Beijing Cooldown?

After Games, Trends Point to Property Growth

By J.R. WU

BEIJING — The run-up to this summer's Olympics ignited an explosion of new commercial and residential space in the Beijing market over the past two years.

The Chinese capital has given itself an urban facelift that includes skyscrapers and sports stadiums, a new third terminal in Beijing's international airport, bigger park space and a more expansive subway system — ingredients for a modern metropolis.

However, the construction boom has been accompanied by fears that once the games end on Aug. 24, Beijing could plunge into a property slump.

That isn't likely to happen. Property agents say the market may see higher vacancy rates and lower rents and sale prices in the months immediately after the Olympics, but they expect spaces to be filled eventually because Beijing remains a key city for doing business in China.

Property prices in Beijing, like those in the rest of China, have been falling from their spectacular highs, and they may correct further. The main reason for the cooling is the government's tightening over the past two years.

Speculation that housing prices are on their way down is helping to depress prices, says Ben Christensen, head of research in Beijing at property agent Jones Lang LaSalle.

"In Beijing that's sort of compounded by uncorrelated speculation that after the Olympics, prices are going to plummet," he says. "I don't see that. Nobody in the property industry sees that happening because there is no reason for it."

Much of what is going on in the Chinese capital is telling of a broader national trend — rising incomes, urban sprawl and the growing sophistication of Chinese consumers underpinning demand for one of the world's hottest real-estate markets.

Migration of people from rural areas into cities looking for better jobs, bigger homes and higher living standards is driving urbanization across China. Foreign companies in China and domestic companies going global want high-grade buildings for their China headquarters.

But the big problem for China in recent years has been that prices rose too quickly to be sustained. "The government wants property prices to decline," says Lehman Brothers economist Mingchun Sun. "But they don't want to see a collapse of the property market because it is still one of the growth engines for the economy."

While Beijing's property market is tracking the national trend of a gradual cooling, policy makers are finding their biggest headaches in places like the southern boomtown of Shenzhen, just across the border from Hong Kong. A steep rise in prices in markets such as Shenzhen helped prompt the government to aggressively curb credit, land sales and mortgages nationwide during the past two years.

The growth in Beijing's property prices peaked in October 2007 at 15.1% and has been steadily slowing to 12.4% in May, based on data of China's 70 large and midsize cities from the National Development and Reform Commission. Shenzhen's swings have been sharper, with the rise in property prices dropping from nearly 21% in August 2007 to 2.5% in May.

Once property prices return to more affordable levels, demand from home buyers should kick in again, supported by individual income growth, which is rising 15% to 20% each year in China, Mr. Sun says.

If Beijing policy makers switch their focus from fighting inflation to shoring up weaker economic growth, the ensuing monetary easing would likely boost property prices again.

The average sales price now in Beijing's high-end residential market is estimated at 24,010 yuan ($3,500) per square meter, compared with 15,838 yuan at the end of 2006, according to Jones Lang LaSalle.

Mr. Christensen says prices in the high-end residential market should start to stabilize by year's end as investors evaluate their property investments more thoroughly. The bottom for prices in this market segment could be around 20,000 yuan per square meter, he says.

Jones Lang LaSalle says the new supply in Beijing's high-end residential and retail markets will roughly triple — or more — this year from last year. New luxury residential space will grow 30.4% this year to include 10,301 more units, compared to 11% growth in 2007. New supply in the retail market will rise 64%, or 1.4 million square meters this year, compared to 16% last year.

Obesity in China Becoming More Common

By SHIRLEY S. WANG

In a development with implications for China's work force and economic growth, a new study says more than 25% of adults in the country are overweight or obese and that the number could double over the next 20 years.

The report, based on data collected from 20,000 patients in China over the past 15 years, says obesity has increased 1.2% a year among men in that time — higher than the rate for adult men in the U.S., U.K. and Australia.

With the population at 1.3 billion, that means an additional 11 million Chinese adults are becoming overweight or obese every year. In addition, 12 million to 14 million adults are becoming at risk for diabetes and hypertension annually, says study author Barry Popkin, director of the obesity center and professor of global nutrition at the University of North Carolina at Chapel Hill.

"When you have this many people becoming diabetic and hypertensive, you think about the health-care costs and it's pretty staggering," says Dr. Popkin. The study is set to be published today in the health policy journal Health Affairs.

The study suggests that the problem may be accelerating. And the reasons for the rise in obesity isn't because of increased consumption of fast food or other Western foods in China, Dr. Popkin says. Rather, improving living standards mean that growing numbers of Chinese can now afford vegetable oil, beef and dairy-food sources that until recently had been too costly. A more sedentary lifestyle for many Chinese plays an important role as well.

Obesity-related costs are likely to lead not only to drastic increases in direct medical costs, but also to indirect costs like decreased worker productivity and absenteeism.

Health-care costs could also have implications for companies looking to invest in China. Many companies provide medical care for workers, and thus they could end up footing much of the bill for obesity-related costs, Dr. Popkin says.

Those costs could prompt companies to invest in less-costly markets, such as Vietnam, and ultimately slow the Chinese economy. "U.S. labor costs skyrocketed and people are moving away from investing here," says Dr. Popkin. "It's the same issue in China."

Based on the S&P 500's current multiple of 16.8 times earnings over the past 12 months, according to Thomson Reuters, investors are anticipating modest inflation. Since 1950, in periods when inflation ran between 2% and 4% (as it has through much of this decade), stocks traded at an average price/earnings ratio of 17.4, according to Strategas Research Partners. But in a 4% to 6% inflation environment, the average P/E ratio dropped to 14.7.

 

Last Friday, the Labor Department reported that the consumer price index for May was 4.2% higher than a year earlier. If inflation rises closer to 6%, it could drive the market's P/E ratio closer to 14. Currently, earnings for the S&P 500 companies are expected to come in at about $92 a share, and a three-percentage-point contraction in P/E multiples means fair-market value for the S&P 500 index drops by 276 points.

 

Stephen Roach argues on Financial Times that a new stagflation scenario is not likely to be wage-price-spiral type, but of Asian-exported.

First, world has never been so integrated in terms of trade:

The globalisation of trade flows is a new transmission mechanism of worldwide inflation that was not evident in the 1970s. According to estimates from the International Monetary Fund, overall exports should hit a record 32.5 per cent of world gross domestic product in 2008…

Second, inflation in Asia is flashing red alert:

For developing Asia as a whole, consumer price index inflation hit 7.5 per cent in April 2008, close to a 9½-year high and more than double the 3.6 per cent pace of a year ago. Sure, a good portion of the recent acceleration in pricing is a result of food and energy – critically important components of household budgets in poorer countries and yet items that many analysts mistakenly remove to get a cleaner read on underlying inflation. But even the residual, or “core”, inflation rate in developing Asia surged to 3.8 per cent in April, more than double the 1.8 per cent pace of a year ago.

China’s inflation problem is much deeper than the food and energy price shocks that thus far have played a disproportionate role in driving its consumer price index higher. Also at work are serious wage pressures reflecting, in part, increases in minimum wages associated with new labour reform laws. Meanwhile the People’s Bank of China has held its policy lending rate below headline inflation, resulting in negative real short-term interest rates.

The result has been an ominous increase in Chinese inflationary expectations, strikingly reminiscent of similar occurrences that plagued the developed world in the 1970s and early 1980s. History does not treat kindly a serious deterioration in inflationary expectations. The longer such a trend persists, the more wrenching the monetary tightening required to arrest it – and the greater the risk of a subsequent hard landing. That is the last thing China wants or needs.

China is hardly alone in its reluctance to take firm action against a worrying build-up of inflationary pressures. That is true throughout most of developing Asia, where hyper-growth is viewed as the panacea for the aspirations of a growing middle class. Throughout the region, central banks are keeping short-term interest rates far too low to combat these inflationary pressures. For developing Asia as a whole, a GDP-weighted average of policy rates is currently about 6.75 per cent, fully three-quarters of a percentage point below the 7.5 per cent headline inflation rate.

Alan Blinder, Professor of economics at Princeton and former Fed Governor, contributes to the much heated debate on whether central banks should prick the bubbles.

He differentiates two types bubbles: bank-centered bubbles and bubbles not based on bank lending. Central banks have more and better information on the bank-centered bubbles and have a lot of tools to deal with it rather than raising interest rate. For the non-bank-based bubble, central banks have no information advantage and monetary policy tools rarely “fit the crime”. (source: NYT)

I would argue that the central bank’s proper role is fundamentally different in the two types of bubbles. Here’s why:

When bubbles are not based on bank lending, the Fed has no comparative advantage over other observers in distinguishing between rising fundamentals and bubbly valuations. It may see bubbles where there are none, or fail to recognize them until it’s too late — or probably both.

Indeed, at the Fed, I recall Mr. Greenspan thinking that he saw a stock market bubble as early as 1995, when Internet stocks barely existed and the Dow was under 5,000. Fortunately, he did not make the mistake of trying to burst it. Conversely, the tech bubble became obvious only in 1999 — by which time it was already enormous.

That’s the first problem, and it’s a huge one. Here’s the second:

Once a central bank correctly recognizes a bubble’s existence, what is it supposed to do? The Fed has no instruments aimed directly at, say, tech stocks, and practically no instruments aimed at stock prices more broadly. (Those who argued that higher margin requirements would have worked were engaged in deeply wishful thinking.)

Of course, the Fed could have raised interest rates. But why would raising the federal funds rate by, say, two to three percentage points have ended the stock market mania when investors were expecting 19 percent annual returns in the stock market? That much monetary tightening, however, might well have stopped the economy in its tracks. If that strikes you as a good bargain, you might enjoy reading Cotton Mather’s autobiography.

But a bank-centered bubble is starkly different in both respects.

As long as the central bank is also a bank supervisor and a regulator, it is extraordinarily well placed to observe and understand bank lending practices — much better positioned than almost anyone else. Beyond merely knowing more, part of a bank supervisor’s job is to make sure that banks don’t engage in unsafe and unsound lending, and to scowl at or discipline them if they do. We know that America’s bank regulators fell down on the job as the housing-mortgage bubble inflated. But that was a failure of bank supervision, not of monetary policy.

AND what about instruments specifically aimed at the bubble? Whereas the Fed’s kit bag is pretty much empty when it comes to stock-market prices, it is stuffed full when it comes to taking aim at bank lending practices. Escalating upward from a sternly arched eyebrow to an outright prohibition of certain types of lending — for example, subprime loans with no documentation for 100 percent of a home’s appraised value — bank supervisors have a broad range of finely calibrated weapons at their disposal. Like the Mikado, they can “let the punishment fit the crime.”

Dollar was up last week (the biggest weekly gain since 2002):

(source: FRED)

The odds for August rate hike has been increasing:

(source: Cleveland Fed)

Multiple rate hikes are expected:

(source: CNBC)

(coutsey of CNBC)