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By early 2011, China had to cool the economy and tackle the rising leverage and speculation. Policymakers also declared a shift in China’s growth model to be more consumption-driven. The transition probably turned out to be more complicated than Chinese policymakers may have expected. Unlike the infrastructure-driven growth model under which the pace of growth could be controlled by adjusting the pipeline of construction projects, a consumption-driven model would let the “invisible hand” of self-interested consumers exert more influence. In other words, a consumption-driven model would cede more control to market forces and experience more unpredictability. While variability in realized growth versus projection is a fact of life in the rest of the world, Chinese officials have sought to minimize this uncertainty as the failure to hit growth targets could affect confidence. With an estimated homeownership rate around 90% and many families holding multiple apartments as investments, China’s housing market has an outsized impact on wealth, consumption and construction, as well as the general economy. As shown in CHART 1, the rapid housing price increases in 2010 and 2011 prompted regulators to cool the housing market, which resulted in price declines in 2012. However, the slowing economy soon pushed them to relax home purchase restrictions. Predictably, housing prices rebounded as a response, with double-digit increases in tier-one cities, prompting measures to tame the bubble once again by 2014. It is quite clear that there isa momentum-driven herd mentality among Chinese buyers, as expressed in the Chinese adage “buy up market, not down” (tk # F HK). In an attempt to wean investors off real estate and channel their capital to highly leveraged state-owned companies, policymakers engineered a stock market rally in the second half of 2014. As the rally gained momentum, the herd flocked in (buy up market, not down) and pumped up a huge stock bubble that eventually blew up by mid-2015. This was followed by the renminbi’s official devaluation in August 2015 to alleviate the pressure from the surging U.S. dollar. Confronted with slowing economic growth, declining foreign exchange reserves, rising capital flight, and a collapsing stock market, Chinese policymakers shelved the reform agenda and went back to the proven playbook—infrastructure and real estate buildout. China even eased property investment rules for foreign institutions and individuals. The result was perhaps the biggest housing bubble ever in China’s tier-one cities—prices surged over 30% year-over-year by the spring of 2016. It is as if China was validating the old physiocratic economic theory which postulated that the wealth of a nation lies in its land development. For years China has justified its rapid property price increases on the basis that it is just catching up to global metropolises such as London, New York, Hong Kong, Tokyo, etc. The latest price surge has indeed accomplished that and more. For example, a run-of-the-mill two-bedroom apartment in Beijing’s financial district now costs more than $2,000 per square foot. Skyrocketing domestic property prices have also distorted many Chinese investors’ views of foreign properties—they are bargains relative to prices in Beijing, Shanghai and Shenzhen. It is no wonder Chinese investors have bid up property prices in many major cities around the globe. As a sign of the times, Warren Buffett’s Berkshire Hathaway HomeServices has recently teamed up with China’s Juwai.com to bring American residential property listings to China. An Under-Appreciated Reflation Story According to a U.S. State Department memo released by WikiLeaks, when Chinese premier Li Keqiang was serving as the party secretary of Liaoning Province in 2007, he supposedly told a U.S. ambassador that he did not have confidence in the provincial GDP data. He preferred to monitor three indicators to assess the state of the local economy: the rail freight volume, electricity consumption and bank loan volume. In 2010, The Economist introduced the Li Keqiang Index, which takes the weighted average of these three metrics’ annual growth rates to track Chinese economic growth. The Li Keqiang Index has indeed tracked the direction of China’s reported GDP data as shown in CHART 2. There was a clear growth deceleration in 2015 and a strong rebound in 2016. CHART 1: YEAR-OVER-YEAR CHANGE IN CHINA NEW PROPERTY PRICES 35% 30% 25% 20% 15% 10% 5% 0% -5% -10% 2006 2007 2008 2009 2010 2011 Ml China 70 Cities New Apartment Prices Mumm China First Tier Cities New Apartment Prices 2012 2013 2014 2015 2016 2017 Source: Bloomberg GLOBAL FORESIGHT THIRPD QUARTER 2017 HOUSE_OVERSIGHT_012085