Economists: China Mirrors U.S. on Eve of Financial Crisis

March 18, 2013, 5:20 PM

Economists: China Mirrors U.S. on Eve of Financial Crisis

The same three warning lights that preceded America’s real estate crash and financial crisis are now flashing over China, two economists say, leaving the government limited time to get out of trouble.

In a research note published on Saturday, Nomura economists Zhiwei Zhang and Wendy Chen outline the way that elevated property prices, a rapid build-up of leverage and a slide in the country’s potential growth rate could lead to a systemic crisis.

House prices in the U.S. racked up an 84% rise between 2001 and 2006, Mr. Zhang and Ms. Chen say, citing the Case-Shiller housing price index. The Nomura economists have their doubts about China’s official index, which shows a “rather benign” 113% rise in the major cities from 2004 to 2012. They argue that it is too broad, including older, lower-quality property across the nation. By contrast, a recent academic paper taking into account these quality differentials found prices climbed 250% from 2004 to 2009, they say.

“The government obviously recognizes the risks in the property sector,” Mr. Zhang and Ms. Chen write. “It has introduced a series of progressively tighter policies to contain property prices over the past several years… The pattern has been for house prices to initially dip after tightening policies are introduced, then to rebound, which suggests that the risks have not been mitigated.”

Local governments, which rely on land sales as their main source of revenue, could be hit as hard as property developers by a real estate crash. The problems would quickly find their way into the banking system – 14.1% of outstanding bank loans are to local government financing vehicles, and 6.2% are to property developers, Nomura’s economists say.

They do think the country still has time to avoid a systemic financial crisis, as long as the government is not afraid to start tightening now. That will come at a cost in terms of this year’s growth outlook – but growth could still be as high as 8.1% in the first half of the year and 7.3% in the second half, Mr. Zhang and Ms. Chen estimate. Early tightening could lead to a manageable number of defaults, they think.

The alternative would be a continuation of loose policy and growth of over 8% this year, followed by a crash perhaps as early as 2014. Contagion would quickly spread through the system, Mr. Zhang and Ms. Chen think, forcing the government to step in and bail out the banks or local governments, perhaps selling off public assets to deal with the mess.

Finally, adding to the likelihood of a crisis is China’s declining potential growth rate. It is not easy to calculate this number, which represents the maximum speed the economy can grow without generating excess inflation, but even analysts more optimistic than Nomura’s agree that it’s falling, driven by factors such as a shrinking working-age population. That gives China’s policymakers a lot less leeway to stimulate the economy than they have enjoyed in the past.

“Financial crises often follow technology revolutions or so-called economic miracles, because investors and policymakers start to overestimate the potential growth of the economy,” write Mr. Zhang and Ms. Chen. “Policymakers may misinterpret a structural slowdown in potential growth as cyclical and utilize expansionary policies to boost growth… planting the seeds for overheating and an eventual painful correction.”

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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