A few months ago, I wrote that the Chinese slowdown was much more than COVID-19-related and highlighted the challenges stemming from the overweight of the real estate sector in the economy.

A research paper by Kenneth Rogoff and Yuanchen Yang (pdf) estimated that the real estate sector constitutes 29% of China’s GDP. Problems stemming from the slowly deteriorating real estate sector have extended to financial challenges for Chinese local governments and could create a relevant fiscal issue for the country’s public accounts.

“Sales of China’s largest real estate developers fell 43% in June from a year earlier, according to China Real Estate Information Corp,” Bloomberg reported, creating an alarming funding shortfall for local governments, where finances are highly dependent on revenue from land sales, and a significant issue for the financial sector and government. China’s central bank has vowed to mobilize a $148 billion bailout to complete unfinished property projects as anger mounts among property buyers who have not received their homes after advancing large payments.

The size of the real estate sector in the economy is enormous, and the impact on gross domestic product (GDP) of a drop in sales may be impossible to offset with other sectors. According to S&P Global, real estate sales in China will likely fall by around 30% this year due to the growing number of mortgage payment suspensions by homebuyers. It could be worse than 2008, when sales fell about 20%, Esther Liu of S&P Global Ratings told CNBC. No industry in China can mitigate the impact of such a drop in tax revenue and production.

JP Morgan explained the scale of the problem in a recent report “China’s property market alarm bells ringing again.” According to the report, “Since June 30, requests for mortgage suspension due to delayed home delivery have spread to more than 300 projects in different parts of China.” JP Morgan’s equity research team estimates that these claims represent a total value of 330 billion yuan ($49 billion) (or a mortgage value of 132 billion yuan ($20 billion) assuming a loan 40% on the value).

Local governments saw their tax revenues fall by 7.9% in the first half of 2022 and land sales collapsed by 31.4%. “Meanwhile, local government budget spending increased by 6.4% due to fiscal spending rigidity and increased costs associated with the zero-COVID policy,” and JP Morgan estimates that a deceleration 5 percentage points of real estate investment would reduce GDP growth by 0.6 to 0.7 percentage points.

There are relevant implications for many sectors and for families. Property developers were the largest issuers of commercial paper in China, and millions of savers invested in bonds and debt securities of property developers to generate stable and secure returns. Many of them are failing. According to ANZ Bank, Chinese bond defaults reached $20 billion in 2022, more than double last year’s total. Of 19 registered defaults, 18 were from property developers.

Real estate is also an important driver of economic activity in services and other manufacturing sectors. The collapse of many developers generates ripple effects in all sectors that thrive on construction and the activity that real estate encourages.

For investors around the world, this is largely a domestic problem, and many expect the government to bring it under control through a series of bailouts and injections of liquidity into the financial sector to avoid a credit crunch. From a financial point of view, this may be fine, but there is no way for the Chinese regime to prevent the macroeconomic implications from bursting a bubble of such magnitude. China’s GDP growth slowed to just 0.4% in the second quarter, and youth unemployment hit new highs.

The Chinese regime may be able to contain the financial implications of the real estate crisis, but to do so it will have to abandon the 5.5% GDP growth target for 2022 and likely reduce the 2023 target to much lower single digits. weaker. For years, the regime worried about the Chinese economy’s rising debt level and heavy housing sector burden, but it seemed like it was expecting growth and improvements in the so-called “new economy” mask the problem.

Many international analysts expected China to be the first economy to prove it could navigate a housing bubble by deflating it through central planning. Too much hope was placed on central planning and too little attention given to the extent of the problem.

It is now clear that no sector can mitigate the effect of a bursting housing bubble. Even if the financial challenge is met with bailouts and liquidity injections, the impact will have to manifest itself in the currency, inflation, unemployment, growth or all of these at the same time. Many believe that the easiest solution is to depreciate the yuan, but the central bank knows that it is not so simple, because inflation would deteriorate the living standards of an already disgruntled population, and devaluation would destroy power. purchase of real wages and the value of savings.

If we can learn anything from this real estate crisis, it’s that inflating growth with a planned real estate bubble never leads to an easy and manageable solution.

The opinions expressed in this article are the opinions of the author and do not necessarily reflect the opinions of The Epoch Times.


Daniel Lacalle, Ph.D., is chief economist at the Tressis hedge fund and author of “Liberty or Equality,” “Escape from the Central Bank Trap,” and “Life in the Financial Markets.”