Real estate, like pollution and traffic, is one of the topics you can’t avoid in China. However, unlike pollution and traffic, subjects on which there is a fair amount of consensus—“It is pretty bad”—the present state and future prospects of the real estate market is a source of intense debate. Pan Shiyi, the founder of the commercial property developer SOHO, ominously predicted that the residential real estate market was like the Titanic, headed for an imminent collapse. An article from Forbes earlier this year declared “China Property Crash Has Begun.” Others take the position that the housing market is not crashing but slowing. Of course, the deeper issue behind these debates is trying to forecast the ripple effects of falling housing prices on the shadow banking sector, government incomes and the economy as a whole.
Even though there is much disagreement about the future of the housing market, its recent past is not as controversial. In fact, as one commentator argues, “the development of China’s housing market is one of the world’s greatest and least recognized privatization success stories.” After allowing people to buy their government-allocated apartments at a significant discount to market value, the rate of home ownership and the housing market took off. Since then, as The Financial Times put it, the property market in China “has never experienced a real crash.”
When was the most recent crash in the Chinese real estate market? If we accept the judgment of the Financial Times that there has never been a real crash since the opening up of the market, we have to look back quite a long way, to Shanghai in the 1930s.
The boom and bust of the Shanghai property market, like a lot booms and busts, stemmed from worldwide trends and individualized, local decisions. China, at that time, under the rule of the Nationalist Government (1927-1937), was on the silver-standard. Since the 1870s, the worldwide price of silver in terms of gold dropped consistently. This trend accelerated in 1920s. Under these conditions, the price of commodities in China rose. There was a general boom. Due to Shanghai’s terms of trade with the interior of China and the fact that silver was valued more highly in China than in other areas parts of the world, the metal flowed into the country. By 1929, the amount of silver stored in Shanghai reached a record high.
With piles of silver sitting in the city, the question became how to put it to use. The answer was real estate. As one real estate company advertised, “Whereas the import-export trade is extremely dull, only the real estate business is flourishing. The only safe investment for the excess silver accumulated in Shanghai is real estate.”[i] Money flowed into real estate. The rationale was familiar. Buildings in Shanghai were safe investments that could not fall in price. T. V. Soong, Minister of Finance for the Nationalist government from 1928-1933, thought banks were over invested in real estate and had expanded credit too much based on these assets.
By the early 1930s, silver began to flow out of China. For many years China had a balance of payments of deficits that were made up for by remittances from Chinese abroad. With the onset of Great Depression these payments dried up and in 1931 China was a net exporter of silver for the first time in more than a decade. By the end of 1931, wholesale prices were dropping. When the United States abandoned the gold standard, the worldwide price of silver rose. During this period, China’s trade deficit continued to grow, remittances continued to shrink and wholesale prices declined.[ii] Whereas the worldwide fall in price of silver had been inflationary for China, the rise in its price was deflationary.
During this period the Shanghai real estate market cooled but it did not collapse until the after the American Silver Purchase Act of 1934. The key figure here was Nevada Senator Key Pittman. Pittman was a life-long advocate for silver interests in Nevada and linked the low worldwide price of silver with the Depression. As he put it in the early 1930s the “general silver question is of great world-wide import and the China question is the most important that we have to consider relative to our surplus production.” The problem, Pittman thought, was that with the low price of silver in terms of gold, Chinese consumers did not have the purchasing power to buy American products. Raise the price of silver, he argued, and it would go a long way to ending the Great Depression.
When the U.S. embarked on a silver-purchasing scheme that mandated the government buy silver at above market prices until it reached a certain point of total reserves and a certain market price, silver flooded out of China. The outflow of silver that had started in the early 1930s picked increased dramatically in late 1934, with a similar impact on prices. The Nationalist government tried to stop the drain of silver but to no avail. With silver reserves shrinking quickly, banks refused to make loans against real estate collateral. Chinese banks “called in their outstanding credit, restricted the amount of advances, demanded additional collateral and refused to renew loans on maturity.”[iii] The falling value of real estate assets rippled through the rest of the economy.
The biggest news in the Chinese real estate world this week comes not from Beijing, Shanghai or Guangzhou but from New York, with Anbang, a Chinese insurer, agreeing to buy the Waldorf-Astoria Hotel from the Hilton Company for nearly two billion dollars, making it “the largest acquisition of a U.S. real estate asset by a Chinese buyer, as well as being the most expensive purchase ever of a U.S. hotel.”
It is the kind of landmark purchase that rightfully brings back memories of the gaudy, go-go 1980s when Japan’s “buying spree went global: first real estate, then banks and resorts and Hollywood studios.”
Despite the natural comparisons to Japanese investment in the 1980s, it is also fruitful to look back to the 1930s. As Patrick Chovanec, chief strategist at Silvercrest Asset Management, told CNBC, the key variable in the current Chinese real estate market “is the reliance on property as collateral to support virtually all forms of lending throughout the economy.” It is a situation very similar to Japan in the 1980s and Shanghai in the 1930s. Will this time de different?[iv]
*This is a cursory treatment of a complex topic. For more see:
Brandt, Loren, and Thomas J. Sargent. “Interpreting New Evidence about China and U.S. Silver Purchases.” Journal of Monetary Economics 23 (January 1989), 31-51.
Friedman, Milton. “Franklin D. Roosevelt, Silver, and China.” Journal of Political Economy 100 (February 1992), 62-83.
Friedman, Milton and Anna Jacobson Schwartz. A Monetary History of the United States, 1867-1960. Princeton: Princeton University Press, 1963.
Lin, Weiying. China Under Depreciated Silver 1926-1931. Shanghai: The Commercial Press, 1935.
Lin, Weiying. The New Monetary System of China: A Personal Interpretation. Shanghai: Kelly and Walsh, 1936.
Young, Arthur. China’s Nation-Building Effort, 1927-1937. Stanford: Hoover Institution Press, 1971.
[i] Tomoko Shiroyama, China During the Great Depression: Market, State and the World Economy, 1929-1937, (Cambridge: Harvard University Press, 2008), 146.
[ii] Shiroyama, 149-150.
[iii] Shiroyama, 162.