Wen Jiabao, the Chinese Premier, may have the economic quote of the year. After China’s central bank declared that it would raise the benchmark overnight interest rate by a quarter point, he commented, that “inflation expectations are more dire than inflation itself,” noting that while inflation is a concern, so too are investor expectations.
Thus far, in the non-emerging markets, it has been the fear of inflation – and not inflation itself – that is sending prices higher. In the emerging markets, at least in China, higher benchmark rates are intended to be a solution to ever rising prices in Chinese real estate. Some contend that this real estate market is indicative of a bubble, and that just like the United States, higher real estate will eventually lead to a pop.
Why the Chinese Market Won’t Pop?
To showcase this point, one country often forgotten in the world of investment will have to make a guest appearance. Canada, which may as well be an extension of the United States, neither suffered a massive real estate bubble, nor did it see any real decline in prices, even as its largest trading partner, the United States, crippled to a bursting bubble.
So what do the 2000 Canadian rise in home prices have to do with a 2010 rise in Chinese real estate prices? Not that much, but they do share a number of similarities.
Learning from Canada vs. the United States
At the height of the US real estate market, one out of four new loans was made to sub-prime borrowers. In Canada, that number hovered around 5 percent. In China, loans for property are difficult to obtain, even by the most creditworthy, and the closest China ever came to “sub-prime crisis” may have been US Treasury default fears following the Fannie and Freddie bailouts with unlimited lines of credit.
At the height of the US real estate bubble, the United States was shedding capital at roughly $50 billion per month in a growing trade deficit, while Canada enjoyed a positive trade balance all the way up to 2008. China has trade surpluses of roughly $200 billion per year, every year.
Canada maintains no reserve ratio for banks, while the US required 10% and China requires a whopping 18.5%, all the while hot money knows no difference between either China nor Canada. Both countries saw massive new foreign investment (Canada’s oil trusts and China’s consumer sector), and each country throughout its bubble had a zero or negative real interest rate policy. As for deleveraging, Chinese speculation is almost entirely in cash, where the United States, and even Canada, had at least some of their real estate runs due mostly to lending growth.
The Long Run
Is real estate a strong, pro-growth investment? No. Real estate is a boring, slowly rewarding, investment that is usually found in consumption, rather than production economies. However, with rates as low as they are, and inflation pushing higher, real estate is an attractive investment.
On the other hand, higher rates means borrowed money will have to find somewhere else to go. If this money finds itself in the stock markets, watch out. There isn’t a ceiling high enough to hold that explosion.