Professor Robert Shiller of Yale University knows a thing or two about asset bubbles: He was jointly awarded the Nobel Prize in Economics with Eugene Fama and Lars Hansen for their pioneering work on the analysis of asset prices. He predicted and warned about two great stockmarket crashes in recent US history -- the tech crunch in 2000 and the subprime housing meltdown in 2008. He first warned about the danger of a housing bubble back in 2003, when bankers were still busy minting mortgage-backed securities. Few listened to him.
The economist warned in a syndicated column a year before the collapse of Lehman Brothers that the US housing bubble, which saw prices soar 86 per cent in real, inflation-corrected terms from 1996 to 2006, was about to burst.
“The boom, and the widespread conviction that home prices could only go higher, led to a weakening of lending standards. Mortgage lenders seem to have believed that home buyers would not default, because rising prices would make keeping up with their payments very attractive,” he warned presciently.
So what does Shiller think of China’s emerging asset bubble, which is causing a lot of anxiety for investors? He was in China last week and spoke to senior Chinese economic policy-makers at the National Development and Reform Commission (NDRC) and did an interview with Chinese media.
Falling housing prices in China’s third and fourth tier cities after years of spectacular rises have sparked concerns about the health of the real estate industry. Nomura's chief China economist says the real estate bubble is the biggest risk to the economy and poses more danger than local government debt and shadow banking (Chinese property bubble trouble?, April 2).
Housing bubble in China
When he was asked whether he believed the housing bubble would burst in China just like the sub-prime meltdown in the US six years ago, he said “It could and I am not predicting it".
“I am thinking that Chinese investors don’t have as many opportunities to spread around the world as the Americans do. So there is a captive audience for real estate investment and that support will be removed as China’s capital flows are liberalised,” he told the Chinese media.
Beijing has capital controls in place that limit the outflow of funds from China. On average, Chinese citizens are only allowed to take $US50,000 out of the country.
“China is in such a rapid growth period, it is very hard to price assets when growth is at the high level. The future matters more, in a stable economy that is not going anywhere, you have a pretty good idea of what they are worth,” he said.
Shiller also argued there were housing bubbles in many emerging economies like Russia and Turkey but “China ought to be the most vulnerable to real estate bubbles, because the transition is so enormously fast".
Local government debt and shadow banking
Schiller also offered his opinion on Chinese local government debt to the econocrats at the powerful NDRC, which is the super economic ministry with overall responsibility for national development strategy.
He prefaced his answer with typical humility:
“I am not an expert on local Chinese government debt but I am concerned though as an outsider that there might be a risk that local governments could overdo that.”
Chinese officials were told an ominous economic lesson from the United States in the 1830s and 1870s. During both periods, the state governments in the US embarked on an ambitious program of infrastructure investments that included canals, highways and railroads.
“They all did it at once and there was something in the atmosphere that got them extremely optimistic,” he said.
But there was a crisis and nine US state governments went into bankruptcy. Since then, every American state government has passed legislation that prevents state governments from borrowing too much. There has been no state bankruptcy for nearly 200 years.
“China is newly reformed after Deng Xiaoping. They haven’t had crises -- you normally learn from crises. I am wondering somehow if your local government might be overly influenced by rapid Chinese growth and was lulled into complacency about what may happen during a crisis,” Shiller said.
He was more sanguine about China’s shadow banking sector, however.
“I believe shadow banking is more imaginative and more likely to support original entrepreneurial activities. So I kind of like shadow banks just as I like crowd funding.
“The only thing is that they have to be regulated and right now. I think the first thing for the Chinese government to do is study them and learn more about them."
Chinese economic outlook
Shiller, who is widely regarded as one of the most influential economists in the world, said he was mystified by the doomsday reaction of Western analysts and commentators on the Chinese economic slowdown.
“It comes as something of a mystery to understand where this comes from and it is normal macroeconomic fluctuations. I understand that China has never had a recession, but I think as China develops and these things will happen here too, it may come as a real shock,” he said.
“It is normal for a vibrant economy. If you are a free market and let people do what they want. It will come a time when they become fearful and pull back.”
On the question of whether China would end its three-decade-long miracle in a hard landing, Shiller said he didn’t believe in that and used the example of Japan. The Asian powerhouse grew spectacularly during the 1950s and '60s just like China but its growth rate gradually tapered off as the economy grew bigger and bigger.
“I don’t expect China to reach a hard landing. I think that economic growth rate will inevitably and gradually decline,” he told the Chinese media.
"It is going to be harder and harder to get 7.5 per cent.”
This article is the second in a series on Chinese housing bubble concerns. Read the first article here.