One fantastic part of the China Story today is the way the liquidity was created. According to the legend, Deng Xiaoping sent out a group of economy whiz kids on a Journey to the West to figure out where all the cash was coming from. They returned with the surprising observation that alot of it came from houses. On average, houses and other real estate in the West had a hypothecary loan to half of the property value. This is considered a low-risk loan, so the interest rate is low, close to zero, when compensating for inflation. This money was available to the house owners as “free cash” to buy cars and televison sets. Remember, this was in the end of the eighties.
Unfortunately, there were two obstacles from duplicating this in the China setting:
1. All property was owned by the state, who would not have any benefit from the liquidity.
2. The valuation of the houses was very, very low.
Therefore, the China government set out on a plan to eliminate these obstacles, and introduced a right-of-use ownership-light for real estate in the city areas. Formally, the right-of-use is temporary for 70 years, but most observers think that it will be extended into real ownership. But anyway, who knows what the world will look like in 2060?
The next move was to increase the valuation of the houses. This was done in a way that is not well reflected in the press coverage in the West, by eviction compensation. Whenever a motorway was built, or a Hutong was razed to give space for a shopping mall, the previous residents were paid a generous compensation. The logic was that the government only needs to pay one house-owner a good compensation, and then automatically all the houses in the neigbourhood would be worth the same or more. A driver of a friend in Beijing cashed out a million RMB for a shed, and used the money to move up the value chain and started a transportation company.
It has worked wonders. Real estate prices have soared with 15-20% increase year after year for decades, and a deluge of cash has resulted in a flood of iPhones and Audi cars.
Unfortunately, it has now gone too far, as clever entrepreneurs have found ways to abuse the system. What we see now is that you can build a house for a million, and get it “valued” to 10 millions. Then you take a 5 million RMB hypotecary credit with low interest rate, as the amount is only 50% of the house value. For the money, you can pay back your first inserted million, and you have four millions for consumption. Or for repeating the trick and building four more houses. Cash is generated, even if nobody lives there! Around every Chinese city, there are thousands and thousands of houses standing empty, in some areas whole cities without inhabitants. It has been a terrific boom for everybody selling bricks, glass, construction machines and door handles.
Two cornerstones of the scam are the shortsighted valuation process and the lack of transparency at the banks. Both these processes are completely opaque and there is really nobody who has a short term interest in slowing down the dance. This year it is slowing down a bit, as the government is trying to reduce the craze, without killing consumption. Good luck!
– afterthought –
I think that this scheme leads to a huge waste for the society, especially since many of the houses are poorly built and will have to be torn down, maybe even before somebody has ever lived there. On the other hand, ten million people move in every year from the countryside to the cities, and as most of the statistics are secret, it is hard to predict how long time it will take to fill up the houses with migrant workers.