China’s economy has grown from near irrelevance to the second largest on the earth in lower than half a century. Perhaps more incredible than its meteoric rise is the undeniable fact that it’s done so with none kind of great economic contraction. Nearly fifty years of consistently positive GDP growth is practically sorcery within the eyes of the west, as our more democratized and fewer managed economies seldom manage to go a single decade without at the least some sort of bust, let alone five.

The assumed impossibility of eternally uninterrupted economic growth has raised increasingly more eyebrows and elicited increasingly more dire predictions about China’s economy as time has passed. Surely the ruling Chinese Communist Party can’t stave off the elemental economic forces indefinitely. Surely the opposite shoe goes to drop soon, and all can be right with the world.

It has to. Right?

We’re alleged to be living in a post-Soviet world. A world where the query of managed versus free economies is long-settled fact. But when the CCP is in a position to keep China’s economy—an economy encompassing the interests of over a billion people—from experiencing a lot as a recession, that settled fact starts to look more like an open query with each passing quarter.

The present situation facing China’s real estate market is the newest and maybe most convincing sign that China has finally reached a tipping point. A generation’s price of breakneck growth, urbanization, and unintended consequences could also be coming to a head.

(Un)Real Estate

China’s housing market is currently the largest asset class on the earth, with a notional value of nearly $60 trillion, greater than your complete capitalization of the stock market. About one third of China’s economic activity involves the true estate sector (in comparison with 15 to 18% of the American economy), a staggering figure that becomes much more so when combined with the undeniable fact that housing accounts for about 70% of Chinese household wealth.

The explanations for the outsized role that housing and real estate play in China’s economy are complex and diverse, though all of them trace their roots back to the CCP.

The present real estate crisis began shortly after China relaxed its rules on private home sales back in 1998. This transformation in policy roughly coincided with the explosive economic growth that’s characterised much of the past a long time, much of which relied on the importation of low-cost labor from the Chinese countryside into rapidly growing metro areas. Over 480 million Chinese moved from the country to the town in pursuit of higher economic opportunities, and real estate developers were only too completely happy to offer the accommodations that the newly urbanized Chinese each needed and will suddenly afford.

Real estate developers and construction firms weren’t the one ones to take advantage of the unprecedented mass urbanization. Regional governments—a lot of which relied heavily on land sales for revenue—encouraged as much development as possible, and the seemingly infinite demand for housing gave yield-starved Chinese investors a spot to park their capital. Developers soon found themselves unable to maintain up with the pace of demand and started to tackle massive amounts of debt, much of it in dollar-denominated offshore bonds, and even began selling properties in developments that hadn’t even begun construction.

China’s government took notice of all this rampant speculation and took what it saw as reasonable steps to mitigate the specter of the collapse of the true estate market. It imposed recent financing restrictions for developers based on their liabilities, debt, and money holdings, in addition to imposed recent rules for banks to limit the quantity of mortgage lending. Some developers, including the enormous China Evergrande Group, were pushed into default by these recent restrictions and were forced to place ongoing projects on hold while they sorted out their balance sheets.

Quirks in China’s real estate system meant that the newly paused or canceled projects were greater than just the developers’ problems. Chinese homebuyers who had gotten mortgages and purchased unbuilt properties suddenly found themselves on the hook for properties which will never be accomplished, and plenty of were understandably upset. Increasingly people began to protest the situation by refusing to pay their mortgages until upwards of $295 billion price of loans were affected before the CCP began interfering with data collection on the topic. To date China’s government has been unsuccessful in attempting to get the situation under control, though they’re stepping up support for distressed developers and providing some special loans to assist ensure certain projects are accomplished.  

How Will China’s Housing Collapse Affect the World?

Planned demolition of unfinished constructing project in Kunming

The present crisis has severe implications for the broader China economy, a few of that are already being felt. S&P Global Rankings has claimed that around 20% of the Chinese developers it rates are liable to going under, and that falling land sales have impacted local governmental revenues to the purpose that 30% of local governments can have to chop spending by the top of the yr. Nonperforming real estate loans held by state-owned banks increased by a full 1% in 2021, a figure that is bound to grow as newer data is made available. There’s every reason to consider that the true estate market will suffer within the short to medium-term.

Harvard professor Kenneth Rogoff estimates that a drop of 20% in real estate-related investments could cut 5 to 10% out of China’s GDP, and that the following drops in real estate and construction employment could create significant instability in China’s job market. Or, more broadly: “On the medium term, China faces a large number of challenges, starting from extremely opposed demographics to slowing productivity…Until now, the housing boom has been sustained by a broad economic boom that now faces steep headwinds.”

The intentionally opaque workings of China’s government make it difficult to predict exactly how the present crisis will play out. It’s, nevertheless, possible to extrapolate the sort of impact the crisis can have on the worldwide economy if China’s real estate market continues to deteriorate. The primary and most blatant consequence of a serious slowdown in China’s economy can be felt by corporations with significant exposure to China. Firms like Wynn Resorts, Apple, Tesla, and Disney would all suffer from the following lack of revenue from China’s market, as would firms like Qorvo, Boeing, Caterpillar, and some other firms that depend on supplies from or sales to China.

By way of Chinese corporations, the rankings agency Fitch identified three fundamental sectors that may be most vulnerable to a slowdown in the true estate market: Asset management corporations, engineering and construction firms, and steel producers. Fitch also believes that small and regional banks could be most vulnerable to continuing difficulties—particularly if the trend of homebuyers refusing to make mortgage payments on properties that will not ever be built continues—though this will likely have little impact on the worldwide economy beyond the implications of a slowdown in China’s economy at large.

Conclusion

As dire as things could seem, nevertheless, it will be important to do not forget that China’s government is aware of the risks its economy faces from the present crisis. Pundits, analysts, and observers alike have been warning about an imminent collapse in China for years now, yet the closest we’ve seen was a self-imposed downturn that resulted from the federal government’s draconian attempts to eradicate COVID-19 inside their borders. There’s little reason to assume that China’s government’s control over their economy has slipped to any significant degree. Anathema because it could seem to western sensibilities, China’s government still possesses the tools, the desire, and the monopoly on violence it needs to forestall the true estate market from destroying their economy as an entire.

The very best response, for now, is to take care of the course. It might be a very good idea to shut positions concerning firms with significant exposure to China’s economy, but treat all other investments the identical way you’d when facing some other sort of economic headwinds. If the economies of Europe and the US made it through the 2008 housing crisis, likelihood is China’s economy will weather this storm as well.