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China’s government is trying to persuade the rest of the world that the property crash is well in hand, everyone’s money is safe, and the growth narrative will resume after the commercial break. After all, the Winter Olympics will begin soon in Beijing, and a little over a half year later, China’s paramount leader, Xi Jinping, will (probably) be named ruler for life.
Unfortunately, there is scant evidence that the “soft landing” is actually under way. For a decade, over-supplied real estate and the attendant construction have been the primary strut of national growth. With the collapse of Evergrande that began last August, that is ending. Even though China’s government loosened credit, opened up mortgages, and funneled money to bankrupt developers, they managed only to make the decline slightly less extreme.
Empty apartment developments stand in the city of Ordos, Inner Mongolia on September 12, 2011. The … [+]
AFP via Getty Images
The chaos started in smaller cities, the ones they call Tiers 4 and 5 in China. Prices there are falling by 20-40% despite government warnings that sellers should not discount too much. Market confidence improved in December but only relative to November. Purchase transactions recovered month-on-month by 29% for China’s top 100 developers but were still down 38% on a year-on-year basis.
The government rushed money into the market:
· Banks were instructed to loosen mortgage requirements and speed up issuance.
· The proposed property tax was mothballed, or at least delayed.
· Restrictions on lending to developers were loosened.
· The People’s Bank of China (PBOC) cut the reserve requirement by 50 basis points in December, the second time since July. The 50 bp cut freed roughly ¥1.2 trn for new lending.
· The PBOC trimmed the benchmark lending rate in December for the first time since April 2020, reducing the one-year prime from 3.85% to 3.8%.
· Purchase restrictions on housing were dropped in many cities.
· About 30 cities put floors on the prices at which housing transactions may be registered.
This helped some but not enough. In December, Vanke (000002 SZ, 2202 HK), Greenland Holdings
(600606 SH), and Shimao Group (0813 HK) all saw sales declines of more than 50% YoY.
YICHANG, CHINA – SEPTEMBER 14: Construction site of an Evergrande housing complex is pictured on … [+]
VCG via Getty Images
Defaults are roiling the sector. Evergrande (3333 HK) is only the best known: the company defaulted on $1.2 bln in bond payments and is undergoing a forced restructuring in China. But meanwhile there have been many more. Kaisa Group (1638 HK), which went through one of the world’s more peculiar defaults in January 2015, defaulted on a payment of $400 mln. Shimao Group failed to pay ¥645 mln of a total ¥792 mln due December 25. Guangzhou R&F (2777 HK) said it would default on $725 mln due January 13. Sinic Holdings defaulted on $250 mln in offshore bonds last October. China Properties Group defaulted on $226 mln worth of notes October 15. Fantasia Holdings (1777 HK) defaulted on $206 mln in early October. And many more are now at risk.
The decline in property transactions has pushed construction into freefall. New housing starts are the lowest since 2017. A fall in steel demand in 2022 of at least 5% – meaning about 100 mln tons of iron ore – Is inevitable.
employees walk past a pile of iron ore covered by canvas at a storage site in Rizhao port, Shandong … [+]
Corbis via Getty Images
If China fails to save its property market, there will inevitably be contagion in the international markets. We see the order of knock-on effects as follows:
· Foreign-supplied commodities such as iron ore, coking coal, copper, and potash
· The share prices of foreign listed companies with significant businesses in China
· China’s luxury segment, so importantly fueled by capital gains from property
· China’s consumer spending
· Chinese exports, significantly fueled by subsidies, and ultimately,
· The value of the RMB. As the RMB devalues, expect deflation to be pushed out into the world economy.
One issue on which there has been too little analysis: China’s property market has been the most egregious example of elite theft on the planet.
In the first two decades of reform, China was so poor that even a small amount of investment capital induced a lot of growth. The great majority of the population was young, rural, and willing to accept any hardship to give the next generation a leg up toward prosperity. Laborers who migrated to the factories on the coast in the 1990s, and of course public officials who took generous cuts of the investment capital, made buckets of money.
By the mid-2000s, the government had a dilemma: they wanted people to have incentive to keep working hard, but they didn’t want to give all the surplus to households. That would have curtailed the ever-rising amounts of investment capital the government deploys as well as ever-rising streams of run-off for government officials. The solution? The property market.
Workers who were starting to get rich poured their money into the millions of apartments being built around the country, and a drumbeat of positive statistics told them that their property was worth many times their annual wage. Local governments converted land designated for agricultural use to residential land and reaped cash windfalls. They got local people to trade up to new residential towers on promises of massive gains and of a future life of urban leisure. During the past decade of the mad real estate bubble, Chinese government officials have collected untold billions, even trillions, of dollars
Now, as real estate values come crashing down, it is the farmers and taxi drivers and waitresses and factory workers who will see their imagined wealth melt away. The officials who engineered all this already have their money overseas.