New property tax for major Chinese cities signals the beginning of the end of the Chinese real estate bubble

Hugh Hendry, Mish Shedlock and many others have been pointing out what a massive construction driven bubble economy China has become.  People in China still believe that housing prices and commercial real estate prices can never go down and so they invest in anything with 4 walls with price as no object.  Even poor people have gotten into the act by pooling their money at the village level and investing in buildings to nowhere.

In layman’s terms what we are seeing is just another massive debt Ponzi.  Here’s how it works:

• People foolishly give control of their money and credit supply to central banks.  This is the first big mistake.
• The central banks manipulate the value of money and credit in order to achieve political means.  In other words, they under price credit in order to stimulate the economy so that they can remain in control.
• Illuminated members of society (AKA crony capitalist friends of government) get first access to the low cost credit and they use it to “invest” in the economy.  They “create jobs” building stuff that really didn’t need to be built.  People flock to invest in these assets and the smart money cashes out of the boom before it turns to bust.  As a result they achieve wealth and power far beyond what they worked to deserve.  It is an age old scam that has been played again and again throughout history.
• At first it seems like win-win so the people don’t complain about it.  The big, well connected con men make huge money and the little guy gets a paycheck that pays the bills.
• Unfortunately, each loan that is taken out increases the money supply.  This is inflationary and as a result it drives up the prices of things.  Buildings and houses that used to cost X now cost 10x or 100x or even 1000x.  In Shanghai today a crappy little flat goes for over $9000 per square meter (almost $850 per square foot!!).  Even an hour outside of the city the places are going for nearly $300 per square foot and they are just shells with unfinished interior concrete walls, no plumbing, no kitchen, no appliances. 
• People who do not want to speculate on housing prices still need places to live and so they are forced to buy into the scam using ridiculous, unpayable leverage.
• Sooner or later the credit bubble busts for a variety of reasons.  In China it appears that the inflationary forces are bleeding over into food prices causing staple items to increase in price at a scary pace.  Chinese people are not rich and so even small price changes in nondiscretionary items like food have a dramatic impact on their quality of life and even on their ability to consume enough calories to sustain life.  When this happens it threatens to cause social unrest and so governments move to “cool down” the economy.  It demands that banks curtail loans and restrict credit and it makes it more painful for people to speculate on high leverage.
• Whatever the reason for the credit Ponzi to bust, without cheap and easy credit the houses and buildings cannot be bought because nobody has that much money in cash.  Thus, the housing and commercial real estate value must fall until they reach the point where people can attain credit again to buy them.
• As prices fall, people become fearful that they will catch the falling knife and so property values end up falling even further than they should have.  Many people end up having to sell during this time for a variety of reasons.  They either default on their debt and take a multi year credit hit IF POSSIBLE or they are required by law to pay on the amount lost on the sale for the rest of their lives.  This effectively turns innocent people into life long debt slaves.
• If enough people are abused like this they revolt against the system in the sure and certain knowledge that they have lost everything and thus have nothing to lose by rioting and breaking social order in every way.

The evidence of bubbledom in China is astounding.  All you have to do is look around major Chinese cities and see all of the shining new skyscrapers which are completely unoccupied.  Add that to theme parks with no visitors, the largest shopping mall in the world that stands empty and dozens of brand new but nearly empty cities designed to house 1 million or more people each which have sprung up around the country.

China has fallen victim to the same disease shared by every other developed crony capitalism country which is Credit Gone Wild.  Central banks which centrally manage their economies “juice” things in order to spur unneeded investment, so called “malinvestment” by followers of Austrian economy theory.  The debt associated with the credit has the effect of expanding the money supply which drives up the prices of all things.  But the stuff built with all that debt is just too much for society to absorb and so it stands there taking up space because people can’t afford to consume it.

The same thing happened in Japan during the 70s and 80s.  Everyone has heard the story about how the land under the imperial palace was worth more than the entire state of California.  Of course, it was fake wealth created by unsustainable levels of credit and debt.  The credit availability caused so much useless building in Japan that it gave rise to the phrase “building bridges to nowhere”.  At some point all the new credit flooding the market chased up prices on everything to the point that people just couldn’t hold their nose and buy it anymore.  At that point began the great unwind.  You might have heard it referred to as Japan’s lost decade, etc. but now it is more like a couple of lost decades and working on a third lost decade.  The money con men of Japan basically stole their children’s prosperity.

If you think that the housing boom in the US was bad then you better not look too closely at China or you will become petrified with fear.  China has been building so much unneeded construction and infrastructure that it has caused housing bubbles in Australia and Canada!!  Whhaaaat??  Yeah, that’s right.  Australia and Canada are known as commodity exporting nations and China has become their main customer.  They have been rolling in cash hand over fist as China’s elite con men have been borrowing money to create “buildings to nowhere”, the act of which requires the commodity resources exported by Australia and Canada.  In light of this artificial economic boom, property values in these commodity exporters have skyrocketed.  A crappy little flat in Toronto starts at $1 million.  Aussie housing is just as ridiculous if not worse.  But when the Chinese credit bubble rolls over then the flow of credit based money to the commodity exporters will collapse and it will cause a domino collapse of their housing markets.

Whew!  Now that you know all that, consider what factors could have contributed to sky high real estate prices even in light of the fact that no buyers were showing up.  Perhaps the main factor is the carrying cost for the assets.  When credit is fairly priced then people do not build stuff that the economy cannot consume because they will be stuck making huge interest payments.  But interest rates have been manipulated to all time lows so that feedback mechanism is no longer a limitation.  In fact, artificially low interest rates caused the problem in the first place.

Another huge potential carrying cost is real estate taxes.  If you don’t have to pay taxes then you can hold for a long time without getting bled to death.  Until now, Shanghai and other major cities had no real estate taxes.  But now Chinese news services report that Shanghai and Chongqing are instituting a “trial” property tax:

http://www1.szdaily.com/content/2011-01/28/content_5306640.htm

If you read the article the tax is clearly levied at real estate speculators.  Any real estate speculator in these cities with an ounce of sense is now listing his Ponzi Property at 5% below current Ponzi market value.  And if it doesn’t sell in 3 weeks the really smart ones will drop the price another 5%.  And they will continue dropping the price like that until they finally hook a greater fool to take that bubble property off of their hands because before the bust is over these properties will return to their real, economically supportable valuations which will be 20 cents on the dollar.  The Chinese property market is about to roll over and with it will go the economies of Australia and Canada and many places in between.