Bubble China

China’s economy is in a very precarious position now. The proximate cause of this economic weakness is the unraveling of the housing market, with several large developers now bankrupt, and many smaller developers in dire straits.

Deflation looms; it is likely inevitable. With the end of the debilitating Covid-Zero policy, China's economy was supposed to be ready for a rebound. Instead, conditions look fragile at best.

Long-time China watchers are not surprised. The constant increase in housing prices over two decades indicated that, at some point, the sector would contract. However the housing crisis, and it is a crisis, is still largely unaddressed, two full years after Evergrande collapsed.

The impact of housing on the wider economy cannot be overstated. Much of the real growth China has enjoyed over the past decade has come from increasing land and apartment prices. Some of those gains will certainly be lost, and this will impact the purchasing power of most Chinese families.

The upstream and downstream effects from this housing crisis also simply cannot be overstated. A significant proportion of the country’s production of steel and concrete has for years been allocated to building new housing. With the major and minor developers cash-strapped, unable to complete unfinished projects, it is inevitable that concrete and steel prices will suffer. The same goes for windows, doors, wood flooring, and all the other inputs of building construction. Elevators, furniture, refrigerators, the list goes on and on.

How did this crisis come about? First and foremost, the official demand for growth has long set the tone. However, a number of additional factors are significant.

Land sales are the primary method of local government revenues. This has encouraged local governments to maximize the value, or rather the sale price, of their land, contributing to today’s bubble. Interest rates for savers have long been artificially low, which spurs these savers to invest, often in real estate. Indeed, real estate has for years been seen as the best way of preserving and augmenting savings.

Finally, the effects of state media cannot be ignored. While propaganda outfits like the Global Times will deny that a crisis exists (for now), and will eventually lay the blame for the crisis on individual players in the market, after they’ve been detained, state media has been deeply invested in the growth of housing prices and absolutely deserves some of the blame.

In some ways the government reaction to the crisis has been smart: so far there has been an unwillingness to bail out the sector. But this is not a positive action, only a recognition that government stimulus is not an effective methodology, at least not in this particular case. That is the correct instinct.

However the government seemingly is not doing the right thing here, which is to use bankruptcy law. China does have a bankruptcy law, but it is rarely used. Usually, the relevant government agency (whether local, provincial or central) will manage the assets of a bankrupt company, finding a buyer for factories, liquidating assets and so on. The main goal is to keep productive assets working, and maintain employment numbers. It is questionable how effective these methods are.

The problem in this case is the vast number of stakeholders. Nearly every half-completed development will have hundreds if not thousands of ‘owners’, each of whom is hoping, or praying, for some sort of relief. Right now they are in limbo, unsure if all of their money is lost, and therefore unable to make any financial decision. They must stay pat until some sort of resolution is put in place.

Add to this the suppliers to the bankrupt developers, who are unpaid and, therefore, in the same position. If they can stay afloat through this loss, that will be an achievement. If they have any financial capital left, that money will be frozen for now. No one takes a huge loss and then quickly throws cash at a new investment, it simply cannot happen.

This economic correction will be painful. Many will lose, some will lose everything. However there is opportunity here as well.

While the vast increase in house prices has led to growth, it has also been a big drag on people’s pocketbooks. Housing, usually apartments, are (or were) considered a necessity for newly married couples, and this caused families to save an excessive percentage of their income. Housing prices kept going up, and so savings had to rise as well.

High housing costs have reduced the birth rate. In order to build a family, a couple needs to obviously have a home, and needs to have enough income to contemplate starting a family. When they have a home but also have a large mortgage, they will not be in a solid position to have a child.

A reduction in housing costs will allow consumers to spend more and will allow families to feel comfortable having a child or children. That is only possible, however, after the crisis is resolved.