funds).
Such a model resembles that of an army in which the headquarters rule through several key branches and send large numbers of soldiers to fight and die. In such a system, infrastructure and real estate are two key pillars of the economy, and thus key tools for sucking private wealth into the centralized state economy.
The fall of the real estate market marks the outflow of private wealth and loss of interest from the remaining wealthy owners. Now the regime can hardly manipulate public funds no matter how hard they try. When private investors start thinking about their own profits and stop purchasing property blindly, the economic system will disintegrate due to the lack of fresh blood. That is similar to an army whereby many soldiers are running away and the officers are losing control.
Local economic systems are the weakest link in the machine. The local governments are haunted by debt, lack of income, and overspending. The central economic system is relatively stronger, but due to the impact from infrastructure construction and real estate market stagnancy, the central government is experiencing slow growth in tax revenue, and the state-owned enterprises see their income dropping as well.
As conflicts over limited profit grow sharper, the central government, local governments and general public are having increasingly different economic interests. Any significant economic changes will further split those three groups, and all will seek security and profit in different ways. A society torn-apart is the Chu song before the final collapse of the Chinese economy.
This article is first of a series by the mainland China netizen-author “Born 0715” at the Institute of Chinese Economy and Culture Study. It is translated from the original Chinese article.
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