Bubbles go on much longer than a rational mind can fathom, especially equity, real estate, and credit bubbles that are supported by governments and central banks. Everyone benefits, so everyone (except for a few hapless shorts) pushes to keep them going. But when they burst, they wreak havoc on the economy. And China is no exception.
China’s pre-Olympics stock market bubble burst on October 16, 2007, when the Shanghai Stock Exchange touched 6,124. Monday, it dropped to 2,456, its lowest level since March 2009, down 60% from its high. The stock-market blowup fostered, as in the U.S., a real estate and construction bubble that has become an outsized contributor to GDP growth. But for some time now, ominous signs have been amassing there too.
Housing sales took a brutal nosedive last week, Golden Week—down 32% from a year ago—though the holidays normally generate peak volumes. In September, residential property prices had suffered their first official monthly hit in a year. Local reports have already pointed at developers who were forced to dump properties at lower prices to raise cash. For years, we’ve seen videos of brand-new ghost cities of high-rises and shopping malls. Overbuilding, funded by an enormous Ponzi-like credit bubble, has led to vacancy rates estimated unofficially to exceed 30%.
Fissures have also appeared in luxury vehicles sales. Luxury car inventories are piling up—a scary sign. To whittle them down, BMW, Volkswagen, Audi, and Mercedes dealerships across China have started to offer previously unheard-of discounts of up to 20% off retail price. Not too long ago, buyers were paying premiums above retail, and they had to wait for weeks or months before taking delivery of their new vehicles. Now they can drive most models off the lot on the same day.
Sales volume of luxury cars exploded by 48% in 2010 and by 29% through the summer this year. But now, growth seems to be slowing, just as automakers have heavily invested to ramp up production. The overall market has already cooled. After rising 32% in 2010, it is expected to scrape by with a 5% increase in 2011, according to the China Association of Automobile Manufacturers.
China, by far the world’s largest market in new vehicle sales, is immensely important to all major automakers. BMW, for example, derives 25% of its profits from China. But high inventory levels, slowing sales, and rising production capacity are a toxic mix. The shakeout, as we know from what happened in the U.S. over the last decades, will be brutal. Nevertheless, luxury automakers are still optimistic publicly. With record production for 2011 already certain, they see slowing but still healthy sales growth going forward.
Inflation is red-hot, up 6.2% from August last year. Alternative numbers are in the double digits. While many Chinese workers have received significant raises—after waves of suicides and protests—others have not. Life, particularly for the poor, is becoming increasingly difficult.
Worried about social unrest, the government has taken a variety of measures. The People’s Bank of China has raised interest rates five times in the past year and has tightened monetary policy in other ways. Monday, in another measure to bring down inflation, the National Development and Reform Commission cut prices for gasoline by 3.5% and for diesel by 3.9%—incredibly, fuel prices are still set by the government.
The bursting of the China bubble has been announced many times, prematurely for most part, correctly for the stock market. China has a lot of resources to patch things back up, among them nearly $2.5 trillion in foreign exchange reserves and hefty trade surpluses. Manufacturing is hanging in there, and well-to-do consumers are still in the mood to go shopping: Golden Week retail sales were up 17.5% over last year, though inflation could be largely responsible for the increase. But, construction and real estate are on the verge of tipping over, or have already tipped over, and the automotive sector is closing in. When they let go, and when the credit bubble that supported them blows up with them, it’s time to deploy multiple airbags.