via Mike Shedlock:
Hello there Purchasing Power Parity GDP advocates and China horn tooters in general, let’s discuss real estate.
Bonds of China’s Largest Property Developer Crash
Please consider Another Big Chinese Property Domino Is Wobbling.
Shares and bonds of property giant Country Garden Holdings dollar-denominated bonds maturing in January 2024 are trading at 25% of their notional value, compared with 81% as recently as mid-June.
Contracted sales at the country’s top 100 developers plunged 33% from a year earlier in July, according to China Real Estate Information.
Beijing’s latest moves to support the sector—including making it easier to buy an apartment—don’t seem likely to help much. The fact that even the biggest developers can still run into trouble, nearly two years after Evergrande’s struggles first reached a fever pitch, presumably gives potential home buyers little confidence.
Speculative demand for housing—in the form of second and third, often unrented homes—supported the market for years, helping paper over China’s weak demographics. But the protracted downturn and the government’s hands-off approach appear to have seriously undermined the assumption that housing prices will keep going up endlessly, over the long run.
Goldman Sachs says China’s urban housing demand will fall to 11 million units this year, from 18 million units in 2017. The country’s developers built around 13 million units a year on average over the past decade. And the bank says Chinese developers have around $9 trillion of inventories—including raw land and uncompleted projects—equivalent to around 4.8 years of estimated contracted sales this year.
Purchasing Power Parity Silliness and the Myth China Passed the US in GDP
The subject of Chinese real estate came up a few times recently with still more readers insisting China passed the US in GDP.
One reader commented “The best comparative measure of national economies is widely accepted to be Purchasing Power Parity (PPP). Comparison of nominal GDP by converting all output to dollar equivalents is not meaningful. PPP GDP captures the real productive value of an economy. By PPP, China’s economy surpassed that of the U.S. several years ago and is substantially larger.”
Let’s review Purchasing Power Parity Silliness and the Myth China Passed the US in GDP
Hoot of the Day
The CIA clings to non-PPP based GDP. What a hoot! The CIA has nothing to do with this. If anything, it is the IMF that wants to back PPP for political reasons. I will skip other inane comments and get straight to the point.
Michael Pettis: “Adjusting GDP for differences in purchasing power makes a great deal of sense in certain cases, but the way it is done is so filled with problems that it is extremely difficult to find any economist who takes these measures very seriously,” and to that I would add, especially for countries that hide debt as assets and who calculate GDP in vastly different ways.
New Comments Today
- If you are going to cherry pick how China over counts GDP you have to also point out the way that the US over counts GDP. The US imputes a huge chunk of GDP that China does not (like owners equivalent rent). Also in the US a significant portion of GDP is generated by transactional inefficiency (legal and accounting services) and price gouging (health care) which happen to a much smaller degree in China or anywhere else for that matter. Even if the Chinese like to carry assets at book value rather than market value this is common conservative approach to company valuation in finance even in the US. I am not convinced that this way of carrying assets introduces an overwhelming amount of bias.
- The bottom line to our world is about real physical entropy changes. This is what ultimately matters the most to most things. On this front the Chinese economy clearly dwarfs the US economy. For example China has about 1/3 the electricity generation capacity of the entire world.
Grossly Distorted Procedures
I have picked on the US countless times over GDP calling it “Grossly Distorted Procedures”. Many have not read my past comments questioning US GDP.
But the property bubble in China is unlike anything else in the rest of the world. China has vacant malls, vacant airport, vacant entire cities. The State Owned Enterprises are all insolvent.
The physical entropy idea is nonsense. Wasting energy to build stuff no one uses is hardly a good measure. And China’s export model makes it overly dependent on energy imports while the US is nearly energy independent. How about we factor in the environmental damage due to coal use in China? What about China’s water pollution and breathable air?
Only crackpots would suggest energy as the best measure of an economy.
Accurate Reader Comments
- One reader commented “So many are just looking for a reason to talk trash about the USA. I wouldn’t read much into it.”
- Another accurately commented “Everyone knows the standard of living in China for the average person is nowhere close to the US.”
- A third accurately commented “The number one reason China is unlikely to overtake the US is communism. It doesn’t work.”
What Product Was Produced?
An important point regarding property bubbles and China pertains to payments. In the US, a mortgage is given when the house is complete.
In China, real estate firms sell homes before completing them. Buyers make mortgage payments even before they are in possession of the property. These payments are used to finance new construction.
Nothing Produced, Mortgage Boycott
In many cases, Chinese builders produced nothing at all.
Evergrande blew up over this. And now, an even bigger developer is crashing.
For discussion, please see my August 2022 post A Mortgage Payment Boycott Fuels the Implosion of China’s Property Bubble
The Secret Behind China’s Ghost Cities
Curiously, vacant, crumbling, uninhabited buildings are worth more than if someone tried to make them livable.
Rent would not come close to paying the mortgage and you would have unhappy tenants anyway.
Flashback 2021
China's recent debt problems may seem to have emerged rather suddenly in the past 3 years, but as Atif Mian points out, they are actually part of a dynamic that started well over a decade ago. https://t.co/IJsMtbqTts
— Michael Pettis (@michaelxpettis) September 17, 2021
Some of us have been aware of this for years. Others cling to the preposterous idea that China has overtaken the US and concoct ridiculous methods of justifying that idea.
What Happened to China’s Ghost Cities?
On December 17, 2022 I wrote A Reader Asked, What Happened to China’s Ghost Cities?
Please give it a look.
More Reflections on PPP
Pettis: “Unless you believe that the US fails to recognize losses on investments to anywhere near the same extent, if you really want to compare the two economies more usefully you would have to do at least two adjustments: you would have to adjust China’s GDP upwards for price differentials and also adjust it downwards for unrecorded losses.”
“Chinese lenders, banks as well as households, treat a substantial portion of the debt as if it were implicitly or explicitly guaranteed by central or local government agencies. This means investment losses don’t show up as losses (expenses) because it is politically difficult to do so, and are instead rolled over and so show up as assets.”
But another difference – and this may be just as important, or even more so, then relative price differentials – is that the two countries’ balance sheets are not comparable, because of debt, and have materially different ways implicitly to recognize the gap between the cost of an investment and the value of that investment. Adjusting for this fact, I would argue, is just as important in any comparison of the two economies as adjusting for price differences.
Yeah, OK. The US drops bombs and gives then to Ukraine who immediately uses them. This added to GDP.
The US also has crumbling malls and a commercial real estate market mess as well. But in the US, we have write downs and losses on CRE and residential property. In general, bad debts are written down by banks. In China they are papered over.
And nothing, anywhere in the world matches the enormous scale of China’s property bubble that added to GDP even before any property was produced.
What’s the PPP on a Home in Dallas vs Beijing?
Someone please explain what the “equivalent” price of a home in Chicago, Dallas, New York, and Beijing is on a PPP basis.
Do we factor in air conditioning, style, location, amenities, crime, and pollution?
How about we start with whether or not the new construction is occupied and livable, assuming the house exists at all.
PPP Repeat Conclusion
“Adjusting GDP for differences in purchasing power makes a great deal of sense in certain cases, but the way it is done is so filled with problems that it is extremely difficult to find any economist who takes these measures very seriously,” and to that I would add, especially for countries that hide debt as assets and who calculate GDP in vastly different ways.
Despite the fatal flaws in PPP, and despite failing to account for the world’s largest property bubble, I expect more ridiculous comments justifying PPP, about energy as a measure of product instead of a means to make a product, and certainly because “So many are just looking for a reason to talk trash about the USA.”
Thoughts of the Day
- Comparisons of US to China using PPP is horrendously flawed. China, by any realistic measure, did not pass the US in GDP.
- “It is far, far better and much safer to have a firm anchor in nonsense than to put out on the troubled seas of thought.” John Kenneth Galbraith (1958).
- “Few things are harder to put up with than the annoyance of a good example.” Mark Twain, The Tragedy of Pudd’nhead Wilson (1894)
Looking for Deflation? Cast Your Eyes on China, Not the US
Please consider China Exports and Imports Collapse, Harbinger of the Global Economy?
More importantly, please consider Looking for Deflation? Cast Your Eyes on China, Not the US
Demographics in China have turned hugely negative. Coupled with a massive debt bubble that resulted from China trying to achieve ridiculous GDP targets, China is following closely in the deflationary footsteps of Japan.
China has not passed the US in GDP and will not do so any time soon.
This post originated on MishTalk.Com
Thanks for Tuning In!
Mish