China’s economy has gone from near-irrelevance to the world’s second largest in less than half a century. Perhaps more incredible than its meteoric rise is the fact that it has done so without any major economic contraction. Nearly fifty years of consistently positive GDP growth is practically sorcery in the eyes of the West, as our more democratized and less managed economies rarely manage to go a decade without at least one kind of breakdown, let alone five.
The supposed impossibility of eternally uninterrupted economic growth has raised more and more eyebrows and led to increasingly dire predictions about China’s economy as time goes on. Surely, the ruling Chinese Communist Party cannot avoid the fundamental economic forces indefinitely. Surely the other shoe will drop soon and all will be right with the world.
It has to be done. right?
We are supposed to live in a post-Soviet world. A world where the question of managed versus free economies has been a fact for some time. But whether the CCP is able to keep China’s economy, an economy that encompasses the interests of more than a billion people, from going into recession, that established fact is starting to look more like an open question with each passing quarter happens
The current situation facing China’s real estate market is the latest and perhaps most compelling sign that China has finally reached a turning point. A generation’s rapid growth, urbanization and unintended consequences may come to a head.
(A) Real property
China’s real estate market is currently the largest asset class in the world, with a theoretical value of nearly $60 trillion, more than the entire stock market capitalization. About one-third of China’s economic activity involves the real estate sector (compared to 15-18% of the US economy), a staggering number made even more so when combined with the fact that housing represents around 70% of Chinese household wealth.
The reasons for the outsized role that housing and real estate play in the Chinese economy are complex and numerous, although they all have their roots in the CCP.
The current housing crisis began shortly after China relaxed its rules on the sale of private homes in 1998. This policy change roughly coincided with the explosive economic growth that has characterized much of the past few decades, much of which was based on importing cheap labor from the Chinese countryside into rapidly growing metropolitan areas. More than 480 million Chinese moved from the country to the city in search of better economic opportunities, and real estate developers were only too happy to provide the accommodations that the newly urbanized Chinese needed and could suddenly afford.
Real estate developers and construction companies were not the only ones to benefit from the unprecedented mass urbanization. Regional governments, many of which depended heavily on land sales for revenue, encouraged as much development as possible, and the seemingly endless demand for housing gave yield-hungry Chinese investors a place to park their capital. Developers soon found themselves unable to keep up with demand and began taking on large amounts of debt, much of it in dollar-denominated offshore bonds, and even began selling properties in developments that were not even they had only started construction.
China’s government became aware of all this rampant speculation and took what it considered reasonable measures to mitigate the threat of a real estate market collapse. It imposed new financing restrictions for developers based on their liabilities, debts and cash holdings, as well as imposing new rules on banks to limit the amount of mortgage loans. Some developers, including giant China Evergrande Group, were pushed by these new restrictions and forced to suspend ongoing projects while they sort out their balance sheets.
The quirks of China’s real estate system meant that recently stalled or canceled projects were more than just developer problems. Chinese homebuyers who had secured mortgages and were buying unbuilt properties suddenly found themselves on the hook for real estate that might never be finished, and many were understandably upset. More and more people began to protest the situation by refusing to pay their mortgages until more than $295 billion worth of loans were affected before the CCP began to interfere with data collection on the issue . So far, China’s government has been unsuccessful in controlling the situation, although they are increasing support for struggling developers and offering some special loans to help ensure that certain projects are completed.
How will China’s housing collapse affect the world?
The current crisis has serious consequences for the Chinese economy in general, some of which are already being felt. S&P Global Ratings has said that about 20% of the Chinese developers it rates are at risk of default, and that the fall in land sales has hit local government revenues to the extent that 30% of local governments may have to reduce spending at the end of the year. Non-performing real estate loans from state-owned banks rose by 1% in 2021, a number that is sure to grow as more recent data becomes available. There are many reasons to believe that the real estate market will suffer in the short to medium term.
Harvard professor Kenneth Rogoff estimates that a 20% drop in real estate-related investment could shave 5% to 10% of China’s GDP, and that subsequent declines in real estate employment and construction could create significant instability in China’s labor market. Or, more broadly: “In the medium term, China faces a host of challenges, ranging from extremely adverse demographics to slowing productivity… So far, the housing boom has sustained by a broad economic boom that now faces strong headwinds.”
The intentionally opaque operation of China’s government makes it difficult to predict exactly how the current crisis will play out. However, it is possible to extrapolate the kind of impact the crisis may have on the global economy if China’s housing market continues to deteriorate. The first and most obvious consequence of a severe slowdown in the Chinese economy will be felt by companies with significant exposure to China. Companies like Wynn Resorts, Apple, Tesla, and Disney would suffer the resulting loss of revenue from the China market, as would companies like Qorvo, Boeing, Caterpillar, and any other company that relies on China for supplies or sales.
Regarding Chinese companies, rating agency Fitch identified three main sectors that would be most vulnerable to a slowdown in the real estate market: asset management companies, engineering and construction companies and steel producers. Fitch also believes that small and regional banks would be more vulnerable to continued difficulties, particularly if the trend of homebuyers refusing to pay mortgages on properties that may never be built continues, although this may have little impact on the global economy beyond the consequences. of a slowdown in the Chinese economy in general.
conclusion
As dire as things may seem, however, it is important to remember that China’s government is well aware of the risks its economy faces due to the current crisis. Experts, analysts, and observers have been warning of an impending collapse in China for years, but the closest we’ve seen was a self-imposed recession that resulted from the government’s draconian attempts to eradicate COVID-19 within its borders. borders There is little reason to assume that China’s government’s control over its economy has fallen to any significant degree. As anathema as it may seem to Western sensibilities, China’s government still has the tools, the will, and the monopoly on violence it needs to prevent the real estate market from destroying its economy as a whole.
The best answer, for now, is to stay the course. It may be a good idea to close positions related to companies with significant exposure to China’s economy, but treat all other investments the same way you would when facing any other type of headwind. If the economies of Europe and the United States weathered the housing crisis of 2008, China’s economy is likely to weather this storm as well.
