The Great Fall of China

"To act on the belief that we possess the knowledge and the power which enable us to shape the processes of society entirely to our liking, knowledge which in fact we do not possess, is likely to make us do much harm."
- F. A. Hayek

"Yeah, the harder they come,
The harder they'll fall
One and all"
- "The Harder They Come" by Jimmy Cliff.

The U.S. economy may have "recovered" according to some criteria formulated in D.C., but for most American citizens, this is the weakest economy they have seen in quite a while. The last time that unemployment was hovering around 9% for this long was before WWII. Over 2.7 million Americans live in a home with a mortgage that has not been paid in more than a year. The U.S. debt crisis has become a concern for the IMF.

The financial reports from Europe are also rather grim. The one country that seems to be avoiding the downturn is China. China benefits from a steadily growing GDP and now has a substantial middle class. But all is not well for the Chinese economy. An Australian news report indicates that China has a serious real estate bubble, and when it bursts, the impact could dwarf the 2008 U.S. recession.

China has a mixed economy, and the communists still control the real estate sector. Anticipating a rapidly rising upper middle class, the communists built vast cities of luxury apartment buildings. These apartment buildings are going up faster (much faster) than the ranks of Chinese yuppies who are supposed to be renting them. There are new towns where the apartment occupancy rate is 25%. The government doesn't provide statistics, but it is estimated that China has 64 million empty apartments.

Even more amazing is the story of the New South China Mall, the largest shopping mall in the world. This impressively designed mall is more than twice the size of the Mall of America. The mall, however, lacks two essential ingredients for a successful shopping center: merchants and customers. Since opening their doors in 2005, the occupancy rate has never risen much above 1%. The New South China Mall was basically born as a dead mall.

So how will this Chinese real estate bubble play out? Anyone who has lived in the U.S in 2008 knows the script. The building owners cannot keep tossing their money into these pits forever, and will have to figure out some way to recoup some of their investment. Undoubtedly, they will have to dramatically slash rents in order to get something for their empty spaces. This will drive down the value of real estate, and therefore any fund based on property values. This devaluation weakens the economy, which creates further downward pressure on rents, therefore making the real estate crisis even worse. The situation is like the 2008 American housing market, but China's bubble is much bigger. And when this bubble bursts, it will be felt across the globe.

The impact of a Chinese bubble burst would have a mostly negative impact on European and American markets, delaying any possible recovery. But there is some good news that could come out of a Chinese market crash.

• A real estate market crash will greatly reduce the prestige and power of the Chinese communist elites. It may even bring an end to one party rule.
  
• The economic success of China has been used to advocate authoritarian measures in the west. On "Meet the Press", New York Times columnist Thomas L. Friedman asked wistfully "What if we could just be China for a day" so that we could pass measures he likes without having to go through our messy democratic process. The failure of the Chinese command economy would end this sort of totalitarian nonsense.
• The crash would teach the nations of the world a valuable lesson, namely to avoid what Nobel prize winning economist F. A. Hayek called "The Fatal Conceit", that is, the belief that "man is able to shape the world around him according to his wishes." In the wake of China's failure to create prosperity on command, governments might take a more flexible, decentralized, market-based approach to decision making.

So hard times may be with us for a bit longer, but we will eventually come out of this both wiser and more prosperous. Unfettered by bureaucracy, humans always work out some ingenious methods to create wealth. As Nick Gillespie and Matt Welch put it in their excellent new book "The Declaration of Independents", we'll see a "future so bright, we gotta wear shades."