The thing to understand about China is that it is not just another booming EM economy that is momentarily struggling to cool-down its excesses in fixed asset investment and make a transition to some kind of more “normal “consumer-based economy. That comforting notion represents an odd-confluence of propaganda from the comrades in Beijing and hopium from Wall Street stock peddlers.
In fact, China is a grotesque economic aberration that bears no relationship to prior economic history or any conventional economic models-–not even to the export-mercantilism model originally developed by Japan, and which has now proven itself wholly unsustainable. Instead, China is a nation that has gone mad building,speculating and borrowing on the back of a credit bubble so monumental (and dangerously unstable) that its implications are resolutely ignored by observers deluded by the notion that China embodies a unique economic model called “red capitalism”.
But when a nation’s debt outstanding explodes from $1 trillion to $25 trillion in 14 years, that’s not capitalism, even if its red. What it represents is monetary madness driven by the state.
Occasionally a picture is worth a thousand words, and here’s one buried in a Financial Times story on China’s rapidly deteriorating housing market. It seems that during the two-year period 2011-2012, which was the peak of China’s much praised “aggressive” stimulus response to the Great Recession in the DM world, China consumed more cement than did the United States during the entire 20th century!
That astounding fact needs to sink in, and it is a fact—blessed by the U.S. Geological Survey. Stated differently, imagine the whole urbanization and suburbanization of America over 100 years; the building of all the office towers, skyscrapers and malls which festoon thousands of city landscapes from coast-to-coast; the building of all the great public works of the 20th century including likes of the Hoover,TVA and Grand Coulee dams and all the Army Corps locks, dams, navigation and flood control projects; the Interstate Highway system and all the derivate highways and suburban sprawl which came with it; all the stadiums, auditoriums, airports, bus and train stations, subways and parking lots that have ever been built in America; and keep imagining because the underlying proposition is itself scarcely imaginable:
The FT reported overnight that “In just two years, from 2011 to 2012, China produced more cement than the US did in the entire 20th century, according to historical data from the US Geological Survey and China’s National Bureau of Statistics.” We showed this two years ago – little did we know that two years later the situation would be completely out of control.
Here’s the thing. You can’t look at China’s entirely doctored and goal-seeked GDP accounts and have any understanding of the thundering collapse which will actually occur when the building boom ends. The idea that fixed asset investment at 50% of GDP is just some kind of economic ratio that the comrades in Beijing can shimmy down to normality–say 25% which is still high by every other economy in the world—fails to comprehend what China’s economy really is. That is, its a continent-wide construction project in which everything flows into obtaining, moving, fabricating and erecting infrastructure—both public and private, retail and industrial.
So when the building stops because the inflated prices of real estate are collapsing and credit expansion can no longer prop up the bubble, the implosion will be thunderous. Cement production could drop from 2 billion tons per year to 500 million; rebar consumption would crater proportionately; industrial fleets of cement trucks and steel haulers would lie idle; demand for tires, engine parts and truck fuel would vaporize; vendors of all the services that support this gigantic flow of cement and steel will be out of business; they empty apartment “investments” held by their owners will be worthless.
That’s what will happen when the building stops. This article from the Telegraph suggest such a turn of event might not be all that far down the road. As one observer ventured:
They can keep on building but no one will buy.”
China’s authorities are becoming increasingly nervous as the country’s property market flirts with full-blown bust, threatening to set off a sharp economic slowdown and a worrying erosion of tax revenues.
New housing starts fell by 15pc in April from a year earlier, with effects rippling through the steel and cement industries. The growth of industrial production slipped yet again to 8.7pc and has been almost flat in recent months. Land sales fell by 20pc, eating into government income. The Chinese state depends on land sales and property taxes to fund 39pc of total revenues.
“We really think this year is a tipping point for the industry,” Wang Yan, from Hong Kong brokers CLSA, told Caixin magazine. “From 2013 to 2020, we expect the sales volume of the country’s property market to shrink by 36pc. They can keep on building but no one will buy.”
The Chinese central bank has ordered 15 commercial banks to boost loans to first-time buyers and “expedite the approval and disbursement of mortgage loans”, the latest sign that it is backing away from monetary tightening.
The authorities are now in an analogous position to Western central banks following years of stimulus: reliant on an asset boom to keep growth going. Each attempt to rein in China’s $25 trillion credit bubble seems to trigger wider tremors, and soon has to be reversed.
Wei Yao, from Société Générale, said the property sector makes up 20pc of China’s economy directly, but the broader nexus is much larger. Financial links includes $2.5 trillion of bank mortgages and direct lending to developers; a further $1 trillion of shadow bank credit to builders; $2.3 trillion of corporate and local government borrowing “collateralised” on real estate or revenues from land use.
“The aggregate exposure of China’s financial system to the property market is as much as 80pc of GDP. This is not a sector that can go wrong if China wants to avoid a hard landing,” she said. The risk is that several cities will face a controlled crash along the lines of Wenzhou, where prices have been falling non-stop for two years and have dropped 20pc.
President Xi Jinping has made a strategic decision to pop the bubble before it spins further out of control, allowing bond defaults to instil market discipline. But the Communist party is in delicate position and may already be trapped.
Reliance on “fair weather” land revenues to fund the budget is like the pattern in Ireland before its housing bubble burst. The IMF says China is running a fiscal deficit of 10pc of GDP once the land sales and taxes are stripped out.
Zhiwei Zhang, from Nomura, said the latest loosening measures are not enough to stop the property slide, predicting two cuts in the reserve requirement ratio (RRR) for banks over the next two quarters. He warned that any such move will merely store up further problems.
Nomura said the inventory of unsold properties in the smaller third and fourth tier cities – which make up 67pc of residential construction – has reached 27 months’ supply. The bank warned in a recent report that the property slump could lead to a “systemic crisis”.
The Chinese state controls the banking system and has $3.9 trillion of foreign reserves that can be deployed in a crisis. The RRR is extremely high at 20pc and can be slashed if necessary. A cut to 6pc, the level in 1998, would inject $2 trillion in liquidity.
Nomura said residential construction has jumped fivefold since 2000 from 497m square metres to 2,596m last year. It is unclear whether fresh migrants will continue to pour into the cities and soak up supply. Nomura said migrant numbers have already halved from 12.5m to 6.3m over the last four years.
What is certain is that China’s demographic profile is already changing the economic calculus. The workforce contracted by 3.45m in 2012 and another 2.27m in 2013. For better or worse, China is already starting to look very like Japan.