After the Peak: The Quiet Period

Dubai is not like China in many important ways, but the psychology of every bubble is the same.

China real estate is now like Dubai before the crash
In October 2008, those of us in Dubai noticed a similar calm. For six years, we had enjoyed a housing boom. And we had all become well-versed in the rationalizations for why the housing bubble wouldn’t collapse (i.e., “it hasn’t crashed so far”, “the government wouldn’t allow it”). That had all ended the month before when housing prices unexpectedly began to fall. And what followed was a similar eerie quiet, like everyone was rethinking and holding their breath.

By December 2008, prices for new Dubai developments had dropped 40%. Real estate stock prices were in free fall. And publications such as the Economist were leading with headlines like “Has the Bubble Burst?” The calm was over and everyone was starting to take action.

In January 2009, foreigners began to leave the country in droves, abandoning their leased cars at the airport by the thousands. State-backed real estate companies began to realize they were facing massive lay-offs. Many real estate developers realized they weren’t going to be able to survive their debts at current housing prices. And the overall government debt at 150% of GDP suddenly went from a theoretical to a very real problem.

By July 2009, Dubai was a ghost town.

The psychology of home buyers is only starting to turn. This is the "wait and see" period, the quiet period before the real price declines begin.

This chart from Mish Shedlock (Updating the Arrow after Home Prices Drop) is a good representation of the psychology:

One point to quibble with:
The ultimate difference between China and Dubai is Dubai had debts that exceeded their cash. The real estate problem did not have to trigger a Lehman-type financial freeze. The real estate debt was enough to bankrupt the city on its own and Dubai had to go to Abu Dhabi for a bail-out. China, in contrast, has a closed capital account with trillions in cash.
Some China bears expect China will have a crisis like other nations. China bulls point out China is not like other nations, so it won't have a crisis. I see China as prone to crises as any nation, only the form is different. China's financial system is far more rigid than Dubai's. The assumption is that there will be lower volatility because China can control the market, but ultimately this is no different than thinking house prices always go up. The concern I have with China is not that it's going to go broke, it's that there's going to be a phase transition and the market will move to a new equilibrium. The exchange rate could fall, the government may allow market to play a far greater role than expected, leading to much larger than expected losses. When everyone assumes X is not possible and places their bets accordingly, it only takes a small change in X to generate large losses in "derivative" markets.

Also, control does not mean no crisis, it means that costs are channeled in different directions. For example, if you know China's real estate market will slow along with credit growth, would your mind turn to soybeans?

China's top soy buyer says to honour import deals, take loss-report
Shandong Sunrise chairman Shao Zhongyi said his firm would honour its purchase agreements despite facing a loss of about 200 million yuan ($32 million), as weak domestic demand means crushers are losing money for processing soy into meal and edible oil.

"Based on current prices, if we take all the cargoes as previously planned, the losses will be 200 million yuan," Shao told the Economic Information newspaper, run by the official Xinhua News Agency.

"Despite the losses, we must honour the contracts," he said, adding that defaults risk ruining the long-term relationships Sunrise has built with suppliers and buyers.

Soybeans Drop After 14% Rally as China May Cancel More Cargoes
Soybeans declined a third day on speculation that a rally since the beginning of February may curb demand and China, the world’s biggest buyer, may cancel more purchases. Corn and wheat retreated.

China Soybean, Rubber Importers Renege on Deals
The cancellations are a big worry for the commodity markets as exporters around the world had relied for years on China's insatiable appetite for a wide range of raw ingredients. But now as jitters rise over the health of the economy, the fallout is rippling through into agricultural commodities, just weeks after the price of copper and iron ore tumbled on worries they had been used in risky Chinese financing deals.

......"The number one problem is weak demand from the credit tightening last year and real estate which has a direct or pass through effect on all of this activity," said Shanghai-based Citi Research commodities strategist Ivan Szpakowski.

1 comment:

  1. Love the graph

    Keep up your excellent blog posts.