Recession in China

Andy Xie is always a pleasure to watch. On Bloomberg last week Andy strongly indicated that China was or would be in recession. He was remarkably upbeat, which implies that he expects the government to recognize the necessity of a recession and manage the economy down to a safer base. Housing needs to drop much further than it has, down to more sustainable levels.

Andy is certainly correct in saying that the government must not re-inflate the shadow banking system, but it is not clear that this will happen. Currently it appears that developers are still operating, as the push to complete some of the projects continues, presumably with government money.

That’s effectively a bailout. The market seems to think that the developers have been truly cut out from the financial system, but we see now that isn’t true. The government is (apparently) picking winners and ensuring loans without financial assessment, through the banking system.

What’s important to understand about the shadow banking system is that it is involved in two very different industries, with very different political implications: Housing and wealth management products.

Housing, as difficult as it is right now, politically represents less risk. Yes, possibly 1.5 million buyers have been jilted as they wait for their housing to be finished, but this is a small number on a national scale. The government has for years bargained with people over housing. In order to build better housing in cities, residents would be compensated with nicer, newer housing in less developed areas. There are ways of managing some of these claims.

Of course, many of these buyers are not families but rather investors. They might be big investors that we might call speculators, or somewhat smaller. The market was hot, people went all-in, and now they may be quite over-extended. This group will really want a bailout, and may get it in the end.

In any case, the creditors are limited and dispersed. While they are a serious problem, they are not the most serious.

Wealth management, on the other hand, is quite politically volatile. There might be thousands of investors, including many families that might only have one or two investment vehicles. This is a much larger group, not as politically-connected, but able to make a big noise if they are delayed too long.

The problem, of course, is that the shadow banks went long on housing, lending out money to developers, using the income from selling the wealth-management policies. We are seeing this now with Zhongzhi, and there will be many others. So this process will not be simple, nor does it seem to be started much less finished.

Andy seems to ignore one important part of the story, when he says that people will have to choose some sort of factory work rather than hope for a white-collar career: the issue of labor law and the very significant distinction in the treatment between white-collar positions and factory work.

The difference is vast. White-collar workers get pensions, healthcare, and other benefits. Factory workers get little beyond their salary and hopefully healthcare while at the facility. They will live in temporary housing and leave when they can. As migrant workers, they are often not even permitted to establish residency in the area.

Shifting people from away from benefits is unwise, because it will further reduce domestic demand. It is also politically troublesome. People are going to notice if large numbers of workers in cities, local people rather than migrant workers, are no longer getting labor benefits.