Monday, June 7, 2010

Real Estate in China vs. the United States: How Two Giants Spar (Part I)

This is part 1 of a multi-part post (probably 3), in which I will discuss the very different roles real-estate has played traditionally in both China and the United States. I will later discuss the global impact of what appears to be a severely overheated real-estate market in China and how the binary stop-go control system of China’s communist leadership is largely incapable (even less so than the US government) of effectively dealing with this segment of its economy, which unlike many other segments that are directly controlled by the State, is much more difficult to manage from a central location. I posit that, as China continues to take on the semblance of a fully capitalist system, with a rapidly growing middle-class modeled after the US economy, they are inevitably going to face a conundrum: to protect their new, thriving, economy by adopting more democratic principles of government; or protect their present form of government at the very large cost of their impressive economic progress, whereby to reestablish totalitarian control over the people, they will inevitably be forced to squash the new found visceral freedoms of its burgeoning middle class. I will argue that the myopic nature of a centrally managed system of government makes it nearly impossible to gauge the ripple effects (and the echoes of those ripples) of an economy as large and widespread as China’s. More importantly to the rest of the world, I will also make the case that the lack of understanding of property rights on the part of the Chinese government threatens not only that particular economy but all others that do substantial business with them (i.e. the entire world). Most of us are familiar with the the expression: "If the U.S. economy sneezes, the the rest of the world catches a cold." Well, for better or worse, there is a new germ in town and the medicine to deal with that germ is not well-known. China does not do things like the United States, and lest we all get too eager to welcome another giant into the room to compete with the current alpha male, it might serve us well to remember that the style of government in the United States is integrally connected to a powerful set of checks and balances that simply do not exist in China. Moreover, China's publicly stated desire to build a middle-class by allowing private ownership of real-estate is not only at odds with the central tenets of communism but also, more specifically, with the enduring power of the Communist Party in China. Nonetheless, to address such an important topic with such a wide brush does the subject no justice, and so I will focus this post and those that follow on the significance of real-estate in both countries and economies and how the development of both may effect us all moving forward.

Before we delve into the intricacies of the changing real-estate landscape in China, it will serve readers well to become familiar with or review the inner workings of the real-estate in the United States. The reason for focusing first on the US real-estate market (which comprises roughly 12% of GDP in the world's largest economy) is three-fold: first, China has recently attempted to adopt (at least in principle) the real-estate-based economic model of the United States (and Japan) without implementing property taxes (which might change in the very near to intermediate future); secondly, because unlike the multi-faceted control system of the U.S. and Japan, China’s centralized, top-down, stop-go system is unsuitable for effectively reaching and slowing all parts of their country's economy with equanimity; and lastly, because, while China seems to be trying to emulate the United States in the way of growing a large middle-class through real-estate ownership, China does not seem to fully realize that the real-estate market in the United States functions (cough-cough) as well as it does largely in part because the US is run via democracy.

Although much of what I am purporting is theoretical in nature and likely will not work itself out in the real-world for many years, it is nonetheless worth considering the possible ramifications of a country adopting an economic system from another country whose political governance is not only contra-stance to its own, but is indelibly linked to a history of oppression and harsh rule and law changes. The United States, for all of its ails, was conceived through hundreds of years of subtle, evolving, organic and natural "progress" that is inextricably tied to the democratic constitution that makes all of its citizens equal in a way that is not possible in communist China. A government that is truly of the people can only be modified in a significant way by the people and through an extremely resistant process (consider, for example, Byrd Rule), whereas with a totalitarian regime, he who giveth can taketh away. For better or worse, these facts leave those who invest in real-estate in the United States and those with similar investments in China with very different levels of risk. The individuals governing China seem to want the best of both worlds for themselves without reconciling that to get the “best of both worlds” they must relinquish some of their control and establish a system that more or less runs itself. For capitalism to work, every individual that belongs to the relevant society must believe that they not only have the ability to achieve capital appreciation, but that the appreciated capital is safe from confiscation and government interference. (*Side note to readers questioning the assertions being made here regarding variant liberties of the US vs. China: this post will not even be accessible from Chinese IP addresses--indeed, a few months back when Google stopped filtering its results in mainland China, we at learned that, like most uncensored content on the web, our blog was (is now again) blocked. In fact, it was impossible not to know it was blocked since, on the day Google announced it had stopped filtering results, the traffic on our blog--specifically for FB's post on Tiananmen Square--increased by a whopping 520% in one day, and then abruptly returned to our average once Google announced that they had been forced to resume filtering and were pulling out of the country.)

I suspect we will see a lot of discontinuity in policymaking over the next few years, especially in the Western World, amid lots of panicking and last ditch efforts to save the world from financial Armageddon II. Meanwhile, during the same time-period, Beijing has grown increasingly worried--and rightfully so--about signs of overheating, and after trying unsuccessfully to pare growth carefully, it has given up the scalpel and brought out the sledgehammer.
This is very significant, because private property in China is a very new concept and it is growing into a very significant portion of China's economy. To underestimate the significant unknowns involved in a country/culture that is thousands of years in the making, is a grave mistake. Indeed, the history of financial cycles itself has changed dramatically during the past 200 years. During this relatively short time period economists have begun to think of the ups and subsequent downs as part of the same process (as opposed to viewing them as emergent consequences of external shocks, such as war or famine). For those interested in learning more about modern thinking on the subject, the Luwig Von Mises Insitute has an excellent article on the business cycle in general and how the subordinate cycle of credit expansion and contraction effects it. This is super relevant to the subject of this post because the birth and growth of the United States, and of its private real estate sector, largely coincides with the inflection point that marks the changing views of the financial cycle. One of the first published acknowledgements of credit cycles in relation to their impact on the greater economy was the 1838 edition of the Encyclopedia Americana where under Credit it states: “The history of every industrious and commercial community, under a stable government, will present successive alternate periods of credit and distrust, following each other with a good deal of regularity.” Clearly this is true in the United States, but we are witnessing more and more evidence that a similar ebb and flow is beginning to make its way east with China experiencing its own periods of credit lust followed by distrust. The two key differences being 1) the fluid complexity of the U.S. political and economic system incorporates self-governing checks and balances that do not exist in China, which allows the US economy to be a living, organic creature that is not so much controlled, but rather guided; 2) due to the self-governing aspects of the US system it is very difficult (though not impossible) to successfully blame a single governing body, institution, or other entity for the ails that may result from the credit contractions that inevitably occur.

I fear that the financial high that many involved in China's economy are experiencing will soon reach a level of intoxication too powerful for those same individuals to feel the ground beneath their feet. Indeed, the credit boom that has been building in China during the past decade is looking more like a tsunami than anything we've seen in the U.S. Some might ask, "who cares? What does that have to do with us?" It has everything to do with all of us. Long gone are the days when nations effect only their own economy and perhaps their most proximate neighbors. Globalism is no longer a buzzword: It is real, it is powerful, and it is here to stay. We need only look at the domino-effect that the small country of Greece (with a GDP of $356 Billion) is having on Europe and the rest of the world to begin to see the potentially catastrophic ramifications of the world's third largest economy (China with a GDP of $4.3 Trillion) slowing or expanding "too rapidly," a phrase whose meaning in relation to China we do not really have the tools to measure. We are in unchartered waters regarding the intricate interconnectedness of global economies. Meanwhile, the rules, laws, and politics of these countries do not have the equivalent international reach as do their economies, which in turn creates an intriguing albeit awkward intimacy. Thus far, such a relationship, with both countries' inextricably connected mutual interests, seem to be inspiring diplomacy and stability. Still, it is important to note that although some economic ties have been strained during the past several years due to the global financial mess through which we currently find ourselves muddling, we have not witnessed (and hopefully never will!) a situation where a political leader of either country has attempted to dictate or mandate policies or laws of the other directly.

... that concludes Part 1. Part II of this post will focus almost entirely on the very particular nature of property rights in the United States. For those who cannot wait, I urge you to pick up a copy of James W. Ely, Jr.'s thoughtful book on the topic The Guardian of Every other Right: a Constitutional History of Property Rights.

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