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Rise and Fall of the World´s Largest Market
21 Jul 2022
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The largest market in the world is the Chinese residential market. It may be worth as much as $55 trillion dollars, considerably more than the value of the US stock market or its residential market.

In his poem "The Waste Land," T.S. Eliot writes: " Did he live his life again in every detail of desire, temptation, and surrender during that supreme moment of complete knowledge? He cried in a whisper at some image, at some vision,—he cried out twice, a cry that was no more than a breath—‘The horror! the horror!’"

Thus ends a harrowing scene from the movie 'Apocalypse Now' that shows a ritual human sacrifice, a sacrifice already pointed out by Frazer in his analysis of magic and religion 'The Golden Bough' or 'The Golden Legend' (one of the few books that the gloomy stay of the psychotic Colonel Kurz, played by Marlon Brando, allows us to see).

The largest market in the world is the Chinese residential market. It may be worth some 55 trillion dollars, considerably more than the value of the US stock market or that of its residential market. Its boom is explained by a confluence of factors. On one hand, the intense creation of middle class households since the economic reforms of Deng Xiao Ping, a demography that until recently was favorable, with fertility rates above two until the eighties, which caused a great demand for houses at the beginning of the 21st century. On the other, average incomes rose strongly as wages reflected productivity improvements, especially since 2000. In addition, Chinese banks focused their financing on real estate activity, both in terms of development and mortgages. Finally, the fact that China does not have an open capital account limits the options for Chinese households to invest money in foreign assets, which, together with a very high savings ratio, made the residential sector the primary area of interest of household investment.

Positive fundamentals, when overly stressed, end up turning against us, as we know well in Spain. China's slower economic growth has translated into a sharp increase in youth unemployment, which is already close to 20%, limiting the purchasing power of the next first-time homebuyers. On the other hand, house prices in China have risen so much that the multiples are far from 'normal'. Thus, in a normal situation, a residential market typically reflects prices equivalent to about seven years of the net income of the household preparing to buy a home. If interest rates are lower than normal, then this multiple rises somewhat. For example, houses in many Western countries are now bought on average at about nine years' rent.

In China, following housing rises much higher than disposable income growth, average prices over rent are at a level close to 30x, with many major cities above 40x. In turn, the Chinese developers went on a building spree, to the point that if a developer market builds an average of three houses per 1,000 people, China reached the level of 11. Very favorable demographics could explain a figure above three, but unfortunately China did not maintain a replacement ratio of 2.1 children per woman, instead births fell sharply to below 1.2. In other words: the demographics are incompatible with the oversupply of housing. To build so many houses, the Chinese developer sector proceeded to issue huge amounts of debt, either with bonds ('investment grade' or 'high yield'), or with bank debt and finally with enormous levels of pre-sales (advances made by families on account of the house that will be given to them).

As the excesses are corrected, with increasing force, "the horror, the horror" mentioned by Eliot is unleashed. In August we learned of the huge problems of China's leading developer Evergrande, but soon it became clear that financial problems were affecting dozens of other developers. As the bond market closed, many of them had to stop developments. However, in recent days we have seen how many Chinese families have gone on a 'mortgage strike', refusing to pay mortgages on houses they had bought before they were completed, as they observed that developments were being halted as a result of the lack of financing from the developers. In this context, the demand for houses has come to a standstill (sales have fallen by 30%) and construction even more (housing starts have fallen by 35% and pre-sales by 60%). It is not surprising that house prices have also started to fall. The adjustment will be hard, something relevant for an economy so dependent on a sector that, apart from generating a lot of employment, contributes to the financing of the Chinese provincial authorities (which are responsible for important tasks such as health and education) through the sale of plots of land.

Dickens, in 'David Copperfield', places the protagonist on a visit to prison to see his former mentor, Mr. Micawber, imprisoned for debt. He advises Copperfield: "My other piece of advice, Copperfield, you know. Annual income twenty pounds, annual expenditure nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery. The blossom is blighted, the leaf is withered, the god of day goes down upon the dreary scene, and - and in short you are forever floored. As I am!'"

Perhaps Dickens and Eliot equated misery and horror. Both plague the world's largest market, which perhaps will cease to be.

 

Published in El Confidencial

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