Puru Saxena is an investment adviser for individual and corporate clients in Hong Kong as well as a widely-cited expert and regular guest on CNN, BBC, CNBC, and Bloomberg. In the following recent interview with Financial Sense Newshour, he argues that Hong Kong, as well as China, is ready for a massive real estate bust and recession. When will this happen? When the U.S. starts raising interest rates. Read on...
From your perspective, living in Hong Kong and having been involved in the real estate market, is China facing a real estate bubble similar to what we faced in the U.S.?
"I was actively involved in the real estate sector here in Hong Kong but recently I’ve liquidated all my positions and have zero exposure to property now in Hong Kong. If you look at the history of asset bubbles, it is clear to me that Hong Kong and China are both in a gigantic property bubble, which is going to end very badly; and, in my view at least, this bubble is even bigger than the bubble we saw in the U.S. If you look at some of the classic metrics, which determine whether property is expensive or cheap or grossly overvalued, if you look at the home affordability ratio, which is the price of a property divided by the annual income, the home affordability in this city—Hong Kong—is off the charts and in China it is even higher. It takes 13.5 years of income to purchase an apartment here in Hong Kong. In some of the big cities in China, the ratio is more like 25 or 30 years of income. If you look at some of the other countries like the U.S. or Australia, it takes maybe 7, 8, or 9 years maximum. In some cities in the U.S. you can now buy a property for maybe 5 or 6 years of income and even less in some areas. So, historically, this property market is extremely overvalued in terms of affordability and the only reason property prices are where they are, at least in Hong Kong, is because of the Fed’s zero interest-rate policy. Our currency is pegged to the U.S. and we don’t have our own monetary policy and we’ve had interest rates at near zero for almost four years now and that’s the reason why property prices are so inflated. I believe this is going to end very very badly."
Puru, do you really think it’ll be as bad as the U.S.? The common refrain, even coming from the head of our own central bank, was real estate prices have never gone down, and that was true even in severe recessions—in 1981 and going back to the 70’s for at least half a century—when real estate prices kept going up. Could it be that bad?
"I think it’s going to be really bad here because if you look Hong Kong, Jim, this is a very volatile market. Between 1980 and now we had two instances where property prices fell by 50-60%. In 1980, property prices topped out and bottomed four years later. That bust saw a 50% reduction in prices. Then, in 1997, prices peaked and they fell by 65% over a period of 4 or 5 years. And, now, we are due for another big fall and if you look at the affordability index that I keep coming back to, in 1980 and 1987, at the previous peaks, the home affordability ratio was also around 12.5-13.5...We are now at 13.5 and, historically, we’ve never been higher; and I don’t care what people say, at the end of the day, what determines the value of an asset on a sustainable basis is affordability; and if people can’t afford to purchase while the government keeps clamping down with various duties and taxes, then, in my view at least, it’s only a matter of time before prices come down. And when interest rates in the U.S. go up, then we will see a big bust in property in Hong Kong."
If China were to go through a real estate bust, would it result in a severe recession similar to what happened in the U.S. between 2007 and 2009?
"I believe it will be worse, because if you look at the shadow banking system in China and the amount of credit that was unleashed on this relatively small economy—and I mean relatively in comparison to the U.S.—as a percentage of GDP the amount of debt unleashed was massive and much bigger than the debt that was unleashed in the U.S. bubble. So, I know a lot of people here that say the Chinese are very rich and they’ve got cash buyers and everything else, but if you look at the raw data—the Hong Kong monetary authority’s data, which they publish on their site through their semi-annual report—anyone can see that it is a classic debt-fueled asset bubble; because if you look at Hong Kong, for example, over the last three years or so since the Fed started its QE program, outstanding mortgage debt has appreciated by almost 50% in 3.5 years; and that is a mind-boggling number. And if you also look at China, the debt that has been issued by the banks, by all the shadow banking institutions, the numbers are mind-boggling and, to my knowledge at least, you don’t have a soft landing..."
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