The world is anxiously watching the Chinese housing market, in the wake of property developer China Evergrande Group’s potential default. Market watchers have been drawing comparisons to the US crash in 2008, and some even to Japan’s property bust two decades earlier. But although there are some similarities, China’s situation is fundamentally different from either of those two episodes.
The most obvious comparison for a potential Chinese real estate crash is the US housing bubble that burst after the fall of Lehman Brothers. By now, we know that land bubbles are especially pernicious since they involve so much debt. When they pop, they tend to take the financial system down with them, causing lenders to pull back out of fear of insolvency and illiquidity. That’s what happened to the US But as commentators have been quick to point out, China is not really in danger of this kind of scenario, because the government controls the banks. If President Xi Jinping tells Chinese banks to continue to lend, they will do so, no matter what sort of toxic Evergrande-style sludge is on their balance sheets.
Japan’s bubble and crash in the early 1990s is an example that relatively few outside the country understand, but which many may instinctively associate with China because both countries are in East Asia.
In the late 1980s, Japan’s efforts to catch up to the West had come to full fruition, but its growth was correspondingly slowing. In an effort to sustain the growth they were accustomed to, Japanese banks got into real estate finance in a big way, helped by deregulation, low interest rates and a strong currency. So far, this sounds a bit like China. Every time China’s economy is in danger of slowing, it commands banks to lend, and they mostly lend to real estate and associated industries like construction. This is a more deliberate version of what Japan did, but the impetus to sustain rapid growth is probably similar.
Another factor that helped pump up Japan’s bubble was its financial system. Unlike in the US, most companies borrowed from big banks instead of issuing bonds. To get loans, companies needed collateral, and the collateral banks were most eager to accept was land. That increased the demand for urban real estate, pumping up the price bubble, but it also exacerbated the collapse on the way down; when companies’ collateral depreciated, banks wouldn’t lend to them anymore, forcing them to curb operations.
Again, this is unlikely to be a problem for China. Chinese companies certainly have a ton of debt, but if real estate isn’t part of their core business, it probably doesn’t matter for bank lending if their land holdings depreciate; the government can still just direct loans their way if it wants. Companies that depend on real estate or construction — and local governments that finance themselves with land sales — will certainly take a huge hit if the property sector goes down, but manufacturers and other companies will likely be safe, unlike in Japan.
So that’s the good news. Basically, both the US and Japan had capitalistic financial systems where lenders could and did pull back when real estate crashed; China has no such vulnerability.
But in every respect except financial stability, China’s economy is more vulnerable to a real estate crash than either America’s or Japan’s was. Real estate and related industries account for almost 30% of China’s GDP — a far higher share than the US at the height of its boom. If Xi is really serious about shifting the Chinese economy away from real estate and toward manufacturing, as he has declared, it will be a painful adjustment. If he uses Evergrande’s fall and a resultant real estate crash as the occasion to make that structural shift, the pain will be even greater because it will be concentrated in a short amount of time.
To make matters worse, Chinese citizens are extraordinarily dependent on real estate for their nest eggs — the homeownership rate is 90%, and it’s estimated that urban Chinese people have more than 70% of their net worth in property. This is something Japan didn’t have to deal with; Japanese houses tend to depreciate rather than appreciate, because the government scraps and rebuilds them every so often. So at least when land prices crashed, the middle class wasn’t wiped out. The US middle class took a larger hit, but if China’s land prices go down, the financial carnage among the general populace will be of epic proportions.
Finally, a long-lasting bust in real estate would greatly lessen China’s ability to respond to macroeconomic shocks. Japan and the US use traditional monetary and fiscal policy to fight recessions, but China has always relied on the expedient of ordering banks to lend. Without real estate, there will be far fewer profitable enterprises for Chinese banks to lend to, meaning China will be vulnerable to the next recessionary shock that comes along.
So China’s real estate situation is fairly different from that of the US and Japan in their housing crashes, but in many ways it’s worse. No, it doesn’t have the financial fragility of a capitalist country, but its middle-class wealth, stabilization policy, and long-term growth are more dependent on real estate. Any company invested in China, or who makes a living exporting to China, should be very nervous about the potential fallout from Evergrande.
Bloomberg
