The Financial Times recently had an excellent analysis entitled, “No One Home,” which opened with the exploration of a newly constructed, completely empty town outside Kunming, in Yunnan Province. Kunming, the capital of the province, has become crowded as the economic center of southwest China (while Chongqing and Chengdu battle for pre-eminence of central China). The town was built with local government funds ostensibly for the people from the countryside encouraged to move to cities. The example sets the stage for the argument as to whether China’s property market is a bubble or not.

I have no doubt China’s property market is bubbly. However, I do believe the market can and will be moderated to a point that property prices will level out over the near term. Not collapse. The problem, though, will be longer term. With more than US$1.7 trillion having gone out to local governments in 2009 – one-third of GDP – and very little transparency and accountability as to how the funds are being spent, China will almost certainly have to revivify the same toxic-loans corporations it had used to relieve its banks of the weight of non-performing loans. As one commentator cites, a 30 per cent default rate would in effect wipe out the paid-in capital of top banks such as China Construction Bank and Bank of China. I would not be at all surprised if the default rate is twice that amount, given the opaqueness of the loan process, the questionable rationale behind the Urban Development Investment Corporations the local governments set up to receive the bank loans, and the sheer volume of mid- to high-end real estate actually under construction or recently finished – property no one just off the farm can possibly afford.

Having taken this shotgun approach to revving up the economy as the world plunged into the global economic downturn, China has used up its ammunition. It’s leadership needs to audit the loan placements and ensure the projects developed with the money are actually being used for productive infrastructure projects – which, all agree, China’s interior in particular is still in dire need of. If manufacturing and service sector productivity do not actually increase in line with the largest fiscal stimulus the world has ever seen (during peacetime), then China will almost certainly head into a double dip recession.

And the world will hold its breath to see what else the Chinese leadership has in its bag of tricks.

Further reading: China at risk of home grown financial crisis; China hits back at Fitch, saying banks sound

Previous posts:

The Enron Effect and China

A Look Under the Hood at China’s Economic Engine

The Bubble Cometh

If it Looks Like a Bubble and It Smells Like a Bubble…

China is a Scam