China's Epic Hangover Begins

It is hard to obtain good data in China, but something is wrong when the country's Homelink property website can report that new home prices in Beijing fell 35pc in November from the month before. If this is remotely true, the calibrated soft-landing intended by Chinese authorities has gone badly wrong and risks spinning out of control.

The growth of the M2 money supply slumped to 12.7pc in November, the lowest in 10 years. New lending fell 5pc on a month-to-month basis. The central bank has begun to reverse its tightening policy as inflation subsides, cutting the reserve requirement for lenders for the first time since 2008 to ease liquidity strains.

The question is whether the People's Bank can do any better than the US Federal Reserve or Bank of Japan at deflating a credit bubble.

Chinese stocks are flashing warning signs. The Shanghai index has fallen 30pc since May. It is off 60pc from its peak in 2008, almost as much in real terms as Wall Street from 1929 to 1933.

"Investors are massively underestimating the risk of a hard-landing in China, and indeed other BRICS (Brazil, Russia, India, China)... a 'Bloody Ridiculous Investment Concept' in my view," said Albert Edwards at Societe Generale.

"The BRI Cs are falling like bricks and the crises are home-blown, caused by their own boom-bust credit cycles. Industrial production is already falling in India, and Brazil will soon follow."

"There is so much spare capacity that they will start dumping goods, risking a deflation shock for the rest of the world. It no surpise that China has just imposed tariffs on imports of GM cars. I think it is highly likely that China will devalue the yuan next year, risking a trade war," he said.

China's $3.2 trillion foreign reserves have been falling for three months despite the trade surplus. Hot money is flowing out of the country. "One-way capital inflow or one-way bets on a yuan rise have become history. Our foreign reserves are basically falling every day," said Li Yang, a former central bank rate-setter.

The reserve loss acts as a form of monetary tightening, exactly the opposite of the effect during the boom. The reserves cannot be tapped to prop up China's internal banking system. To do so would mean repatriating the money – now in US Treasuries and European bonds – pushing up the yuan at the worst moment.

The economy is badly out of kilter. Consumption has fallen from 48pc to 36pc of GDP since the late 1990s. Investment has risen to 50pc of GDP. This is off the charts, even by the standards of Japan, Korea or Tawian during their catch-up spurts. Nothing like it has been seen before in modern times.

Fitch Ratings said China is hooked on credit, but deriving ever less punch from each dose. An extra dollar in loans increased GDP by $0.77 in 2007. It is $0.44 in 2011. "The reality is that China's economy today requires significantly more financing to achieve the same level of growth as in the past," said China analyst Charlene Chu.

Ms Chu warned that there had been a "massive build-up in leverage" and fears a "fundamental, structural erosion" in the banking system that differs from past downturns. "For the first time, a large number of Chinese banks are beginning to face cash pressures. The forthcoming wave of asset quality issues has the potential to become uglier than in previous episodes".

Investors had thought China was immune to a property crash because mortgage finance is just 19pc of GDP. Wealthy Chinese often buy two, three or more flats with cash to park money because they cannot invest overseas and bank deposit rates have been minus 3pc in real terms this year.

But with price to income levels reaching nosebleed levels of 18 in East coast cities, it is clear that appartments – often left empty – have themselves become a momentum trade.

Professor Patrick Chovanec from Beijing's Tsinghua School of Economics said China's property downturn began in earnest in August when construction firms reported that unsold inventories had reached $50bn. It has now turned into "a spiral of downward expectations".

A fire-sale is under way in coastal cities, with Shanghai developers slashing prices 25pc in November – much to the fury of earlier buyers, who expect refunds. This is spreading. Property sales have fallen 70pc in the inland city of Changsa. Prices have reportedly dropped 70pc in the "ghost city" of Ordos in Inner Mongolia. China Real Estate Index reports that prices dropped by just 0.3pc in the top 100 cities last month, but this looks like a lagging indicator. Meanwhile, the slowdown is creeping into core industries. Steel output has buckled.

Beijing was able to counter the global crunch in 2008-2009 by unleashing credit, acting as a shock absorber for the whole world. It is doubtful that Beijing can pull off this trick a second time.

"If investors go for growth at all costs again they are likely to find that it works even less than before and inflation returns quickly with a vengeance," said Diana Choyleva from Lombard Streeet Research.

The International Monetary Fund's Zhu Min says loans have doubled to almost 200pc of GDP over the last five years, including off-books lending.

This is roughly twice the intensity of credit growth in the five years preceeding Japan's Nikkei bubble in the late 1980s or the US housing bubble from 2002 to 2007. Each of these booms saw loan growth of near 50 percentage points of GDP.

The IMF said in November that lenders face a "steady build-up of financial sector vulnerabilities", warning if hit with multiple shocks, "the banking system could be severely impacted".

Mark Williams from Capital Economics said the great hope was that China would use is credit spree after 2008 to buy time, switching from chronic over-investment to consumer-led growth. "It hasn't work out as planned. The next few weeks are likely to reveal how little progress has been made. China may ride out the storm over the next few months, but the dangers of over-capacity and bad debt will only intensify".

In truth, China faces an epic deleveraging hangover, like the rest of us.

The last of Wukan’s dozen party officials fled on Monday after thousands of people blocked armed police from retaking the village, standing firm against tear gas and water cannons.

Since then, the police have retreated to a roadblock, some three miles away, in order to prevent food and water from entering, and villagers from leaving. Wukan’s fishing fleet, its main source of income, has also been stopped from leaving harbour.

The plan appears to be to lay siege to Wukan and choke a rebellion which began three months ago when an angry mob, incensed at having the village’s land sold off, rampaged through the streets and overturned cars.

Although China suffers an estimated 180,000 “mass incidents” a year, it is unheard of for the Party to sound a retreat.

But on Tuesday The Daily Telegraph managed to gain access through a tight security cordon and witnessed the new reality in this coastal village.

Thousands of Wukan’s residents, incensed at the death of one of their leaders in police custody, gathered for a second day in front of a triple-roofed pagoda that serves as the village hall.

For five hours they sat on long benches, chanting, punching the air in unison and working themselves into a fury.

At the end of the day, a fifteen minute period of mourning for their fallen villager saw the crowd convulsed in sobs and wailing for revenge against the local government.

“Return the body! Return our brother! Return our farmland! Wukan has been wronged! Blood debt must be paid! Where is justice?” the crowd screamed out.

Wukan’s troubles began in September, when the villagers’ collective patience snapped at an attempt to take away their land and sell it to property developers.

“Almost all of our land has been taken away from us since the 1990s but we were relaxed about it before because we made our money from fishing,” said Yang Semao, one of the village elders. “Now, with inflation rising, we realise we should grow more food and that the land has a high value.”

Thousands of villagers stormed the local government offices, chasing out the party secretary who had governed Wukan for three decades. In response, riot police flooded the village, beating men, women and children indiscriminately, according to the villagers.

In the aftermath, the local government tried to soothe the bruised villagers, asking them to appoint 13 of their own to mediate between the two sides – a move which was praised. But after anger bubbled over again local officials hatched another plan to bring the rebellious village back under control. Last Friday, at 11.45 in the morning, four minibuses without license plates drove into Wukan and a team of men in plain clothes seized five of the village’s 13 representatives from a roadside restaurant.

A second attack came at 4am on Sunday morning, when a thousand armed police approached the entrance to the village.

“We had a team of 20 people watching out, and they saw the police searchlights. We had blocked the road with fallen trees to buy us time,” said Chen Xidong, a 23 year old. “They banged the warning drum and the entire village ran to block the police.”

After a tense two-hour standoff, during which the villagers were hit with tear gas and water cannons, the police retreated, instead setting up the ring of steel around Wukan that is in force today. The village’s only source of food, at present, are the baskets of rice, fruit and vegetables carried across the fields on the shoulder poles of friendly neighbours.

Then, on Monday, came the news that Xue Jinbo, one of the snatched representatives, had died in police custody, at the age of 43, from a heart attack. His family believe he was murdered.

“There were cuts and bruises on the corners of his mouth and on his forehead, and both his nostrils were full of blood,” said Xue Jianwan, his 21-year-old daughter. “His chest was grazed and his thumbs looked like they had been broken backwards. Both his knees were black,” she added. “They refused to release the body to us.”

Mr Xue’s death has galvanised his supporters and brought the explosive situation in the village to the brink. “We are not sleeping. A hundred men are keeping watch. We do not know what the government’s next move will be, but we know we cannot trust them ever again,” said Mr Chen. “I think they will try to prolong the situation, to sweat us out.”

From behind the roadblock, a propaganda war has broken out. Banners slung by the side of the main road to Wukan urge drivers to “Safeguard stability against anarchy – Support the government!” Nearby, someone has scrawled, simply: “Give us back our land.”

The news of Wukan’s loss has been censored inside China. But a blue screen, which interrupts television programmes every few minutes inside the village, insists that the “incidents” are the work of a seditious minority, and have now been calmed. “It is all lies,” said Ms Xue.

Her brother, meanwhile, said life had improved since the first officials were driven out three months ago. “We found we were better at administration. The old officials turned out not to have had any accounts in their office, so they must have been swindling us. And we have a nightwatch now, to keep the village safe. We have all bonded together,” said Xue Jiandi, 19.

With enough food to keep going in the short-term and a pharmacy to tend to the sick, the leaders of Wukan are confident about their situation.

But it is difficult to imagine that it will be long before the Communist Party returns, and there are still four villagers in police custody.

“I have just been to see my 25-year-old son,” Shen Shaorong, the mother of Zhang Jianding, one of the four, said as she cried on her knees. “He has been beaten to a pulp and his clothes were ripped. Please tell the government in Beijing to help us before they kill us all,”