China’s Economy In a Bad Situation
Today I wanted to talk about the situation in China. Yes, I know I’m very late to the situation. There are already a lot of people talking about the situation in China.
But there’s also a lot of sensationalized and very clickbaity type information out there that are claiming that China’s entire economic system is about to collapse.
With this kind of trend of posting the number of days until China ends, China is over.
Five banks went bankrupt, which was spread into 20 banks, then 100, and eventually the entire banking system. China’s Economy In a Bad Situation
a lot of people have taken that and then extrapolated to the point of saying china’s economy is therefore going to collapse because of these issues currently being faced.
The purpose of this information is to give an overview of the situation. I know a lot of people have done it, but my hope is to do it in a way that it’s, plain and simple, I said it and to provide some perspective to the situation that I think is very much missed by a lot of these other information about the scope of this current crisis, if you will.
The current issues plano and China really have two focal points that a lot of people are focusing on, the first of which has to do with its real estate bubble.
But to give a sort of a recap, back in 2020, china’s government instituted a three red line policy whereby it outlined three leverage criteria that real estate developers would have to meet if they wanted to borrow more money.
And if anyone violated all three of these, they could no longer expand their credit. Back in October of 2021, when Evergreen, the largest property developer in China, was making a lot of headlines for its own financial struggles.
Nearly half of the top 30 developers in China violated at least one of these three red line criteria, meaning that many property developers all of a sudden saw a very strict crackdown on the amount of money that they were able to borrow to fund their operations. China’s Economy In a Bad Situation
While the idea might not sound all that impactful, given that it’s really just limiting the growth of credit, if you will, it revealed many problems with the real estate market in China that many have since deemed a quasi Ponzi scheme with how it was run.
To really understand it, you have to understand a bit more about how Chinese real estate works, because it’s very different from the rest of the world.
First of all, the government actually owns all the land in China, and individuals cannot purchase land. Instead, individuals lease the land from the government.
So when they purchase a property, they’re rather purchasing the lease that property or the land that it’s on and the value of the materials used to build the actual structure.
In over the last decade or so, many property developers took on excessive leverage to expand their property development business and to sell properties to develop properties, leading to this expansion of leverage within the country.
And part of this was fueled by very strong demand from Chinese citizens for property in China, because also, unlike many other countries, home ownership in China is actually very high. China’s Economy In a Bad Situation
Roughly 90% of the population in China owns real estate to some extent. And a big reason for that is real estate ownership is seen as one of the main methods of investing in the country of China.
Here in North America, obviously, we see the stock market as one of the principal vehicles for investing your wealth and seeing it grow.
It’s not really the case in China. In fact, only 5% of corporate financing actually comes from equity.And that, combined with different capital restrictions from the government of China itself, has led to only 7% of the population owning stocks.
So anyone looking to invest their money typically turn to real estate, which over the last couple of decades, has seen their prices skyrocket thanks to this heightened demand and this heightened loan activity encouraged by the governments that earned that leasing revenue.
In fact, according to Forbes, since the year 2000, home prices in China have more than quadrupled, making it for some of the most expensive real estate in the world.
In fact, in top cities in China, the average price to income ratio sits at roughly 34.9 times, meaning it would take 35 years of your full income to afford a property.
To put that in perspective, new York has a price to income ratio Of roughly 5.4 times. And that’s a very expensive place to live for a lot of people.
This didn’t actually deter their demand for real estate because as long as the price continued to rise, it was deemed to be worth it.
So this led to a lot of people using not just multigenerational wealth, but at times multifamily wealth where different families would pool money together to try and buy property. China’s Economy In a Bad Situation
And led to this heightened demand for real estate over the last couple of decades.
And many property developers not only took on leverage to meet this excess demand, but started carrying out more kind of questionable practices that eventually became commonplace, such as, for example, making a presale or taking a deposit or at times full payment for a property that had yet to be built, meaning that many individuals were making mortgage payments on properties that weren’t yet inhabitable.
And again, because these were primarily investments, that aspect wasn’t necessarily a primary concern. And in many circumstances, this led to property developers taking pre sale funds that people had paid for new projects and using that money to fund the building of older projects that they had already committed to.
And this is why we saw a liquidity problem in the space when the government introduced its three red lines, because all of a sudden, these developers, which were already using new obligations to fund old obligations, lost a key source of their financing to also help fund their operations.
But hey, at least these property developers still had new presale funds coming in to help fund their old operations, right?Well, no. Because of concerns around the solventies of these developers and faith in their ability to actually complete these property developments, many people started to pull back their purchasing in the area of real estate. China’s Economy In a Bad Situation
In new home sales plummeted in the country for 2022, home prices are expected to fall 1.4%, while new home sales or the volume of properties actually being sold is expected to drop by roughly a quarter 24.5% year over year.
And all these concerns about real estate in China, which have really been in play over the last year, so have only been compounded by more recent updates.
The second focal point of the situation here, if you will, which is the turmoil in the banking sector.
Back in April this year, regional bank clients in the province of Annan found that access to their funds had been frozen. They were no longer able to withdraw their money and turn out.
The $6 billion worth of these client deposits had been frozen, seemingly the result of illegal lending activity. Allegedly, this led to a number of protests where depositors were demanding access to their funds, including one that was held July 10, where people met up outside the People’s Bank of China and were attacked for speaking out.
Now, it’s unclear what the extent of that banking scandal was, but after this protest, China arrested gang members that they alleged had taken over regional banks, including the ones involved with the original asset freeze and had carried out illegal lending activity and money laundering which had caused these assets to be frozen or by some accounts, lost.
Now, the government has since ordered these banks to release some of the funds back to the depositors. But the situation shook faith of depositors across the country who no longer believed that their funds were safe.
At the same time this turmoil was playing out, there was another hit to the country’s banking sector a mortgage boycott. It all started with a 590 word letter from angry buyers of a half built Evergreen property development who demanded that progress continue on their property by October 20 or else they would stop making their mortgage payments. China’s Economy In a Bad Situation
And while the letter itself was only concerned with a single property development in the country of China, it kicked off a sort of movement.
There are now over 300 property development seen boycott from their buyers with SMP forecasting that up to $356,000,000,000 worth of mortgages or 6.4% of all outstanding mortgages are at risk in this situation, in a worst case scenario.
And all this is happening in an already stressed economic environment where we have high inflation, severe state imposed COVID restrictions within the country of China which are impairing economic output.
Given that China has been very severe in its crackdown on covet outbreaks and of course, the negative macroeconomic environment where economic growth is expected to slow down or possibly contract which would impact China’s own growth and even longer term concerns around their population which could impact their future economic growth. So it’s not a pretty picture. It is a bad situation.
But is this enough to claim that China is on the brink of collapse? Maybe, but probably not, I would argue. And there are a few points I want to highlight to put this all into perspective. The first point is that, well, yes, leverage for property developers is quite high and certainly concerning.
With the current restrictions in place, individual households are in a much more moderate position. China’s Economy In a Bad Situation
Household leverage for 2021 sat at 62% of GDP and 112% of household disposable income which by global standards is pretty moderate.
In Canada, for example, household leverage to disposable income is 180%, which is quite a bit higher. China’s Economy In a Bad Situation