China Stock Market: Real Estate Downturn Is Not A Disaster

Caifu Magazine | by Caifu Global

At 2000 points, when people are still worried about the Chinese stock market, the article pointed out “When government is forced to lower the interest rate due to problems on Real estate sector, the lowering of interest rate may not be able to save real estate, but it may very likely drive up the Chinese stock market.”

In reality, China Central Bank’s lowering of interest rate in November 2014 has become the trigger for the new round of Chinese bull market. This new bull market has been confirmed.

In June, more Chinese cities started to see housing prices drop. People are deeply concerned whether the property market will eventually collapse, dragging China’s economy and stock market into a mess. This in part explains why China’s stock market has been sluggish recently. Will the property sector slowdown evolve into a stock market disaster? This relies not only on the sector itself, but also on the responsive measures to be taken by the central government.

Shoring up home prices by expanding scale of credit available for home buyers is like drinking poison to quench one’s thirst. The higher prices artificially become, the stronger the force dragging them back down will be. Further, allowing the property bubble to burst as a means to forcibly regulate the economy will wreak destruction on the country. Economically and politically, both approaches are unacceptable. The prime choice is to stabilize asset prices. Asset price stabilization measures coupled with fiscal and taxation system reforms, from consumption tax to asset tax, and financial reforms to reduce funding costs will pave the way for the real economy to find balance. This is the only theoretical path to a solution.

However, economic reality never follows idealized theory, just like one cannot know how to truly grasp real battlefield conditions from simply studying military strategy from textbooks. Though it is impossible to accurately forecast the stock market, it is possible to get some clues out of the stock market’s complicated phenomena.

First, the credit crunch last year led to the plummet of stocks. As long as this credit situation continues the stock market will not turnaround. Asset prices, especially property prices, are driven by credit, so higher prices require larger credit. If the driving forces of expanding credit wanes, cash shortages will occur. This will be a reflection of an intrinsic economic problem, not a result of capital flight. Last year’s credit crisis was actually a stress test manipulated by the country.

Second, once housing prices begin to decline, it is extremely tough to stabilize them. Decades of rising prices has formed a strong tendency that cannot be easily reversed. So once prices start to fall, the reverse force will be strong as well. Since stringent regulations will not be accepted, it is inevitable for monetary policy to be eased as the situation intensifies.

Third, as monetary easing is gradually adopted, the RMB will face devaluation pressures. And capital outflow is certain to happen during this period. But even when facing possible waves in the international financial market, China is capable of preventing large-scale capital outflows. Caifu Magazine has mentioned before that when necessary, devaluating the currency is a valid policy.

Four, if the government’s tightening of credit supply to curb a property bubble causes rising funding costs, the stock market will be greatly suppressed. Compounded by concerns over the future, money invested in the stock market will not increase rashly. If interest rates are lowered to solve problems in the property sector, the result may not be satisfactory either. But during a period of correction the stock market may rebound after hitting bottom. Following a fall, the market will turnaround before the economy starts its recovery. And around the time when interest rates begin to drop some shares may hit bottom even earlier than the market.

Five, it is argued that China’s economy may be Latin Americanized. In fact, it is impossible in China. The so-called Latin Americanization is when increasing wage costs undermine low-end industries. Meanwhile, high-end industries cannot catch up, leading to stagnation of economic growth. Latin Americanization is based on the premise of market liberalization, but China’s economy is dominated by the government in many ways. Therefore, as long as China’s political stability is not weakened, the economy is bound to escalate sooner or later and long-term stagnation, like in Latin America, will not happen.

Six, in the face of an economic growth slowdown, if the government can ensure employment does not fall below the prescribed minimum level, and inflation does not rise above the projected acceptable level, as implied by Likonomics (a new term coined in reference to China’s economic growth plan as implemented by Chinese premier Li Keqiang), the economy will not be a major problem even if the growth rate further declines. But the dilemma lies in the difficulty to ensure both of them at the same time. However, if asset prices fall and the economy slumps, an economic stimulus may exacerbate inflation before driving the economy and employment up, causing a tough situation. What if this really happens? Personally, employment should come first. That’s why I have consistently believed it will be hard for the renminbi to appreciate within the coming two to three years.

Seven, it should be pointed out that last year’s credit squeeze was endogenous, even man-made, rather than a result of the U.S. withdrawal from QE policies. In addition, the U.S. Federal Reserve dares not to raise interest rates rashly, not because of China, but rather its own unsolved problems.

Remember, the stock market is driven by credit. If the four trillion yuan stimulus plan was not necessary in 2008, it was absolutely necessary to increase liquidity during last year’s credit crunch, because China cannot afford a housing market crash. If home prices go into a nosedive anytime in the future, monetary easing will be unavoidable. In the short run, a drop in property prices is unfavorable for China’s stock market, but in the middle and long run, it will cause the stock market to hit bottom in the future.