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This popular video on YouTube, "China's Reckoning: Housing Crisis", suggests that the housing market in China is in a bubble, because the vacancy rate is very high.

However, it also acknowledges that there is no credit bubble like there was in the US.

I don't understand this argument. As the video claims, the Chinese are culturally "obsessed" with real estate, and buy houses even though no one lives in them, which drives up the price of real estate.

However, isn't this exactly what we have with gold? Most gold is not being used for anything productive. It's our cultural obsession with gold that keeps up its price. No one suggests that gold is in a bubble because of this.

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  • $\begingroup$ Are you asking how there can be a housing bubble without a credit bubble, or how there can be a housing bubble but not a gold bubble? $\endgroup$ – user253751 Mar 25 at 12:52
  • $\begingroup$ @user253751 How about "How can there be a housing bubble without a credit bubble, while there is no gold bubble?" $\endgroup$ – bobcat Mar 27 at 19:59
  • $\begingroup$ why would a gold bubble and a credit bubble be related? $\endgroup$ – user253751 Mar 27 at 20:31
  • $\begingroup$ @user253751 A credit bubble can cause a housing bubble (see 2008). Excluding that possibility, the question suggests that irrationally expensive housing is somewhat analogous to gold (Emphasis on the relation you are asking about) $\endgroup$ – bobcat Mar 28 at 0:30
  • $\begingroup$ This writer thinks former "ghost city" Ordos is fine... forbes.com/sites/wadeshepard/2017/06/30/… $\endgroup$ – H2ONaCl Mar 29 at 16:41
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This issue has been at the fore among China watchers for many years. While bubble classification is often subjective (even the Fed concedes):

[The] econometric detection of asset price bubbles cannot be achieved with a satisfactory degree of certainty.

However, there is mainstream consensus that China's real estate sector likely has cause for concern. The below are not intended to be smoking guns, but may be useful heuristics for intuition:

  • Property developers are typically among the most leveraged operations in China (leverage has been associated with previous "bubbles" like US in 1929 and 2000.)
  • As you mentioned, property transactions as a result of speculation is increasing versus organic demand from end-users of property (also have divorce legal loopholes to acquire more real estate)

China began a deleveraging process several years ago but rebooting the economy after economic shutdown in 1Q20 required stimulus. However, recently, PBoC has been tapering liquidity after a banner year in financial assets and even some alternative assets (like real estate). As mentioned, leveraged companies often feel the brunt of a tightened liquidity environment first. China Fortune Land was perhaps the first casualty, defaulting on billions of dollars in 4Q20. A few days ago (at the time of writing) the financial media also picked up a similar situation unfolding with an even larger developer:

https://www.bloomberg.com/news/articles/2021-03-25/rating-cut-ignites-fresh-concern-over-chinese-real-estate-firms

Housing vs credit vs gold

To get at your question more directly, I think it's still fair to say that credit is at play here. The latest macro leverage figure from December 2020 prints 270% of GDP. (M6404532 is the code if you have a Wind financial terminal). Ultimately, this number plays a large role in guiding policy decisions. In the last year alone, property restrictions and land developer bond financing rules were tightened in an attempt to bring leverage down and cool the sector as a whole. Still, there is a lot of nuance and market quarks to be aware of here; this is where the 'art of policy' comes into play.

On the one hand, regulators want to preemptively de-risk the financial system and develeraging is one of several paths forward.

However on the other hand, real estate is a vital part of the fiscal income of many regional governments -- many of which have very troubled financial situations. Many provincial governments turn to non-standard credit to bolster their fiscal budget: real estate developers and other local SOEs are often the issuers. Global ratings agencies are not currently allowed to rate these local government financing vehicles, and local rating agencies tend to be rather generous, so this could explain partially the necessity and propensity of a 'bubble' to emerge and sustain itself.

The notion of 'cultural obsession' has its role too. After all, capital markets are somewhat new to China; the SSE has only been around for 30 years. We can see that the median investor portfolio tilts towards real estate more so than most:

enter image description here

However, after we peel back the financial engineering, China's housing bubble is not so different from the US experience. Or, it could arguably be characterized as a combination of cultural obsession and leverage.

Let's try and tie this to gold. Any bubble, again, as the Fed has conceded, is subjective. However, if we look at what prices reflect on the various portions of the economy, you could find conflicting signals.

  • In a reflationary scenario, or if deleveraging turns out to be successful, the real estate and financial markets could march forward into the next few years unscathed. This might suggest the bubble was in gold.
  • Alternatively, if we view gold as a safe-haven asset and succeeds in preserving wealth after a vicious correction, then life in a rear-view mirror makes the bubble appear to be in assets (financials/alts).

Ultimately, if we subscribe to the belief that capital markets produce informative prices, then the prices in these different asset classes could reflect diverging views of the direction of the economy. Still, in a world of momentum traders and Fed interventions, fundamentals aren't the only thing at play. For this reason we should pay attention to who is investing with stewardship or high-conviction from those who are trying to turn a quick buck. I'm sure there are plenty of speculators in the gold market.

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  • $\begingroup$ It would be nice if there were more points on the graph. If we drop Taiwan because of risk of war and drop Japan because of population decline the remaining dots might produce a best fit line that is descending and plausibly explained by the hypothesis that higher income means more diversification, so less real estate weighting in a portfolio. $\endgroup$ – H2ONaCl Mar 29 at 15:23
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Gold has implicit worth as an alternative store of value. You can buy gold, keep it in a safe or safe deposit box until you need it, carry it around in your pocket, or even on your wrist. It's convenient as a form of non-fiat currency, costs almost nothing to maintain, is functionally infinitely divisible, is fungible, and has reliably kept its value, gaining some during downturns when it may be a more reliable store of value than fiat currency (cash). Further, gold is immediately recognizable as valuable, easy and inexpensive to verify (any jeweler can do this easily), and has an agreed upon value around the world.

Real estate is none of these things. You can't store a house somewhere safe, you can't keep it in a safe or in your pocket, you certainly can't carry it around, it's a troublesome store of value because it's incredibly illiquid, it's expensive to maintain, it's expensive to verify as valuable, and if you ask 5 realtors from each of 5 different cities to price a property, you'll get 25 different answers. Further, you can't cut a small chunk of a house to sell if you need quick cash, and I'd hardly call selling any piece of a house quick.

A house is not a very useful store of value, therefore, and as such has two uses:

  • As a home
  • As an investment

You could live in it or store things in it, using it as the first, you could buy it and hope it appreciates, using it as the second, or you could rent it out, using it as the second while someone else uses it as the first. Either way, its value comes from its usefulness to be lived in, or its usefulness as an investment. Gold, meanwhile, derives its value from its usefulness as a store of value, and to a smaller degree from its usefulness in industry. Notice the difference here, where usefulness directly impacts the price of real estate on a property by property basis, whereas usefulness is fairly unchanging for gold.

Maybe the biggest problem though is maintenance. Houses sitting vacant in China are often poorly maintained, meaning that their book value is far higher than their actual value, so that assets currently valued at X are actually worth far less at Y, which alone is already a significant warning of a bubble.

So why are houses worth what they are? Because people hope that someday someone will need them. Gold has value for what it does today, whereas China's vacant homes serve no purpose today once built besides looking nice, and as such have value for what they'll hopefully do tomorrow. With a stagnant birthrate, a falling population, and increasingly unmaintained property, China doesn't offer much promise for these homes ever being useful for anything. The problem is that just as gold derives much of its value from its use as an alternative investment, investment options for the Chinese are fairly limited, with real estate the only major reliable investment available to middle-class Chinese offering decent returns.

This amounts to a fairly scary set of circumstances for Chinese citizens holding much of their wealth in real estate, especially those who plan on retiring in the next decade or so, with an already tenuous safety net due to the age distribution. If real estate falls, much of China's wealth falls with it, and the average citizen will be the first to suffer. I hope your skepticism stands correct, and there is no real estate bubble in China. I fear, however, that there almost certainly is.

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  • $\begingroup$ first part is a good explanation of housing bubbles, but doesn't really explain why the same thing shouldn't apply to gold $\endgroup$ – user253751 Mar 25 at 12:53

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