Real Estate in China vs. the United States: How Two Giants Spar (Part I)

This is part 1 of a multi-part post (probably 3), in which I will discuss the very different roles real-estate has played traditionally in both China and the United States. I will later discuss the global impact of what appears to be a severely overheated real-estate market in China and how the binary stop-go control system of China’s communist leadership is largely incapable (even less so than the US government) of effectively dealing with this segment of its economy, which unlike many other segments that are directly controlled by the State, is much more difficult to manage from a central location. I posit that, as China continues to take on the semblance of a fully capitalist system, with a rapidly growing middle-class modeled after the US economy, they are inevitably going to face a conundrum: to protect their new, thriving, economy by adopting more democratic principles of government; or protect their present form of government at the very large cost of their impressive economic progress, whereby to reestablish totalitarian control over the people, they will inevitably be forced to squash the new found visceral freedoms of its burgeoning middle class. I will argue that the myopic nature of a centrally managed system of government makes it nearly impossible to gauge the ripple effects (and the echoes of those ripples) of an economy as large and widespread as China’s. More importantly to the rest of the world, I will also make the case that the lack of understanding of property rights on the part of the Chinese government threatens not only that particular economy but all others that do substantial business with them (i.e. the entire world). Most of us are familiar with the the expression: "If the U.S. economy sneezes, the the rest of the world catches a cold." Well, for better or worse, there is a new germ in town and the medicine to deal with that germ is not well-known. China does not do things like the United States, and lest we all get too eager to welcome another giant into the room to compete with the current alpha male, it might serve us well to remember that the style of government in the United States is integrally connected to a powerful set of checks and balances that simply do not exist in China. Moreover, China's publicly stated desire to build a middle-class by allowing private ownership of real-estate is not only at odds with the central tenets of communism but also, more specifically, with the enduring power of the Communist Party in China. Nonetheless, to address such an important topic with such a wide brush does the subject no justice, and so I will focus this post and those that follow on the significance of real-estate in both countries and economies and how the development of both may effect us all moving forward.

Before we delve into the intricacies of the changing real-estate landscape in China, it will serve readers well to become familiar with or review the inner workings of the real-estate in the United States. The reason for focusing first on the US real-estate market (which comprises roughly 12% of GDP in the world's largest economy) is three-fold: first, China has recently attempted to adopt (at least in principle) the real-estate-based economic model of the United States (and Japan) without implementing property taxes (which might change in the very near to intermediate future); secondly, because unlike the multi-faceted control system of the U.S. and Japan, China’s centralized, top-down, stop-go system is unsuitable for effectively reaching and slowing all parts of their country's economy with equanimity; and lastly, because, while China seems to be trying to emulate the United States in the way of growing a large middle-class through real-estate ownership, China does not seem to fully realize that the real-estate market in the United States functions (cough-cough) as well as it does largely in part because the US is run via democracy.

Although much of what I am purporting is theoretical in nature and likely will not work itself out in the real-world for many years, it is nonetheless worth considering the possible ramifications of a country adopting an economic system from another country whose political governance is not only contra-stance to its own, but is indelibly linked to a history of oppression and harsh rule and law changes. The United States, for all of its ails, was conceived through hundreds of years of subtle, evolving, organic and natural "progress" that is inextricably tied to the democratic constitution that makes all of its citizens equal in a way that is not possible in communist China. A government that is truly of the people can only be modified in a significant way by the people and through an extremely resistant process (consider, for example, Byrd Rule), whereas with a totalitarian regime, he who giveth can taketh away. For better or worse, these facts leave those who invest in real-estate in the United States and those with similar investments in China with very different levels of risk. The individuals governing China seem to want the best of both worlds for themselves without reconciling that to get the “best of both worlds” they must relinquish some of their control and establish a system that more or less runs itself. For capitalism to work, every individual that belongs to the relevant society must believe that they not only have the ability to achieve capital appreciation, but that the appreciated capital is safe from confiscation and government interference. (*Side note to readers questioning the assertions being made here regarding variant liberties of the US vs. China: this post will not even be accessible from Chinese IP addresses--indeed, a few months back when Google stopped filtering its results in mainland China, we at nospoonblog.com learned that, like most uncensored content on the web, our blog was (is now again) blocked. In fact, it was impossible not to know it was blocked since, on the day Google announced it had stopped filtering results, the traffic on our blog--specifically for FB's post on Tiananmen Square--increased by a whopping 520% in one day, and then abruptly returned to our average once Google announced that they had been forced to resume filtering and were pulling out of the country.)

I suspect we will see a lot of discontinuity in policymaking over the next few years, especially in the Western World, amid lots of panicking and last ditch efforts to save the world from financial Armageddon II. Meanwhile, during the same time-period, Beijing has grown increasingly worried--and rightfully so--about signs of overheating, and after trying unsuccessfully to pare growth carefully, it has given up the scalpel and brought out the sledgehammer.
This is very significant, because private property in China is a very new concept and it is growing into a very significant portion of China's economy. To underestimate the significant unknowns involved in a country/culture that is thousands of years in the making, is a grave mistake. Indeed, the history of financial cycles itself has changed dramatically during the past 200 years. During this relatively short time period economists have begun to think of the ups and subsequent downs as part of the same process (as opposed to viewing them as emergent consequences of external shocks, such as war or famine). For those interested in learning more about modern thinking on the subject, the Luwig Von Mises Insitute has an excellent article on the business cycle in general and how the subordinate cycle of credit expansion and contraction effects it. This is super relevant to the subject of this post because the birth and growth of the United States, and of its private real estate sector, largely coincides with the inflection point that marks the changing views of the financial cycle. One of the first published acknowledgements of credit cycles in relation to their impact on the greater economy was the 1838 edition of the Encyclopedia Americana where under Credit it states: “The history of every industrious and commercial community, under a stable government, will present successive alternate periods of credit and distrust, following each other with a good deal of regularity.” Clearly this is true in the United States, but we are witnessing more and more evidence that a similar ebb and flow is beginning to make its way east with China experiencing its own periods of credit lust followed by distrust. The two key differences being 1) the fluid complexity of the U.S. political and economic system incorporates self-governing checks and balances that do not exist in China, which allows the US economy to be a living, organic creature that is not so much controlled, but rather guided; 2) due to the self-governing aspects of the US system it is very difficult (though not impossible) to successfully blame a single governing body, institution, or other entity for the ails that may result from the credit contractions that inevitably occur.

I fear that the financial high that many involved in China's economy are experiencing will soon reach a level of intoxication too powerful for those same individuals to feel the ground beneath their feet. Indeed, the credit boom that has been building in China during the past decade is looking more like a tsunami than anything we've seen in the U.S. Some might ask, "who cares? What does that have to do with us?" It has everything to do with all of us. Long gone are the days when nations effect only their own economy and perhaps their most proximate neighbors. Globalism is no longer a buzzword: It is real, it is powerful, and it is here to stay. We need only look at the domino-effect that the small country of Greece (with a GDP of $356 Billion) is having on Europe and the rest of the world to begin to see the potentially catastrophic ramifications of the world's third largest economy (China with a GDP of $4.3 Trillion) slowing or expanding "too rapidly," a phrase whose meaning in relation to China we do not really have the tools to measure. We are in unchartered waters regarding the intricate interconnectedness of global economies. Meanwhile, the rules, laws, and politics of these countries do not have the equivalent international reach as do their economies, which in turn creates an intriguing albeit awkward intimacy. Thus far, such a relationship, with both countries' inextricably connected mutual interests, seem to be inspiring diplomacy and stability. Still, it is important to note that although some economic ties have been strained during the past several years due to the global financial mess through which we currently find ourselves muddling, we have not witnessed (and hopefully never will!) a situation where a political leader of either country has attempted to dictate or mandate policies or laws of the other directly.

... that concludes Part 1. Part II of this post will focus almost entirely on the very particular nature of property rights in the United States. For those who cannot wait, I urge you to pick up a copy of James W. Ely, Jr.'s thoughtful book on the topic The Guardian of Every other Right: a Constitutional History of Property Rights.

WSJ Reports "China's Property Market Freezes Up"

If we didn't already know that China's top-down stop-go economic policies weren't dangerous already the Wall Street Journal gives us evidence. (side note, I've been working on a detailed post about this issue over the past two weeks and will try to get it up later today or tomorrow.)

From the WSJ article: "Government policy changes have thrown China's booming property market into a period of paralysis that some industry executives say will last for several months, weighing on global growth prospects already battered by the turmoil in Europe."

"A rebound in China's property market has been central to the nation's rapid recovery from the financial crisis, but surging housing prices had led to increasingly open discontent from middle-class families in major cities. After months of indecision, Beijing in mid-April announced a package of policies intended to blow the froth out of the market by restricting speculative purchases."

[...]

"China's economic growth was already widely expected to slow in coming months, as the impact of last year's stimulus policies fade. Some forecasters, seeing weaker prospects in a key industry, are now further marking down their numbers for this year. China International Capital Corp. now expects the economy to expand 9.5% in 2010 as a whole, rather than the 10.5% it previously forecast."

My initial take on the matter is that first of all, with the rest of the world dealing with very low inflation and in some places deflation, 10% economic growth for the largest exporter seems not only unsustainable, but also very dangerous. There have already been talks about China manipulating its currency in order to hold up its competitive advantage in manufacturing and exports. If this is true, we are already looking at a squeeze to its burgeoning middle-class before its really clear that the country truly has a middle class. On the other hand, as is also widely reported, China's savings rate, historically around 40%, has edged up over the past several years to 50% of GDP. Clearly the only individuals saving 50% of their earnings are those wealthy enough to do so. Nonetheless, it is an indication of the incredible cushion China has built to protect itself should the economy spiral into a free-fall. I suppose the question then becomes, how long can that cushion support them if cheap exports go to the wayside? (more to follow)

Another one bites the dust: credit card companies stealing your credit score

I'm sure many of you have heard of or been affected by the credit card companies slashing credit indiscriminately in order to clean up their balance sheets. In fact, they have been doing so in a rather coordinated way since 2007 when this financial mess hit the fans (see graph below). Of course, that's exactly what they should do, since it is we, the consumers, that are to blame for this mess and not the bankers and predatory lenders who specifically sought to sell mortgages to under-qualified borrowers at a time when home prices had reached such exorbitant price levels that qualified buyers were no longer interested. Three years have passed since we ventured into this mess until finally we have reached the blame-casting stage of this game. Unfortunately none of the political or "bankstah" rhetoric comes remotely close to helping solve the real problems that plagued--and continue to plague--the real economy (and the banks tangible balance sheets). I have recently been forced into a situation that permits me to speak knowingly from one perspective and therefore to showcase at least one very negative result (or side effect) of this crisis that will necessarily have long-term ramifications for this country, its economy, and most certainly its middle class.

On April 19th, 2010, I received a letter from Citibank, explaining that:

"a routine review of your account activity shows that you have not used your Citi Account for and extended period of time. We are sorry if this card has not met your needs. Due to prior inactivity, your account will be closed on May 13, 2010. Use of this card between now and the date listed will not enable us to revers this decision and your account will still be closed. We appreciate your business." blah blah blah.

Now, on the surface it seems pretty straight forward: you have been extended credit; you don't use that credit; when we extend credit to someone we have to take a hit on paper in terms of liabilities; therefore, since you haven't used your credit card we are going to remove the liability from our balance sheet.

Okay fine. But what they don't tell you is, A) I have had this account since 1999--yup, 11 years! B) I have never once had a late or missed payment in those 11 years. C) I have a credit rating of 790. D)Here's a crucial one--I tried to cancel this account 3 times (2001, 2003, 2004) with each attempt being met with incredible pitches aimed at keeping my business. Each time, the one that won me over was, "sir, you have been a customer with us for quite some time and you have an excellent credit history with us. If you cancel your account you will lose those years of credit history unless you have another card that you have had longer.

I did not, in fact, have any cards longer than this one. The truth was, this credit card is my Student Associates Bank Credit Card. It was my very first credit of any kind and it came with a measly $400 credit line. The selling point for the card was that every 6 months if the card was in good standing, the customer could request a credit line increase without a credit report being pulled. The automatic credit line increases were incremental, but perfect for a student starting out in the world with no credit to his/her name. Well 11 years later, I have worked that card up to a credit line of $7,600. I only use it when my next oldest credit card, an Amex card that gives me 5% cash back, isn't accepted. Well, during the past few years--which coincides with the financial chaos that has ensued--I haven't used my credit cards as much. Why? Well, because that was what we were instructed to do, by our President, by our media, and by the true head Chieftain, Dr. Common Sense.

Does that mean I don't care about this credit card? No, absolutely not. Does that mean I'm a credit risk, or that my credit score should take a 50-60 point hit because Citibank decides after all this time, that I no longer need the credit. Emphatically, No! One does not get a credit card for the singular and linear purpose that they want to max out the dang card and pay 31% interest. In fact, the credit card banks business model depends as much on the good credit risk customers as it does the bad credit risk customers. Those with higher risk profiles end up paying the company directly at such high rates that even if they default the Credit Card company still ends up making a profit on the whole (at 30% interest, it doesn't take long to earn a profit). On the other hand, those with extremely low risk profiles would become part of CC bank's other revenue stream, i.e. the merchants' fees that get paid as a right to accept the much easier to deal with credit cards of their customers. There is another angle on this (those who keep the card as an emergency or back up card), but it is tangential, so I will ignore it for now.

So, then, once again, it makes sense that the credit card company would want to remove individuals from the system that are not positively impacting their major revenue streams, especially when they have Uncle Sam breathing down their necks to raise the share price of their stock in order that they might sell it at inflated prices so that they can report back to the people that the "bailout" was actually an investment. In any case, as far as the Credit Card is concerned the formula works like this: remove liabilities from the deficit side of the balance sheet--regardless if its low risk and harmless to the actual business model long term--as it makes the bottom line appear much more healthy than it was before. In reality, what really just happened--at least in my case--is that they just pissed off a dormant but very happy customer of 11 years with an incredible credit history who never thought negatively towards the Citigroup/Citibank brand. How is that going to help the longer-term health of the company? I'll let you decide.

Now my real beef with this whole thing is that I never even got a warning. They never sent me an email or a letter explaining, if you do not start using your card we may be forced to retract the credit we have offered you. Furthermore, contrary to what they wrote in the letter, this wasn't an indiscriminate routine review. How do I know this? Well, for one my fiance, who has the same card, received the same letter the same day. (She too has a great credit history and score). My brother, who lives in an entirely different state, also received this same letter on the same day. Lastly, and this was what led me to write this post, from chat rooms and other blogosphere interactions I gather that a whole lot of people, specifically with very high credit scores received similar letters from many banks during the past several weeks.

The ultimate point of the post can be extrapolated from the graph below (click to enlarge):




As the graph from my favorite blog Calculated Risk shows, this trend has been well underway for a very long time and had just recently begun to subside. Looking at the chart, it appears that although low, we are at a point at which we might expect the trend to reverse. On the contrary, however, a whole new wave of credit has just been or is scheduled to be removed from the system that has yet to be reflected in the chart.


In the most recent Federal Reserve Report, the Chairman explains:

Consumer credit decreased at an annual rate of 5-1/2 percent in February 2010. Revolving credit decreased at an annual rate of
13 percent, and nonrevolving credit decreased at an annual rate of 1-1/2 percent.

The report goes on to imply likely stabilization. I don't buy in. Indeed, my knowledge of business and real-life experience tells me three very important things as a result of these actions: First, the banks are definitely not as healthy as they portend since they are kicking out their VIP's in order to mask their balance sheets. Secondly, the net result of this whole escapade is that a great deal of people who really need credit to get past this "bump in the road" or those who are doing alright but whom were potentially about to make a large and important purchase are going to be unable to navigate the waters for a long time as their bearings get messed with from the sidelines. I, for example am saving up for a home right now (and have been for 5 years). I'm just shy of a 20% down payment for the kind of home I'd like to buy. However, this reduction in available credit will affect not only my credit history, but also my debt to credit ratio, two crucial components to the rate that the banks will expect me to pay. This rate, in turn, could very potentially effect the available funds I might be able to procure. Lastly, with residential construction spending still at abysmal levels, and the termination of the Federal Home Buyers Tax Credit set to negatively impact demand for existing home inventory moving forward, now is not a good time to be chipping away at the credit scores of responsible borrowers; they are categorized as "responsible" for a reason. This "recovery" is going to need all the help it can get from the consumer. Yet, all consumers seem to be having the punch bowl taken away from them regardless of whether or not he or she has had too much to drink. Therefore, how can any kind of consumer spending recovery take hold? (for those that don't know, roughly 70% of US GDP since WWII comes from consumer spending).

Those concerned with inflation, although a very real concern that I plan to discuss in a later post, must also consider the alternative when so much spending power is being sucked out of the system so indiscriminately and "routinely." I realize that banking reform and the Consumer Credit Protection Act was enacted with good intentions, but just because the shoulder shove that put you on your a$$ was intended to be a love tap, it doesn't ensure that you're not bruised as a result. Intentions only matter to a point.