How Can You Tell When China Breaks?

First Understand the Role of Real Estate Prices in China

… about 80% of Chinese people’s wealth is in the form of real estate, totaling over $65 trillion in value — almost twice the size of all G-7 economies combined. A significant slowdown could, therefore, have a substantial impact on citizens’ financial health.

To him, Chinese people have “played around with leverage, debts, and finance, and eventually created a mirage in a desert that will soon entirely collapse.”

In December, [Ren Min University Professor] Xiang challenged the government’s official economic growth estimate of 6.6%, saying it was actually just 1.67% — or possibly even negative — in 2018. He then went on to warn of a potential crash in the property market.


In China, real estate prices drive the economy.

Real estate plays a key role in China’s economy.

Land sales have provided significant funding for provincial government budgets. Around 85% of budgeted spending is done through local governments. Home construction has delivered millions of jobs to working-class Chinese, the kind that are not walking up and down Ivy League campuses here in the U.S. or on spendthrift vacations in Paris.

Property also provides significant collateral, securing much of the debt issued by the country’s banks and even by some publicly traded companies that are heavily invested in land and real estate.

More importantly, real estate is the Chinese savings account. Most middle-class Chinese have at least one house, as opposed to renting. Upper-income earners have two or more houses, made all the more easy to acquire by generations of single-child households and rising wages translating into few children to spend money on.

Chinese savers cannot invest overseas easily due to the barriers of a closed capital account. Stuck at home, they gamble in the stock market and put their serious money in real estate.


But what happens when Chinese workers are no longer in a position to help fuel the real estate bubble and bread machine? Chinese manufacturing and exports are hurting. Foreign corporations — and many Chinese companies — are finding it necessary to move production away from mainland China. Part of the exodus of employers is caused by rising costs of Chinese labor. Another part of the problem is that the US government has finally gotten wise to Chinese theft and piracy — and China’s grossly unfair trade policies toward foreign businesses.

If the Chinese property bubble bursts, a cascade of unfortunate events for China’s economy will surely follow. China’s property developers are far out on the debt limb and crawling further out every day. Consider the China Evergrande Group, China’s third largest developer:

Evergrande is now in the headlines for all the wrong reasons. Shares are down 36% this year, the worst performer among Chinese developers listed in Hong Kong. Its bonds are falling, too, as a 45% fall in profit in the first six months of 2019 has markets worried about its $114 billion of debt. That is debt greater than the annual gross domestic product of Ecuador.

But this is just the tip of the proverbial iceberg. If growth drops below the 6.2% second-quarter rate, Beijing has a choice: continue tightening the vice on homebuilders to deleverage the economy, as Xi pledged in 2013, or support the market.

Under Xi, China has not shown great tolerance for headline-grabbing defaults. Yet letting reckless borrowers miss bond payments — or fail altogether — is part of any economy’s maturation process, particularly considering that China is the world’s second-largest financial power.

Granted, Trump’s trade war is a challenge Xi’s party hardly needs. __

China’s export and manufacturing sectors are also critical pillars in China’s economic future. They are showing recent problems as well:

The outlook for China’s manufacturing sector deteriorated further in August, underlining the weakness in the domestic economy just as a new round of tariffs kicks in.

The manufacturing purchasing managers’ index dropped to 49.5, according to data released Saturday by the National Bureau of Statistics, with sub-gauges showing that domestic and new overseas orders contracted. On Sunday, higher U.S. tariffs on roughly $110 billion in Chinese imports took effect, as did Beijing’s retaliatory duties on U.S. goods coming the other way.

U.S President Donald Trump’s tariff war continues to heap pressure on China’s economy and policy makers at a time when economic output already is in a long-term deceleration.

… The Trump administration imposed additional 15% duties on consumer goods ranging from footwear and apparel to home textiles and certain technology products like the Apple Watch. A separate batch of about $160 billion in Chinese goods — including laptops and cellphones — will be hit with 15% tariffs on Dec. 15.

That’s pushing many American companies to move manufacturing out of China to avoid being affected. __

Over the last few decades, manufacturers in China have developed a very good set of supply lines for product fabrication and assembly. Moving to another country will be difficult if they do not make proper preparations. But the longer they wait, the more likely these reluctant companies will share in China’s woes when the house of cards begins to collapse.

A large part of China’s economic growth is built on real estate and related infrastructure spending. Where is the danger, and how can you tell when things begin falling apart?

Functional vs. Dysfunctional Infrastructure Spending

China became wealthy recently based upon the foreign direct investment of overseas manufacturers, a massive transfer of technology from foreigners to China, and the booming export economy that resulted. But after the global deleveraging of 2007-2009, exports began to slow along with foreign investment, and China had to resort to other means for maintaining economic growth and a sufficient rate of employment to prevent a popular uprising.

The CCP government turned to massive stimulus and a huge infrastructure bubble began to take form. As a relatively primitive and developing nation, China needed a lot of infrastructure. But without a significant economic and political “opening,” China’s shiny new infrastructure amounts more to Potemkin window dressing. China has taken the route of the “broken window fallacy” to create the appearance of economic growth.

China is a “closed society,” a top-down command society where independent entrepreneurship is not tolerated outside of certain boundaries and tight connections to communist party officials. 90% of Chinese millionaires are closely related to top party functionaries, and if the ties of connection were more closely traced the number would be even higher. Wealth is concentrated in the corrupt hands of a few, rather than being reinvested broadly across Chinese society.

When expensive infrastructure of dubious quality is tossed into an authoritarian system on the command of government officials for purposes of “creating growth,” the society does not benefit to a significant degree. That is not how a healthy organically growing economy works.

We have seen huge “ghost cities” built across China — cities that are doomed to break down and collapse decades earlier than should have been the case. We see massive and hugely wasteful investment in solar and wind developments, much of which will never be connected to the electrical grid — the main purpose of their construction only to act as an economic stimulus and a propaganda point in the global game of political influence.

The exporting of China’s dysfunctional infrastructure overproduction is clearly seen in the Belt and Road initiative, which has made a lot of corrupt officials in Africa and other primitive areas wealthy, but has the ultimate effect of casting the people of those primitive places deeply into debt to China — and forcing them to hand over valuable collateral of land and resources to their new overlord China.

Interesting perspective on China infrastructure investment

Desperately seeking financing


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