Only a couple of years ago, China was on the path to overtaking the United States, and becoming the world’s largest economy. In 2014, many were speculating that this could happen as soon as 2024.
Dubbed by many as an economic Miracle, China Grew From a third world country to a global superpower in just a matter of a few decades.
Few could foresee the effects that the economic reform in the late 1970s would have on the developing country. Soon the lists of the largest companies in the world began to feature more and more Chinese Enterprises.
Globally the country was one of the most important trade Partners, fueling globalization on a scale never seen before, and with that power came influence.
Fast forward a few years and China finds itself in a myriad of problems; both economic and political.
A catastrophic Zero COVID Policy, Real Estate Debt Crisis, External Infrastructure Issues, Internal Debt Issues, a Mini Revolt of the Youth, and the slowing down of the economy, are just some of the things that have been plaguing the nation recently.
The results of these issues, threaten the very power structures of the country. So how did China get here, and what are the consequences for the country and the world as a whole?
1. The Housing Bubble Pops
Let’s begin by understanding the most talked about issue, the real estate bubble.
The main growth both for the Chinese economy as well as the housing market began in 1979, with economic reform. From here, China opened up to the rest of the world. Massive civilian migration from rural locations to main city hubs ensued as people look to improve their quality of life.
Hundreds of millions of sons, and particularly daughters of Chinese farmers who move from the farm, where they were earning really the same as they were earning a thousand years ago in Chinese history.
Absolute subsistence wages. They traveled four or five hours to the local city and there they began working in the big factories, the workshop of the world.
Due to that, in four decades China went from a mostly rural population to a country where two-thirds of the entire population lives in major city hubs.
2. Real Estate Impact on Marriages in China
On top of relocations, a cultural element also boosted the sales of housing. Owning real estate was considered a source of financial stability for a family as well as a prerequisite for marriage.
As a result of the one child policy and the Chinese preferring male heirs, they are 35 million more men than women in China. That creates intense competition for brides with men often having to prove their material worth. This often means owning a home.
This led to entire families and their friends pooling money to contribute to the purchase of a house for their relatives.
Why you might ask? Because the prices of Apartments have gotten so out of control, that according to the financial times, housing affordability in China is among the worst in the world.
Taking into account living expenses, it would take the average earner 50 years to buy an apartment. This Collective pooling of money is a major difference between the Chinese property market and the West.
Little inventory and slow development, combined with rapid growth, led to Major supply issues, thus prices rose and affordable housing became an issue for local governments.
The solution was to issue loans to property development companies, as well as easing the credit lending standards to individuals. Due to these factors the Chinese real estate market became a rocket ship, and it fueled massive economic growth.
Some companies like the infamous Evergrande took full advantage of the situation and expanded aggressively. Aided in a large part by the availability of cheap credit. Evergrande became so large that they even built a theme park and purchased a soccer team with some of the money.
The Theme Park is now abandoned. Here’s how it looks like now, it really is a sad waste of money time and resources.
Many of these property institutions quickly became the largest in the country and many expanded projects into overseas markets. Commercial housing sales reached 2.7 trillion dollars in 2020.
In China today, the general population has about 70% of their total wealth stored in the real estate market. However, the supply of housing was still short, in part due to speculation, it was commonplace to purchase a second or third home as an investment, since it was considered wise and a stable use of savings.
Seeing the never-ending demand, developers created an ingenious system to further fuel expansion, these were based on two key pillars;
- They started to finance their operations with foreign debt the appetite for Chinese debt and Equity was increasing around the world, since their massive growth brought very attractive yields.
- Developers created pre-sale options for buyers that quickly became the norm in the country. In it, home buyers would give money to Developers, for a home that has yet to be built. All they had was a promise that once it was finished it would be theirs.
The whole construction period would take about two to three years usually, and people will start paying their mortgage way before the completion of the project. Years even years or maybe over a year over a year and a half.
In the past it wasn’t seen as a risky business, because as I said and people would not expect, developers cannot complete their home at a large scale, not like now.
While this made sense for both sides, it quickly escalated, with loose regulations around how much money the property developers needed to keep. They started to game the system to their advantage.
By obtaining pre-sales they were able to start new projects without finishing the old ones once the new projects yielded new pre-sales they would use some of that money to finance the actual construction, while the rest went to new projects and so on.
In essence, they created a Ponzi scheme that relied 100% on the stable and Perpetual growth of the housing market. However, once the influx of people to major cities started to slow down from 4.1 to 1996 to 2.1 percent in 2020, the scheme started to fall apart.
With the slowdown in pre-sales, developers started to rely more and more on Banks and foreign debt to keep expanding. Sometimes the debt payment was too large to pay with an operating income, so they used further debt to finance their obligations.
It all continued for some time, but soon the Chinese authorities entered the scheme. In August of 2020, the Chinese government implemented the Three Red Lines Policy. Each line represents a debt ratio that the companies had to respect. If not their ability to contract more liabilities was severely hampered.
Developers with extreme amounts of debt such as Evergrande crossed all three lines, meaning that they were not able to increase their liabilities any further. And since Evergrande used debt to finance old liabilities, it was not long before they started to run into liquidity troubles.
- They failed to repay the wealth managers who had a direct investment in the company. And this provoked a large revolt by wealth managers and investors who went to their headquarters to protest.
In September 2021 there was a hugely crucial moment. Evergrande missed payments on wealth management products the wealth management Market in China as well Ordinary People can put their savings, and the money is usually going into real estate, often to companies like Evergrande.
And these people who had invested hadn’t got their money back they descended on the headquarters of over ground in Xinjian.
This was the point of which went from it might be a crisis to well it probably is a crisis.
Soon after, Evergrande started to fail on its payments of dollar bonds and these Bonds were sold to the Western world, and they weren’t the only property company in trouble.
Property developer Kaiser, missed a 400 million Bond payment in November of 2021. And in January of 2022, Shimao group defaulted on a 101 million dollar loan. And most recently The Yuzhou Group requested to defer a payment of offshore bonds, worth 582 million.
This resulted in a large loss of confidence in the Chinese housing and bond market both internally and externally. This accumulated in mortgage strikes by distinguished buyers, who were paying their monthly bills without seeing any progress on their purchase property.
To date more than 320 groups of homeowners are believed to be refusing to pay their mortgage loans. Anger erupting among the Chinese are home buyers as property developers hold construction on their homes.
Since July, Home Buyers in over 100 cities across China, have declared a mortgage boycott, just like Tim, many home buyers are desperate. Some have taken to Street demonstrations but these have been quickly quashed with officials citing COVID concerns.
Backed into a corner, home buyers that have threatened to stop payments on their mortgage in over 300 projects.
The value of these loans is estimated to be worth between 150 and 300 billion dollars. The Chinese government has since slightly relaxed the rules, and on top of that the Chinese Central Bank has cut interest rates in an attempt to revive the credit and housing markets.
We have to see what happens with this it’s not clear if the situation will subside or if more property developers go insolvent, causing civil unrest.
On top of all of this, real estate related activities represent close to 30% of total Chinese yearly GDP.
If the property sectors go under there’s going to be a ripple effect, it’s a risk to Banks, local governments, and the stability of China.
3. Internal Debt Struggles
While all of that might sound bad enough, other debt issues are starting to rear their ugly head. There’s been many unprofitable and huge debt-ridden infrastructure projects.
One famous case is the Super Speed Railroad. The infrastructure project began after the 2008 financial crisis, as an attempt to pump money into the economy and create employment opportunities.
It was a classic fiscal policy boost, that worked to perfection. The project was a major success, offering employment to millions and single-handedly pushed some industry sectors such as steel and concrete out of default.
This was in large part why China avoided the turmoil that most other countries faced during the 2008 crisis.
While it did save the economy from recession, the problems started right after construction finished. Since the railway connected secondary locations and not main destinations, the demand was not always there. And to add to this the ticket prices were out of reach for the majority of the population.
The lack of Revenue may not have been an issue, however, this project was funded by massive amounts of debt by Major Banks, local governments, as well as some publicly issued bonds.
From 2015 up to this day, the interest alone on these payments have surpassed the operating income of the project. That’s right the interest on the debt has been more than the company’s income.
As of 2021, the total liabilities of 5.9 trillion Yuan or 900 billion dollars, in other words five percent of the Chinese GDP. The majority of these liabilities are bonds which were sold to State Banks.
Thanks to the Zero COVID Lockdowns, the rail infrastructure is being used even less, as a response the Chinese government announced an economic stimulus to lift the covert hit economy. This included allowing the China Railway to issue another 300 billion yuan in the form of Railway construction bonds.
The doubling down on an already unprofitable venture. It seems like China is putting appearances above functionality and profitability. A path that can lead to major issues if not addressed accordingly.
Due to massive amounts of debt expansion, profit motives, and poor planning, there are numerous ghost cities in China. These are areas of vast amounts of infrastructure and property, that virtually remains unoccupied.
The financial times explains ‘the ratio of empty apartments in China could range between 10% and as high as 40% or even 50% in some small cities’, ‘there are enough empty homes in China right now to house about 90 million people, greater than the population of Germany or the UK’, ‘newer developments were built quite quickly without a lot of consideration for the logistics’.
‘I’ve traveled to many parts of China where you go to a suburb, and suddenly you see this forest of apartment blocks. Carry on for five ten minutes in your taxi, and you’re still going through apartment block, after apartment block with nobody in them’, ‘I visited one of the most more famous ghost cities Odos, in the middle of the desert, very far away from anything. It was quite strange because it’s not like there’s necessarily jobs there’.
4. Risky International Loans Backfire
To add to the internal debt issues, China is also struggling with external infrastructure projects.
The grand Belt and Road Initiative is threatening to turn out to be one of the most unprofitable global projects of all time. The initiative is a large investment into more than 100 countries. It’s China’s ambitious attempt at growing Global influence as well as creating Global links to China in theory, strengthening its import export markets.
The thing is though investment in risky countries is just that risky, and if not calculated properly these Investments can turn out to be very unprofitable ventures.
In just 2020 and 2021, China has had to renegotiate more than 52 billion dollars in debt. And a lot of the countries that China deals with are unwilling or unable to pay.
The Belt and Road Initiative has become so large that China has become the world’s largest source of development credit, overtaking the World Bank as well as the IMF.
Considering that this project is political in nature, no matter how unprofitable the state government is likely to keep financing it. China could gain untold geopolitical leverage but it comes with the risk of a catastrophic outcome, both for the financial stability of China, as well as causing a political debacle due to its involvement in other countries foreign affairs.
5. Zero COVID Policy and Its Implications
As if debt issues, both on the internal and external front are not enough, the Chinese government continues to support a zero COVID policy to this day. The plan on paper was to eliminate the disease. The government was to be seen as competent and to be able to deal with whatever came its way. And it worked for some time.
As of today, according to the official statistics the death toll from the virus in China stands at little over 5 thousand, while, the US is over 1 million. No matter how staged these numbers might be, the authorities could point to this low number as a rationale for lockdowns.
While the rest of the world is moving on due to herd immunity, China on the other hand can’t do so, they’ve had no natural immunity.
The latest mandate is for every major city to have a test site, within 15 minutes’ walk of every resident. It looks like they’re going to become a permanent fixture on the streets, and having a negative result will be required for going to school, work, shopping or eating out.
There will be no living with the virus in China. It is pursuing a pandemic victory at all costs.
Once they announced the Zero COVID Policy and how it could go on for more than five years the lockdown’s perception in the general population’s eyes quickly changed.
People are now protesting lockdowns in what can only be described as a dystopian nightmare. However, even if the state wanted to, going back on its policies now would be a complete disaster, both on a humanitarian and political scale.
According to Shanghai’s Fudan University, the death toll could reach more than one million people, and it would be an admission of failure on the part of State leadership. Completely unacceptable, as the government is preparing for its 20th party Congress, where current president Xi Jinping will go on for his third consecutive term as party leader.
Thus, having a Slowdown of the economy and popular discontent seemed to be no matter how wrong, the only viable path for the state authorities moving forward. If they backtrack, its weakness. And saving face, is a big part of Chinese culture and the government must showcase their superiority, no matter how staged it might seem to their Western counterparts.
What does this mean for the economy? Well to start a massive decline in internal demand and increasing unemployment, especially among the young. For educated young people one-fifth of themselves find themselves jobless at the time.
On the external front the Zero COVID policy has been one of the main issues fleeting into the global recession there’s been a weakening of confidence of foreign businesses that rely on China for exports and imports.
The most extreme example is Apple, who is moving some of their manufacturing of the iPhone 14, to rival India.
6. The Youth Revolt
The economic and political issues are not the only problems for the state government either. Increasing unemployment among the young and educated is quickly on the rise, climbing to a record 20% in July of this year. This is mainly due to the slowing down of the economy and the shrinking opportunities that come with it.
The popular online movement called “Tang ping / Lie Flat” basically it was an online movement of Youth that decided to stop playing the rat race stop climbing that corporate ladder and just to take things more slowly.
But now in 2022, this has evolved into something new a more extreme movement known as “Bai Lan, or to Let It Rot”. These youths have completely decided to give up on the system and are just doing the bare minimum to get by.
It’s a complete shock to the older generation of Chinese, who have never seen anything like this in their lifetime. The Bai Lan youth believe that, there’s nothing to be gained by working hard, and putting in extra effort isn’t going to result in reward.
It didn’t take long for the Chinese government to take notice. In May of 2022, president Xi Jinping in a speech to the entire nation emphasized the importance of young people, and their contributions to the country as a whole stating that quote ‘China’s hopes lie in youth’.
Reducing inequality and improving opportunities has been their main priority for some time, and yet the measures taken, such as cracking down on big Tech and banning private school tutoring, so far have not helped the situation much.
7. Is China Going to Implode?
So the preceding was a brief summary of what’s been going on in China. There was plenty that wasn’t said we didn’t even get to the Rural Bank runs, we’re around 400,000 people aren’t able to access their life savings, but you get the idea.
Is China going to implode? Well the answer is more complicated than that it seems clear that China is putting its political agenda in front of economic and humanitarian situations.
The stubbornness of the ruling class has caused China to be in an uncomfortable position. A seemingly unstoppable nation, suddenly has major cracks appearing in multiple places. Cracks that need to be patched with more than a Band-Aid solution.
The major threat across all of these topics covered is a loss of confidence by its people in the state government, and getting that confidence back will be a difficult challenge.
Perhaps the most likely outcome, may be a slow grinding recession and political upheaval in the coming years. But ultimately, it’s too complicated of an analysis for anyone to give a definite answer.
But there’s definitely more work that needs to be done to keep things from escalating further, and for the people to trust their government again.
One thing is sure the next few years for China carry a lot of risk. And whether things get a lot worse or not depends on how the situation is handled by the Chinese government.
8. What Does this Mean for Everyone Else?
But what about the rest of the world? Well for the rest of the world these problems in China will certainly have major Ripple effects. Especially for those who rely directly on the import export market of China.
We can expect the inflationary trend to continue, as Chinese supply diminishes. For the United States this means 20% of the total imports can be affected.
On top of that the growing deglobalization Trend will make prices higher as more countries bet on local production and that means less cheap labor.
For some economies like Australia, might be in a lot of trouble because Australia’s exports to China account for about 65% of total trade. That’s a massive exposure risk and as most Australians would know, they don’t really have that many other trading partners that could back up such a loss.
Specific Industries will also see major setbacks; case in point is the EV battery sector. The Chinese lithium-ion Global battery production was 76%. While there are constant efforts by the European and U.S governments to increase their production, the Stark truth is that China is a massive trading partner that can’t be replaced on short notice.
Lastly, it’s also important to mention the investment exposure that many countries have to Chinese debt and equities. This includes many investment firms in Europe and the US, not to mention all the funds that have suffered losses from the numerous delisting of Chinese equities over the past few months.
On top of that, China’s slowdown could mean more difficulty for the US to issue debt, since China is the second largest holder of U.S treasuries.
On the positive side less demand for fuel, China imports 80% of its needs and is going to put some downward pressure on prices, giving a little help to the energy crisis now and a small downward force on the input costs, on basically every good produced.
Conclusion
Overall, the interconnectedness between global markets has been the engine of growth for some time, both in Achilles heel and the key to economic prosperity of this century, a recession in one major economy means a global slowdown for the rest of the world.
It will be very interesting to witness the changes that happen. Will this change global trading in the future, will globalization continue to be a trend or after this, will countries tend to look more inward, and will production be more localized? whether it’s the outlook of China or the global economy as a whole?
Only time will tell!
It’s never nice to see innocent people suffer.
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