The Chinese chronicle of a crash foretold

Image of Jamil Anderlini

The highway leading to the birthplace of Mao Zedong in central China is lined with forests of half-built or empty apartment towers. On your way to pay homage to the Great Helmsman you can visit the spot where, less than three years ago, an ambitious local billionaire flew in on his private helicopter amid great fanfare and broke ground on what was meant to be the world’s tallest building: the 838m Sky City. Today the excavated foundations lie submerged in a makeshift fish farming pond.

Economists have long pondered the so-called skyscraper curse, the uncanny correlation between construction of the world’s tallest building and an accompanying financial crash. From the end of Roaring Twenties America to the bursting of the credit boom in the sands of the Gulf, the Empire State Building (started in 1930), Sears Tower (started in 1970), Petronas Towers (completed in 1996) and the Burj Khalifa (completed in 2009) have foretold or coincided with crises — apparent signs that irrational exuberance can manifest itself in physical form.

Today, some analysts describe the Chinese real estate market as the single most important sector in the global economy — and the biggest risk factor. This is less fantastic than it sounds when you consider that in two years — 2011 and 2012 — China produced more cement than the US did in the entire 20th century.

Because of this, the fate of everything from Hong Kong financial institutions to German carmakers to Australian miners is now in the hands of homebuyers in places like Changsha, the city where Sky City was supposed to be built.

In recent years, overbuilding has been encouraged by local officials, who collect large portions of their revenue from land sales. The results can be seen across China: from ghost cities looming out of the frozen Manchurian plains to the fringes of Lhasa, where Tibetan nomads graze yaks in the yards of empty luxury villas.

China’s economy is extraordinarily reliant on investment, which accounts for nearly half of the country’s gross domestic product. But slowing investment in Chinese real estate in the past two years has contributed to a collapse in global prices of commodities and declining growth in raw material exporters such as Australia, Brazil, South Africa and Indonesia.

The building boom of recent years has led to enormous excess inventory but the true scale is impossible to estimate because developers and local governments are offered incentives to under-report the problem. Despite a slowdown in 2015, real estate investment in China rose by 1 per cent, even as average house prices in the 70 largest cities fell.

Similarly, Chinese commodity imports in volume terms increased last year, as price collapses caused a large import contraction in value terms.

In other words, China’s economy has slowed by a couple of percentage points and global commodity prices have plummeted even before any correction in the country’s property sector begins in earnest. An outright decline in real estate investment, which is surely coming, will also have profound implications for the rickety, debt-laden Chinese financial system. Analysts estimate that more than 60 per cent of Chinese bank loans are directly or indirectly tied to real estate.

With a debt-to-GDP ratio that is higher than the US and Germany, serious trouble in the Chinese property sector would send shockwaves round the globe and make the recent fallout from declining Chinese currency and equity markets look like a minor squall.

Local governments in places like Changsha have started to recognise that many of the shoddily built, overpriced apartments will never be sold. But their response is alarming from the perspective of the wider economy.

According to officials in several Chinese cities, their solution is to break ground on entirely new districts and to offer land to “better quality” property developers at marked down prices. The hope is that developers will abandon the existing empty blocks, and build higher quality apartments that can be sold to consumers for big discounts because of the lower land costs.

In the twisted incentive structure of Chinese officialdom, this is rational because it will prompt the flow of fresh finance, revive land revenues and boost GDP. But if that sort of thinking prevails, it may turn out that merely breaking ground on Sky City was enough for the skyscraper curse to fall on China.

jamil.anderlini@ft.com

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