One of the factors that has made Australia's economy the standout performer in the OECD since the global financial crisis is its relationship with China. That is starting to deteriorate, as the Chinese economy begins to change character. China is beginning to make the transition up the "value chain": a move towards creating a higher quality industrial base rather than industry that heavily depends on low wage costs. For China to be politically stable, wages must rise -- this is actually stipulated in the latest Five Year Plan -- and that means a different type of industry base.
The fall in the iron ore price is one indication that the "China effect" is starting to ease. It will put pressure on the economy, although volumes remain high. But Australia's place as a provider of raw materials to the Middle Kingdom seems likely to weaken.
It is important to interpret China correctly. The comments in The Guardian that China's housing market is starting to weaken are another example of interpreting China as if it is like a modern Western economy. The housing market is not the same bell wether that it is in developed economies. There has only been private property ownership since the mid-90s in China, and the over building should be seen in the context that over 300 million Chinese are expected to move from the country to the city over the next decade. Moreover, the Chinese government still owns most of the land in China, which is tier 1 capital they can sell off to underpin their banks if they get in trouble.
The problem for investors in China is that they have nowhere to put their profits. The banks provide low interest rates and the stock market is unstable and mostly government owned. There is no bond market to speak of. They can't take money out, at least not legitimatley (the increasing buying of Australian property indicates there are other options). So they have put their money into Chinese property, which has become an asset bubble.
That process appears to be at an end. The growth rate of investment in real estate development has dropped off. This time last year it was growing at around 19% year on year; now it is down to 13.7%. It is similar with commercial buildings, with the growth of sales in commercial buildings for the first seven months of this year 8.4% below what was achieved last year.
The weakening of the housing market in China is probably one reason why the iron ore price is dropping. But it should be remembered that the Chinese government will still engage in massive infrastructure investment and the Chinese have over $3 trillion in surplus funds. It is unlikely that iron ore demand will collapse just because of what is happening in the housing market.
But what it does indicate is that China's property bubble is actually worse than Australia's, especially in terms of income yield. That is likely to create an even greater incentive to buy Australian property for those Chinese who can get money out of the country.
The Guardian makes this point:
"The volume of exports increased 1.3% in the June quarter, but the actual dollar amount of exports fell 0.6%.
And so we keep looking to China, hoping their real estate market will hold up, and that their demand for our exports will continue to grow strongly.
But a collapse in the Chinese market would also have another sting – if Chinese real estate investors can’t achieve growth in their own markets they will start looking in even greater numbers for value elsewhere – places like New York, Toronto ... and Sydney."