This housing bubble has different characteristics from those in the West
For the past few weeks, people all over the world have been fretting about Evergrande. The company, which is the second largest property developer in China, missed payments on its debt during the summer and last week announced that they would engage in an asset fire sale to meet its obligations. Just this week a new report found that one third of Chinese property companies could be heading towards bankruptcy as a knock-on effect.
Commentators are therefore quick to point out the similarity of these events to what the Western economies experienced in 2008. There is every chance that they’re correct and that the Chinese economy really is on the brink – which, given its size, would surely have knock-on effects for the rest of the world.
But it is just as likely, if not more likely, that these commentators are drawing a bad analogy.
Even though consumption goods in China are distributed by markets, the investment side of the economy is effectively state controlled. So is the financial system. The Chinese economy is very different to the old Soviet model, but what they do share is that finance and investment is planned by the state.
When housing markets unwind in market economies, they cause havoc in two ways. First, the mortgages and other lending financing these markets go sour. Companies and banks involved in housing development and mortgage lending then find themselves experiencing liquidity crises and often outright bankruptcy. That is what we see at Evergrande. Secondly, housing investment dries up and those working in construction and housing sales lose their jobs. This is how the financial problems bleed out into the real economy. A recession soon follows.
It is not clear that either of these issues would impact China. In the late-1990s, Chinese banks found themselves with mounds of bad debt after the madcap government investment drive in that period. By 2003, non-performing loans were valued at over a third of Chinese GDP. Yet there was no financial crisis. Why? Because the Chinese state set up entities called ‘asset management companies’ (AMCs) that took the bad loans off the balance sheets of the banks. These AMCs were backed by the central bank. In effect, the bad loans were tossed down the memory hole — something that is not hard to do if the state can use the central bank to simply create cash.
What about the impact of a burst housing bubble on the Chinese economy? Well, as we have said, the Chinese state controls investment. So, in theory, they can simply invest in something else other than housing — infrastructure perhaps, or military equipment. Those currently building houses can be employed, via state diktat, to build something else. Given that the Chinese government has explicitly stated it wants to tackle the housing problem, it would be surprising if they were not planning for this.
There are risks. Maybe the Chinese government has not come up with contingency plans. Maybe they have, but maybe things do not end up going according to plan. There are many possibilities. But interested observers need to understand that the Chinese economy is not like a Western free market system. The government calls the shots in China, not the markets. That is where interested observers should be looking.