Manager Commentary, April 2012
considerably. This was not allowed to happen. The scaleof Chinese FX interventions became legendary as bureaucrats sought to maintain the cheap currency. Thelevel of FX reserves rose to unprecedented heights forany country at any time in history. China was on a roll.However the boom came at a cost. The Chinesegovernment had effectively printed money to purchase vast amounts of Treasuries. This was akin to shortingtheir own currency. In time the new money began tooverwhelm the domestic money supply. The Americaneconomy was three times the size of
economy yet Chinese broad money exceeded that of the US. Andof course waves of credit such as this are not just aboutmoney, they are about temptation as well. In any othereconomy that would have meant runaway inflation. InChina it did not. Instead, the rate of consumer priceincreases averaged just 3% p.a.
How Did They (Almost) Get Away With It?
The Chinese did it with a cultural revolution; they did itthrough financial repression on a gigantic scale. Thecentral bank kept the deposit rate low, incredibly low.On February 21
, 2002 the monetary authorities set theinterest rate that banks could pay on demand depositsat just 0.72% and then kept it unchanged for aremarkable six and a half years. By the first half of 2008, inflation was running at 7.9% and the real rate of return on demand deposits had fallen to -7.2%. This
appalling rate of return on bank deposits probably
accounted for 20% of the decline in householddisposable incomes as a share of GDP over the period1992 to 2008 and significantly contributed towards theconsequent collapse in consumption relative to GDP.Having averaged more than 50% of GDP during the1980s, consumption had fallen to just 34% by 2010.This was a record low for any nation and, to my mind atleast, a very potent sign of the disequilibrium created by the currency peg and the repression required tomaintain it.
It must have all seemed devilishly clever to theauthorities. Unfortunately they failed to take intoaccount the law of unintended consequences. Chinesehouseholds mounted a rearguard offensive actionagainst this repression. Instead of accepting low rateson their money in the bank, they became a nation of property speculators. There was temptation in all thatnewly printed money after all and the populace gave into it. Investment in residential real estate averaged only 2.4% of GDP back in the years before the financialrepression. As deposit rates became more and moreunattractive and the
Bank shorted more andmore of its own currency domestic speculators lit thetorch paper under residential real estate investment. Itgrew to 9.1% of GDP by H1 2011. Chairman Mao musthave been turning in his grave.
The Mother of All Housing Booms?
At first the scale of this speculation was hidden under
the guise of an entirely plausible argument based on
mass urbanisation. China, we were told, was merely investing as peasants moved en-masse to the coastalcities. Perfectly plausible. But perfectly wrong. Duringthe period 2000 to 2003 mass migration to the citiespeaked at 24 million people per annum. At the sametime residential investment expanded to 4.1% of GDPand housing starts rose from 240m sqm per year to440m. After that the urban population growth ratedecelerated (to an average of only 19 million people per year) but residential development did not. Instead,housing starts went crazy, rising from 490m sqm in2004 to 1,290m sqm six years later.It is also worth noting that by the time all thishappened the sharpest rise in home ownership hadalready passed. In 1983 the home ownership rate inChina was a mere 10%. By 1998, thanks to theauthorities' commendable privatisation of the housingstock in the mid 1990s, it had reached 80%. Its growthsince has been, by comparison, unspectacular.
30%35%40%45%50%55%60%1970 1975 1980 1985 1990 1995 2000 2005 2010
Household Consumption (% China GDP)
Source: Bloomberg/EAM Research