China: The great slowdown

Signs the mammoth property bubble is finally bursting belie Beijing’s upbeat GDP data

On July 16 the Chinese government released its GDP figures for the second quarter, causing global financial markets to heave a collective sigh of relief as 7.5 percent growth was announced. This figure (Beijing’s GDP data is notoriously prone to manipulation) does not signal that the world’s second largest economy has ‘stabilised’ however. This was “a recovery, on paper,” noted Keith Bradsher, Beijing correspondent for the New York Times (16 July 2014). As Bradsher’s report points out, “independent surveys of businesses across China show that in sector after sector, sales and confidence are still deteriorating.”

The statistical lift, from an annualised 7.4 percent growth in the first quarter, was mainly achieved with the help of yet another ‘mini stimulus’. Like similar measures last year, this has been pushed through surreptiously by Premier Li Keqiang and his economic team, who officially adhere to the line: “No more stimulus!” Li’s latest measures include extra spending on public housing and railway construction – up 32 percent in June from a year earlier – and a package of tax cuts and looser credit (lower reserve requirements at some smaller banks) to boost the small business sector.

Debt soars

But China’s exceptionally rapid accumulation of debt has narrowed the government’s scope for stimulus. According to Bloomberg, total debt surged from 166.6 percent of GDP at the end of 2011 to 202.1 percent in the first quarter of 2014, and 206.3 percent in the second quarter. The increase in debt over the past five years has been more rapid in China than either 1980s Japan, 1990s Southeast Asia or the US economy in the 2000s – all of which produced severe financial crises. In Japan, for example, the debt-to-GDP ratio rose by around 45 percent from 1984 to 89. China has accomplished a similar feat in less than three years.

It’s becoming clear that the Chinese economy has now entered a period of crisis that can set off social and political eruptions. The measures taken by President Xi Jinping to beef up state security and clampdown further on any organised expressions of dissent, are tantamount to “battening down the hatches” before entering rough seas. The CCP (Chinese Communist Party) dictatorship faces a ‘trilemma’ of unpleasant alternatives: disarming the debt bomb (deleveraging) which also risks strangling investment and growth, allowing the property bubble to burst which could trigger a banking crisis, and reining in overextended local governments which, however, are the source of most investment. Beijing’s pressure on regions to speed-up infrastructure spending in accordance with the latest ‘mini stimulus’ contradicts its efforts to deleverage the economy and aggravates the debt problem.

This has led capitalist commentators to complain the government is stalling over neo-liberal market reforms promised at the Third Plenum of the CCP in late 2013. Similarly, they bemoan the fact that the promised “economic rebalancing” towards higher consumer spending and a lower GDP share from investment (which hit a record 54 percent of GDP last year) is not happening. For Beijing, as shown in the past, such a rebalancing is much easier said than done. Even a modest slowdown in investment could translate into a much more painful economic slowdown, which in turn could trigger a property-linked financial crisis. This is why some economists describe China as a “bicycle economy” that could fall over if its slows too much.

The city of Tianjin’s ‘Manhattan project’ – a replica of New York’s original.

Housing slump

In a survey conducted by CNNMoney in July, 2014, eight out of 10 economists said the property market poses the biggest threat to China’s economy. Another report, from Japanese bank Nomura, warned, “It is no longer a question of ‘if’ but rather ‘how severe’ the property market correction will be.”

The volume of sales for new housing units in the four largest cities (Beijing, Shanghai, Guangzhou and Shenzhen) fell by 40 percent year-on-year during the first quarter of 2014. Nationally, new homes starts fell more than 25 percent in the quarter and the value of sales fell 7.7 percent. Of China’s 27 biggest cities, 21 had housing inventory levels exceeding 12 months’ supply. Nine cities had more than two years’ supply.

The market downturn is welcomed by the vast majority who are excluded from buying a home at today’s inflated prices. House prices have skyrocketed, in Shanghai’s case by 273 percent in the past seven years. This explains why 83 percent in a recent People’s Daily poll said the government should not “rescue the property market” by relaxing cooling measures it imposed in 2011. The Financial Times (12 May 2014) reported that the richest 1 percent of households own around one-third of China’s residential property. Another report from CLSA, a Hong Kong-based finance group, states that 53 percent of house purchases in China are for “investment purposes” rather than for a place to live. The majority of these properties are left empty to fetch the highest selling price.

Corrupt CCP officials have been very active in the housing market, in many cases acquiring hundreds of apartments as a means to park their illicit wealth. Not surprisingly, therefore, Xi Jinping’s anti-corruption drive has also contributed to the market downturn by dampening officials’ appetite for property. Xi’s campaign has exceeded the scale of previous graft-busting campaigns, reflecting an acute crisis and power struggle within the state.

A construction frenzy the likes of which the world has never seen was the most important single element in the monster stimulus package launched by the Chinese regime in 2008, in an attempt to offset the effects of the global crisis. As always in the context of China, the economic data contains some staggering figures. “In just two years, from 2011 to 2012, China produced more cement than the US did in the entire 20th century,” reported Jamil Anderlini in the Financial Times (13 May 2014). China built half the world’s new residential buildings last year, according to the vice president of Premier Li’s Development Research Centre. An estimated 200 million housing units have been built in the past 5 to 6 years – more than 1.5 times the total housing stock in the US (130 million units).

Construction on this scale far outstrips market ‘demand’ – which is not determined by the needs of China’s almost 1.4 billion people, but by the grossly unequal wealth distribution that has accompanied the past 30 years of capitalist ‘reform and opening’. Low wages and non-existent welfare protection are still the reality for the majority of the population, and even the middle classes face increasing difficulties to buy an apartment at today’s prices.

Capitalist commentators and China ‘bulls’ dismiss evidence of massive housing oversupply, including endless ‘ghost town’ developments, arguing “it’s not a bubble” because, they claim, tens of millions will move to cities and soon fill the empty developments. This argument is a modern day version of the equally flawed slogan of the British capitalists in the 1850s, who dreamed that, “If every Chinese adds four inches to his shirt-tails, Lancashire cotton mills will be kept busy for generations.”

In fact urban migration has already peaked in China. The number of new arrivals from the countryside each year has halved from 12.5 million to 6.3 million since 2010, according to Nomura. The bank predicts there could be a net outflow of migrants by 2016. More to the point, the proportion of migrant workers who purchase a home is less than 1 percent per year.

China’s building boom, especially during the mega-stimulus era since 2008, has been driven by an extreme form of financial speculation. Local governments, property developers, corrupt officials, state-run banks and their shadow finance offshoots, have all conspired to inflate land prices, massively expand credit and ‘juice up’ GDP performance. This process has enormously enriched a tiny elite, while inflicting economic misery on the majority. Among the top 10 property billionaires worldwide, seven are from China, according to the South China Morning Post (26 February 2014).

As in Japan in the 1980s, inflated property values have helped to fuel an unprecedented wave of bank lending that now threatens to run in reverse. “Property [is] essentially the asset that underwrites all credit in the Chinese economy,” noted China-based economics professor Patrick Chovanec. Falling land prices will erode the book value of assets held by banks and other companies, increasing the risk of defaults that could paralyse the financial system.

Globally there has been an increase in debt of 30 trillion US dollars over the past five years, of which China accounts for half. According to JPMorgan, the shadow banking sector alone has ballooned from US$2.4 to US$7.7 trillion since 2010, accounting for 84 percent of China’s GDP. These sums dwarf even the scale of the US ‘subprime’ crisis.

Turning Japanese?

There are striking similarities with what happened in Japan almost a quarter of a century ago, which arrested that country’s stellar economic rise and condemned it to a double-decade of stagnation. In Japan, as in China today, around 80 percent of loans were directly or indirectly tied up in the property sector. The collapse in real estate prices, which began in 1989, spilled into Japan’s banking system creating a tsunami of bad loans (with debtors unable to repay). In China, a big part of the debt is concentrated in the nexus of local governments and their investment vehicles, overextended property developers, and the shadow banking entities created by banks (and even non-financial state-owned companies) to get around government controls.

Comparisons with 1980s Japan are not surprisingly common in today’s economic discussions. A leaked recording of a speech by Mao Daqing, who is vice-chairman of China’s biggest property developer, Vanke Group, spelt out the bleak reality that government spokesmen would prefer to conceal:

“In 1990, Tokyo’s total land value accounted for 63.3 percent of US GDP, while Hong Kong reached 66.3 percent in 1997. Now, the total land value in Beijing is 61.6 percent of US GDP, a dangerous level,” he said (The Telegraph, 2 May 2014).

“Overall, I believe that China has reached its capacity limit for new construction of residential projects… I don’t see any possibility for a rise in home prices, especially in cities with large housing inventory, unless the government pushes out another few trillion [stimulus]. Beijing and Shanghai have already been listed among the most expensive cities in the world in terms of the median central city property prices.”

This admission, from one of the industry’s top insiders, leaves no doubt that a gigantic property bubble exists in China, and this is now reaching its limits. While the timing cannot be predicted with certainty, it is clear that this situation is unsustainable, and that which is unsustainable will come to an end at some point. As in Japan, and the US more recently, when asset bubbles burst they unleash a chain reaction of falling prices – deflation – that can massively exacerbate today’s debt problems.

The Chinese dictatorship, with its control – at least formally – over the state-owned banking system, has already begun to take measures to try to avert a financial crisis. Bad loans within the banking system are being concealed and underreported. In an authoritarian system with almost total control of the media, the cover-ups will increase in order to prevent bad news sparking a market panic.

The regime is preparing to again bailout failing financial institutions and establish so-called ‘bad banks’ as it did 15 years ago, at the time of the last explosion of non-performing loans within the banking system. These are companies where debts that cannot be recovered are buried, like the financial equivalent of toxic waste. This creates the impression – as if by magic – that bank balance sheets have been restored to health. The banks are then recapitalised with a government injection of money. The scale of this operation will have to be much bigger this time around, however, and rather than a national rescue, at this stage, Beijing wants provinces and cities to set up ‘bad banks’ so the bailouts can be performed at local level, partly to avoid the appearance of a systemic crisis. The previous round of bank bailouts, in 1999-2000, cost as much as 40 percent of China’s GDP. This was used to ‘clean up’ the Big Four state-owned banks and prepare them for flotation on stock markets in China and overseas. But the bad debts which were transferred into four ‘bad banks’ (asset management companies) at the start of the century are still there today. Repeating this trick on an even larger scale will be no easy feat.

From early this year, the government has attempted to manage, on a selective basis, the first ever defaults by companies and also involving some highly speculative ‘securities’ sold through the shadow banking sector. This is an attempt to rein in the more reckless forms of speculation. But in most cases Beijing has opted to allow bailouts and avoid defaults, so great is the fear that the failure even of some obscure shadow financial products could trigger a wider systemic crisis. Not for nothing has Premier Li compared reform of China’s banks to “disarming land mines”.

The housing downturn has already begun to weigh on economic growth, through reduced investment which is the main driver of GDP. It is also exacerbating the financial woes of heavily indebted local governments, which rely on land sales for a large portion of their revenues – an average of 39 percent in 2013. In some provinces, especially where the housing bubble has been most extreme, the situation is more acute. In Zhejiang province, revenue from land sales accounts for nearly 70 percent of local governments’ direct debts, with Tianjin not far behind this level.

Global fallout

“Chinese property is the most important sector in the global economy,” declared former UBS chief economist George Magnus in the Financial Times. This underlines the high stakes at play for global capitalism. According to official data, real estate contributed 16 percent of China’s GDP last year, compared to 8.9 percent of GDP in the United States at the height of its housing bubble (2006). A study by Moody’s Analytics puts the housing market’s share of China’s GDP at 23 percent in 2013.

China’s construction boom has sucked in resources from the whole world, creating a global ‘super cycle’ for commodity prices – from fossil fuels to iron ore and timber – which has boosted GDP growth rates across Africa, Latin America and Asia. The end of this boom will therefore be dire news for global capitalism.

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July 2014