A very micro economic view of China

In past notes, I have mentioned that almost every conversation I have in China eventually turns to the subject of real estate. In my last visit, I compared it to California in 2006 where it was all that anyone talked about. During Thanksgiving this year, I noticed that Californians are talking about real estate again, but in China the subject never went away.

Beijing real estate is still more expensive than San Francisco, but I did get the sense that the rapid price gains everyone enjoyed over the past few years have slowed. No one knew of any price declines, but the lack of growth is being noticed by property owners everywhere. And since every middle manager I know in China owns a few apartments, the subject remains of great concern.

Several people mentioned to me a sense that the easy growth of the past few years seems to have evaporated. This applies not only to real estate but also the growth of other industries. Small handset vendors are still doing well, but they continue to have a sense that their opportunity is finite. I will come back to this group below.

In some cases, this de-heating is a good thing. A few years ago, manufacturers in Shenzhen were complaining that hiring skilled labor is challenging. That sense has defused. The ‘workshop of the world’ is in full swing. However, a few people pointed out to me that the air in Shenzhen is very clean. This is seen as a direct result of the financial crisis when thousands of small factories in Dongguan and other cities around Shenzhen shut down.

The most interesting conversation I had revolved around interest rates. (The fact that this subject was somehow superlative says a lot in itself.) One manufacturer told me that banks charge 0.5% interest for loans, but it is impossible for private businesses to actually get this rate. In practice, the interest rate available is 3% for a heavily collateralized loan (i.e. a personal mortgage) and that businesses really had to pay something like 6%-10%. “Wow,” said this naive foreigner, “10% a year is a lot.” To which my friend responded, no, all those rates are per month! That is pretty staggering, and the fact that companies can still operate with that cost of capital is telling as well.

I will not pretend to know much about macro-economics, but I know enough about China to know that these kinds of conditions cannot last forever. For readers interested in more on this there is plenty written by the sell-side community, but for a more bearish stance I would point you to Michael Pettis’ China Financial Markets blog.[1] 

From all of this, I have to wonder if the change in administration at the highest levels of China’s government are going to spell change for the industry soon. Ten years ago, the last big change in government eventually brought some major changes in the economy. In particular, interest rate subsidies of the big state-connected companies led directly or indirectly to the rise of Huawei and ZTE as major players in the telecom equipment market. Both companies financed their own operations and trade finance through some heavy borrowing. I am not saying that will change, as both companies are now firmly established major telecom players, but at the same time, I have to wonder if there is a new direction coming.

One anecdote stands out for me. The CEO of a smallish but successful components vendor I know in China is a wealthy man, by anyone’s standards. When I saw him last, he owned dozens of apartments all over China, as well as some very sizeable ‘mansion penthouses’ in his base of operations. During this visit, I heard that he had sold everything. He still owned his company, but he had sold off all his real estate in China, equivalent to tens if not hundreds of millions of dollars. He has downsized from a 15,000 sq ft mansion to a two bedroom apartment. Maybe he has personal reasons for doing this, but he has also proven himself a very astute investor, so maybe there is another message in this.


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