The Chinese property market has been in a decline for about 2 years now. The problem? Oversupply.
Economic law teaches us that an increase in supply for any good creates downward pressure on its price. To get a sense for the size of this oversupply, one needs to understand that we are talking about the most populous country in the world. The population of China is roughly 1.4 billion people (as of 2014 statistics), which is almost a fifth of the population of everyone on Earth. Consider further that the median age in China is 36 and that 54% of the population is urbanized. To give you a sense of the scale of these numbers, this is approximately double the population of the United States, living in the rural countryside of China.
In the big drive to urbanize the population and sustain dizzying levels of growth, the Chinese began to build. Not apartments, mind, entire cities. Spurred by government policy, banks began loosening lending requirements and funding construction projects all over the country.
The Jingjin New City development is an example of the issue at hand. A 15 square kilometre residential villa development which has an average occupancy rate of 10-20%. But this isn’t all, the development is merely one part of an entire zone stretching to 105 square kilometres, all for residential villas and developments.
Indeed the term “ghost city” may be a misnomer in this instance. A ghost city is one which has been at the centre of economic activity in the past, but has effectively “died” due to that economic activity all but disappearing. The truth is these Chinese ghost cities were constructed for economic activity which the government planned, but which hasn’t actually materialized yet.
The economic implication of all of this wasted construction is being felt. Raw commodities, which powered the engine of Chinese growth and were bid up all through the 2000s, are tumbling. The reason is that there’s simply not enough demand now to sustain the prices that the market was previously seeing. Furthermore, supply that was commissioned under the auspices of high prices is starting to come online. The net effect is massive downward pressure on prices.
Indeed the Chinese government themselves have stated that the investment-led model would be phased out in favour of consumption-led growth. In addition, a target growth rate of 7% would be followed. This policy has been dubbed the “new normal”; an attempt to guide market expectations of growth downward.
However, for many it seems downright false that Chinese officials claim the economy is growing at 7%, especially when the premier, Li Keqiang, has said in the past that the numbers are made up. Conservative estimates place growth under 5%. This is, however, with considerable policy effort from the Chinese government, who have slashed rates, reduced reserve requirements for lending institutions and now, depreciated their currency (the first significant depreciation since 1994).
What does this mean for commodities going forward? China demands raw commodities to build infrastructure and for manufacturing, and indeed, this demand could be reduced even further now that their currency renders imports more expensive. This is actually significant; China accounts for 50% of the world’s industrial metals demand. It is worth noting, however, that the Chinese stockpile their key commodities. But, the fact is that replenishing stockpiles would still be more expensive. The outlook doesn’t exactly look sparkly.
The best case scenario is one in which the cheaper currency doesn’t spark a currency war among Asian economies (a net loss to everyone involved), boosts exports and at least maintains growth in the Chinese economy. But, one cannot be too optimistic; the Vietnamese Dong, Malaysian Ringgit and Kazakh Tenge were all devalued recently on the back of the Renminbi devaluation.
In summary, it seems that the Chinese growth story is winding down, at least for now. Pictures of these Chinese ghost cities which are springing up on the web are merely poignant reminders of this. Government long-term plans of shifting GDP from export and investment-led to domestic consumption and services-led growth need to fully pan out. The real question is whether the Chinese will allow this rebalancing to take place organically, or whether they will continue to deny the hard landing the economy needs to achieve sustainable economic growth.