–We’re going to take a break from the European Union/US Dollar death watch today to focus on something closer to home: China. And we’ll begin with a simple observation: Central planners are definitely no fun.
–China’s National Development and Reform Commission (NDRC)-the bureaucracy responsible for planning China’s economy and implementing its five-year plans-has recently forbidden the construction of big new theme parks in China. Parks already under development, like the new Disney theme park in Shanghai, the Hello Kitty park, and the Monkey King park in Beijing, are okay. But the rest face the chopping block.
–What is behind this attack on fun?
–Well, it turns out there’s been a bit of a theme park boom in China. The official explanation is that the theme parks are a result of the rise of China’s leisure class. A rapidly urbanising population with money in its pocket (higher per capita incomes) needs a place to kick back and escape the rigours of modern industrial life. And everybody loves a Magic Kingdom.
–But there is obviously more here than meets the eye. So what gives?
–It’s one of many recent attempts by China’s central planners to halt a speculative property boom. This pits the NDRC against local governments. And it is evidence that the Chinese property boom is becoming a bigger threat to China’s economy, its growth, and thus Australian resource exporters.
–But let’s back up and look at the facts. The NDRC has only banned the construction of theme parks larger than 20 hectares and with development costs higher than around $80 million. This means it’s only targeting large-scale developments that could be residential property projects in disguise. This puts it directly at odds with local governments.
–Local governments in China benefit from rising land values in two direct ways. First, land sales are a source of direct revenue. According to UBS, local governments get as much as 30% of their total revenue from land sales. Thus, the higher land prices are, the more revenue for local governments.
–The second benefit is more complicated. It results from the 2008-2009 directives by Beijing to spend money on infrastructure to promote GDP growth. This was China’s famous $600 billion official stimulus program. But that was just the central government response. Less famous but even more dramatic was two consecutive years of over $1 trillion in new loans made by China’s banking system.
–Local governments and property developers were the biggest borrowers. And here is where property comes back into play. In order to borrow money, China’s regional governments set up the equivalent of off-balance sheet entities. The acronym you’ll need to be familiar with is LGFV; it stands for local government financing vehicle.
–The LGFVs have borrowed hundreds of billions of dollars from Chinese banks to finance a cornucopia of development projects. The collateral for these loans – when collateral was posted, and sometimes it wasn’t – is property. Thus you have a massive property and building boom financed with borrowed money and securitised by rising property prices.
–Does this sound familiar at all?
–Now China is dealing with two aspects of the same problem: a property bubble and a bad loan problem. There are close to 65 million vacant apartment units in China – enough for every Australian to have his or her own overseas crash-pad. Yet because of rising property prices – and an affordability crisis – the central government plans on building an additional 40-50 million low-priced housing units in the coming years.
–Of course, you might argue that 65 million vacant units is a statistical blip in a country with 1.3 billion people. Sooner or later, the argument goes, enough people will migrate from the farm to the city and have enough income that they’ll be able to buy those empty units. Just give it time.
–But the big issue with China’s investment boom is how productive it will turn out to be. Will the projects built by LGFVs generate enough cash flow to repay the loans? Based on the research we’ve done in our most recent issue of Australian Wealth Gameplan, the answer is, “No chance in hell”.
–Not everyone will agree with that conclusion. For example, investment in infrastructure doesn’t always generate enough of a short-term return to interest private capital. But you could argue that the long-term benefit of sound infrastructure – bridges, roads, railways, ports and the like – is that it creates the physical setting for growth, commerce, and business development. All these things will eventually generate incomes, trade, and taxes, and some return on government investment.
–That’s the textbook case for large-scale government borrowing to finance infrastructure. The question is, how much of LGFV borrowing has financed critical structure and how much has simply gone into property developments and vanity projects? Even worse, how much has gone into make-work projects designed to keep people busy?
–The answers to these questions are going to start coming this year. Stay tuned. You have the NDRC vs. the local governments. And you have inflation in China – a product of the central government’s currency policy – forcing people into the stock market and property as a way to beat that inflation. It’s no-win financial by-product straight out of the textbook of Keynesian economics.
–All of this may turn out to be just a blip on China’s path to 21st economic ascendancy. And that brings us back to the Monkey King. China is an old culture. Its experiments with unsound money are relatively new. And they needn’t impoverish it. But they could make for a rough ride.
–The story of the Monkey King is one of the four great novels of classical Chinese literature, according to our research. The Monkey King is a monkey born from stone. He acquired supernatural powers, such as the ability to change into one of 72 different shapes. He can travel in the clouds. And each of his hairs can be plucked and cloned into another Monkey King.
–After gaining great power, the Monkey King eventually rebelled against Heaven itself. The forces of Heaven and Hell were unable to defeat him. If anything, he became more powerful until Buddha trapped the Monkey King under a mountain and imprisoned him there for five centuries. He was only freed in order to accompany a pilgrim, Xuanzang, on his journey to the West to retrieve Buddhist scriptures from India.
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