International financiers and governments are watching carefully as China’s real estate debt crisis plays out with growing contagion in the sector. However, the real estate crisis is just one threat to the stability of the Chinese economy. Increasing state intervention poses further threats, as does the potential for (eventual) international trade action as a response to growing Chinese aggression.
I have previously discussed the Chinese economy and, in particular, the problems in the real estate sector that were revealed by the debt crisis of the real estate giant Evergrande. For those paying attention, it is apparent that, despite the severity of the potential problems of such a huge company defaulting on debt, the wheels have not yet fallen off the Chinese economy. In place of any drama, the problems instead continue to simmer. In recent news, it seems that several other very large real estate companies in China are having similar debt problems, and this is reflected in falling bond prices. The same article reports that the belief that the Chinese Communist Party (CCP) would not allow the situation to spiral out of control has been a stabilising factor. However, doubts about the ability of the CCP to manage the situation are growing:
China’s property woes rattled global markets in September and October. There was a brief lull in mid-October after Beijing tried to reassure markets the crisis would not be allowed to spiral out of control but concerns have resurfaced.
“The problem is, it is getting systemic,” said Viktor Szabo, a London-based emerging market portfolio manager at abrdn, saying many Chinese property developers could no longer access borrowing markets and get financing.
“The big issue is that we don’t know what (Beijing’s) ultimate plan is … and how long can you hold on to the view that China can handle it?”
The problems in China’s real estate have even caught the attention of the US Federal Reserve. In their most recent stability report, they have flagged concerns about the problems in China’s real estate market, as well as broader concerns about China’s economy:
In China, business and local government debt remain large; the financial sector’s leverage is high, especially at small and medium-sized banks; and real estate valuations are stretched. In this environment, the ongoing regulatory focus on leveraged institutions has the potential to stress some highly indebted corporations, especially in the real estate sector, as exemplified by the recent concerns around China Evergrande Group. Stresses could, in turn, propagate to the Chinese financial system through spillovers to financial firms, a sudden correction of real estate prices, or a reduction in investor risk appetite. Given the size of China’s economy and financial system as well as its extensive trade linkages with the rest of the world, financial stresses in China could strain global financial markets through a deterioration of risk sentiment, pose risks to global economic growth, and affect the United States.
However, although many are spooked by the real estate situation in China, there are some who think that the problems are being exaggerated. In particular, Goldman Sachs consider that the degree of distress is less than is widely viewed, and they notably think that the CCP will intervene to stabilise the situation. And they are putting their money where their mouth is and buying Chinese real estate debt. Whatever some might think of Goldman Sachs, they are no fools. Nevertheless, they are gambling on the CCP acting to rescue the real estate market which might be seen as questionable due to the sheer scale and depth of the problems.
So where does this leave China’s economy?
As I discussed previously, real estate is one of the pillars of China’s economic growth. I will not repeat here the multitude of other problems that are buried within the Chinese economy that I discussed last time. I was focused on the many internal problems in China but missed some of the developing headwinds that will potentially harm the Chinese economy. The first of these comes from Xi Jinping’s new economic policies. In recent news, Xi Jinping has cemented his role as permanent dictator of China, seemingly defeating the rival Jiang Zemin faction. In light of this, a recent speech will raise concerns for businesses throughout China. This is from the CCP mouthpiece, the Global Times (thus a good indicator of CCP direction):
Although Xi has been promoting Common Prosperity repeatedly, he crystalized it in August 2021 at the 10th meeting of the Central Committee for Financial and Economic Affairs, which emphasized that Common Prosperity is the prosperity of all people in their material and spiritual lives. It is not the prosperity of a few people; nor is it uniform egalitarianism.
The most obvious example of the new Common Prosperity agenda came with the “disappearance” of Jack Ma of Alibaba, which was the CCP’s way of reigning in his growing influence and power. However, this is just the tip of the iceberg of increasing state intervention in China’s private business sector. This has been going on for many years with more and more firms forced to have CCP representation within the firms, but the most recent developments are seeing the government taking a far more active role in the affairs of private businesses. The impact of the new approach is already being felt:
SHANGHAI, Nov 2 (Reuters) – Chinese stock market investors are swapping big tech names for “small giants” and luxury brands for mass market companies, aiming to cash in on President Xi Jinping’s “common prosperity” plan for the economy.
The intent behind Xi’s drive is a narrower gap between the rich and poor in the world’s second largest economy.
But the first policy moves rattled markets as authorities introduced heavy new regulations on industries such as technology, property and private tuition, sending shares in those sectors tumbling.
While some active fund managers have shunned China for the time being, others see opportunity in an economy aiming for a larger and richer middle class.
The first point of note is that Xi’s power to entirely reshape the Chinese economy is taken for granted. The second point of note is that the assumption is that China’s economy is about to be turned upside down by the new policies. In other words, there will be massive state interventions in the economy going forwards (in an economy where state influence is already outsized). This degree of state intervention in an economy, of course, has a woeful track record. The new heightened interventionism may also raise some serious doubts for firms with investments in China; Yahoo, for example, has just pulled out of China entirely due to new tech regulations.
All of this is coming at a time when China’s foreign relations continue to deteriorate. Whilst the West has failed to unite fully against China, there is a growing collective interest in clipping China’s wings. The Inter-Parliamentary Alliance on China, a group of international politicians (US, UK, Australia, EU, etc.), may prove to be a harbinger for a far stronger and unified line against China. Strikingly, the group is comprised of every different political stripe and includes influential politicians such as Marco Rubio from the US. Notably, one of their objectives is “trade fairness” and this potentially means trouble for China and the Chinese economy. It is unsurprising that Xi Jinping is expressing concerns about a return to a cold war mentality; trade with China will be a potential “front” in any cold war.
The extant problems of China’s economy are already prompting some to consider that China’s “economic miracle” is finally coming to an end. The multitude of problems within the Chinese economy, from the problems of real estate to massive levels of debt to growing interventionism, have the potential to be compounded by international action against China’s increasing aggression, and that is likely to be in the form of some kind of trade policy. For the moment, the Chinese economy is shaking under the weight of the real estate crisis, but may not yet topple. The “common prosperity” agenda may add further instability. If there were to be concerted international trade action against China, it seems very likely that the economy will fall. The Chinese economy is, after all, on very shaky foundations.
Note: None of this is to say that the West is in much better shape!