Break in China Housing Bubble Affecting GDP

“To us, it is no longer a question of ‘if’ but rather ‘how severe’ the property market correction will be,” said Nomura analysts in their report, adding there “isn’t much the government can do to head off problems.”

The housing problem according to some analysts stems from the attempt by China to urbanize migrant workers. Housing has boomed in rural areas but, because of the Hukou system of household registration, urbanized rural areas fail to have necessary access to public services like schools and social welfare programs. An article in the Economist (March 22, 2014) explains hukou as follows.

“Yet at the heart of prosperous, urban China sits an enormous inequality, based upon the hukou system of household registration. To have full access to schools and hospitals in the cities at subsidised urban costs, you must have an urban hukou. But if you were born in a rural area then your hukou (and that of your children) is registered there—and changing that is very difficult. Only 36% of China’s total population are urban hukou holders. This has, in the past, helped control the flow of people and kept urban labour costs down while letting the new urban middle class retain their privileges.”

The lack of supporting social structure has turned many new developments in rural China into “ghost villages,” adding to the glut in housing.

Bank of America Merrill Lynch China economist Ting Lu suggests China must revise the hukou system to give rural residents access public services. Ting Lu also suggests the government should allow migrant workers to swap residential and farm land for homes and hukou registration in cities as well as providing mortgage financing for first homes.

UBS is less pessimistic than Nomura, suggesting that the Chinese government can still mitigate the housing downturn. UBS forecasts a China GDP of 7.3 for 2014, down from 7.5 percent, and a fall to 6.8 percent in 2015.

The housing situation is of crucial importance to the steel industry because it is estimated that 20 percent of China’s steel demand comes from the urban housing sector. Property investment indices fell into negative territory in four Chinese provinces in the first quarter of 2014, foreshadowing further declines in other provinces. Less investment leads to less construction and sales and less steel usage, resulting in falling GDP.

Financing Schemes

To complicate matters, financing for major investments like construction are commonly secured by metals market imports. Import inventories of metals such as copper and iron ore at China ports are sometimes used several times to secure financing. This potentially results in inventories having multiple owners, leading to legal tangles in cases of loan default.

These “dark inventories” can keep stocks of commodities out of circulation, upsetting supply and demand fundamentals.

Iron ore is one of the most vulnerable commodities due to high inventories at China ports. As of June 2, iron ore at Chinese ports stood at a record high 115.9 million tons, up .32 percent from the previous week (Steel Orbis). MySteel estimates that 30-40 percent of iron ore inventory at China ports is tied to finance deals. Spot prices have fallen by about 30 percent so far this year putting additional pressure on loans secured by iron ore inventories.

China, and its influence on the world as well as U.S. steel economy, is a critical subject to understand. Steel Market Update will host a special panel on the subject at our 4th Steel Summit Conference to be held on September 3 & 4, 2014 in Atlanta, Georgia. Details and registration can be found on our website.