China’s Bubble That Never Bursts

International | Oct 05 2022

Is it possible the Chinese financial system is more resilient, and its policymakers more innovative, than Western critics give them credit for?

-Real estate remains the dominant nest egg investment for your average Chinese citizen
-One narrative says funding for Chinese lenders remains secure because of excessive savings
-The country is presently battling multiple headwinds outside of property

By Richard Acello

If laws of supply and demand run business, it might explain the infinite supply of breathless, clickbait YouTube videos predicting the imminent collapse of China’s financial system.

Don’t hold your breath, says Thomas Orlik, Chief Economist for Bloomberg Economics, and author of the book, China: The Bubble That Never Pops, now in its second edition.

Orlik’s message is that the Chinese financial system is more resilient, and its policymakers more innovative, than Western critics give them credit for.

A little background: Chinese have few options when trying to grow a nest egg, so they rely almost exclusively on real estate investments.

In most places, the house is built and then the buyer contracts for the sale, but in China, buyers contract for the sale, pay on the mortgage, and then wait for the house to be built.

Developers take advantage of the situation to use home buyers’ money to fund other projects.

The situation has deteriorated to the point of home buyers going on “mortgage strikes,” refusing to make any more payments on their mortgages.

This has led to weakness in the banking sector, and the spectacle, broadcast on the Internet, of Chinese citizens lining up outside banks to remove their money. Which has led to banks being guarded by tanks.

According to The Guardian, estimates of China’s real estate bubble range as high as $58trn, but will the bubble burst and if so, when?

“Financial crises do not start because banks make too many loans, or because banks have too many bad loans, financial crises start because banks run out of funding,” Orlik says.

In 2008, “Lehman Brothers did not collapse because they had too much exposure to subprime mortgages, but because they could no longer finance their activities by borrowing in the money market.”

Because China is a nation of savers, and China makes it difficult to move money overseas, funding for the banking system remains secure, Orlik says.

In the current real estate crisis, sales and construction are down, giant developers like Evergrande have defaulted, and there are mortgage strikes.

In spite of it all, a systemic crisis is unlikely to occur because, Orlik says,“this isn’t China’s first rodeo,” pointing to the 2012 “ghost town” scare when China witnessed entire cities of empty apartments, but the system survived.

Because China is a government managed state, Orlik suggests policymakers can pump liquidity into the system, bring sales and construction to a functional level and prevent the worst case scenario of the real estate downturn spiralling into a systemic crisis.

Real estate isn’t the only pressing problem affecting the Chinese economy.

Vaccines, Lockdowns, Droughts & Xi's Personality Cult

Because China’s vaccines are largely ineffective at combating the Covid Omicron variant, brutal lockdowns of entire cities are China’s only strategy against stubborn virus outbreaks.

When these occur in major manufacturing centers, supply chain disruptions result, undermining China’s ability to export goods.

Droughts have not only hampered Chinese agriculture, but are leading to electricity shortages, as China depends on hydroelectric power.

Geopolitical strategist Peter Zeihan, author of the recently released book The End of the World Is Just the Beginning; Mapping the Collapse of Globalization, says food is now a major issue for China as well.

China is trying to recover from an outbreak of African swine fever, which caused culling over two thirds of the herd, Zeihan explains.

Pork, he points out, is extremely important to Chinese culture and the main source of protein.

In an attempt to rebuild the herd, “China is buying up every scrap of food they can find anywhere on the planet even if it isn’t normally designed for pigs,” Zeihan says, including French baguette wheat.

Another issue for China is the consolidation of power under Xi. “Chairman Xi has consolidated power unto his person to a degree that not even Mao attempted”.

Zeihan: “It is a full cult of personality. He has executed, or exiled or intimidated everyone in the country who is capable of an independent opinion. And he has shot the messenger sometimes literally so many times that no one wants to bring him bad news.”

In recent days, reports of a shakeup in the Chinese government have surfaced. Chinese foreign affairs expert Gordon Chang thinks there have been some extremely troubling developments at the top of the Communist Party, "so something is terribly wrong.”

Someone is trying to destabilise the regime, and “the regime itself is going through turmoil,” suggests Chang.

Incidentally, widely commented-on rumours about Chairman Xi being placed under house arrest by the military have proved grossly misguided. Xi remains truly in power.

If China’s economy goes south, would it take the global economy with it?

Although major multinational corporations such as Apple and Tesla have Chinese manufacturing facilities which could be affected by turmoil in China’s economy, the rest of the world already has (plenty of) problems of its own.

Inflation is at a 40-year high in the US, which is raising the spectre of stagflation, where prices remain high but consumers stop buying.

The US is technically in a recession, with two consecutive quarters of GDP decline, but financial markets are worried about a genuine recession in which corporate profits, labour markets and consumer spending will suffer badly.

Europe is bracing for a potentially deep recession caused by rising energy prices, the result of the war in Ukraine.

It’s unlikely an economic downturn for China will be blamed for the world’s economic worries.

As far as the Chinese housing bubble goes: don’t hold your breath.

Thomas Orlik is confident.

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