China’s Economic Slump Is Here to Stay

China’s economic crisis has reached a critical point, with growth rates declining and debt levels soaring. In 2023, China’s debt-to-GDP ratio hit a record-breaking 288%, a figure that doesn’t fully capture the gravity of the situation. A significant portion of this debt was used to acquire assets that are no longer generating enough income to cover the repayment. The housing sector, in particular, has been severely impacted, with sales dropping by a third since the pre-pandemic peak and new construction decreasing by 60%. This housing crash is one of the worst the world has seen in the last thirty years.

A Cyclical Debt Crisis

While many Western observers see this crisis as a failure of China’s economic system and leadership, it is more akin to the cyclical debt crises that have plagued capitalist countries throughout history. An apt comparison can be drawn to Japan’s crisis in 1989, which marked the end of a period of high growth and rising asset prices fueled by a debt bubble. Over the next thirteen years, Japan’s Nikkei stock index plummeted nearly 80%, and real estate prices fell for two decades. Japan’s transition from the fastest-growing major economy to the slowest is a cautionary tale that suggests China may face similarly prolonged difficulties.

The Rise and Inevitable Fall

China’s remarkable economic rise was accompanied by an exponential increase in debt following Deng Xiaoping’s market-oriented reforms in the late 1970s. Similar to Japan’s post-war economic miracle, China experienced substantial growth driven by exports and a booming real estate market. In less than fifty years, China transformed from an impoverished centrally-planned economy to the world’s leading exporter and second only to the United States in the number of billionaires.

However, every boom-and-bust business cycle is bound to end as the rapid expansion of debt creates conflicting interests. Bullish developers in China rely on increasing mortgage lending to sustain rising real estate prices, while bearish creditors, such as banks and bond owners, fear that price inflation will devalue their debt assets.

Bursting the Bubble

The bubble has already begun to burst. Chinese creditors are scaling back new lending and raising interest rates, following the government’s guidance known as the “Three Red Lines.” As highly indebted Chinese companies go bankrupt or panic sell to repay their loans, asset prices continue to plummet. This wealth redistribution from debtors to creditors is inevitable during every crash.

Policy Dilemmas and Consequences

China’s government faces a policy dilemma. Rising real estate prices have slowed consumer demand and led to a decline in marriage and birth rates. High property costs have also driven businesses toward the internet, causing brick-and-mortar establishments to struggle. On the other hand, falling prices negatively impact homeowners, speculators, and businesses burdened with mortgage debt, potentially leaving them underwater.

While the Chinese government shoulders part of the blame for the crisis, its magnitude is largely driven by private incentives to borrow and lend. When the economy appeared overheated, Beijing enforced credit restrictions through the Three Red Lines policy. These restrictions proved challenging for bullish speculators and companies that had overextended themselves. As prices plateaued and then fell, demand from speculators evaporated. The current slump is therefore a victory for the bearish party, not a policy failure.

The Long Road Ahead

The Chinese economic slump is far from over, and it may take a significant amount of time for the government to redistribute losses and stabilize prices. A plethora of unsold or partially constructed apartments adds to the challenge, with estimates ranging from 50 to over 100 million empty units. Even if no additional homes were built, it could take a decade or longer to sell existing inventory. The government’s efforts to preserve construction jobs by resuming lending for halted projects will likely intensify the price slump by increasing the supply of unsold units.

If the government allows prices to continue falling until consumers and speculators believe they are low enough, a price floor will eventually be established. However, this floor may be too low and sales too slow, leading to bankruptcy for real estate developers and investors who borrowed heavily to build or purchase these properties. Such a wave of bankruptcies would pose a threat to the Chinese financial system, especially the unregulated shadow banks that aggressively invested in the housing bubble.

The Price of Rapid Growth

It is essential to understand that China’s slump is a consequence of its long period of fast growth, which resulted in the accumulation of vulnerable and unsustainable debts. The higher an economy flies, the harder it falls. China’s economic crisis serves as a stark reminder that unchecked expansion can lead to severe consequences. As the country navigates through this challenging period, it remains to be seen how China’s leadership and economic system will adapt and steer the nation towards recovery.

This article is written as part of Business Today’s commitment to providing expert analysis and commentary on finance and economics. For more information, visit Business Today at biztoday.us.