Why real estate development in China would lead to skyrocketing inflation

Yet despite properties in some Chinese cities costing up to 43 times the disposable income of city dwellers, the two have survived relatively unscathed, largely thanks to support from the Chinese government.

Every once in a while a real estate developer or state-owned company would find itself in trouble after its real estate betting went badly, but until recently – pretty much every time – Beijing would come to the rescue if the company was large enough to create risks for the system.

Like a daredevil chicken game on a lonely, lonely country road, Beijing and the real estate industry would look at each other every now and then, knowing that if neither side stepped aside, it could all end in a crash. all powerful.

Until now, Beijing has always swerved whenever its opponent is big enough that its potential demise has an impact on systemic stability.

It was up to Evergrande.

Evergrande: the time bomb of the Chinese real estate sector

In recent months, mega developer Evergrande has been making headlines as it struggles to manage more than $ 300 billion (A $ 400 billion) in liabilities.

To date, several US dollar bonds have experienced missed payments and bonds issued by others but guaranteed by Evergrande are on the verge of default. Domestic Chinese investors have so far been somewhat isolated from the woes of Evergrande, but are largely expected to suffer significant losses.

Yet despite Evergrande’s importance to the Chinese economy and the fact that it is more in debt than most countries in the world, the Chinese government has so far been reluctant to intervene.

An already weak Chinese economy

In the recent release of China’s national accounts for the third quarter, the Chinese economy grew by just 0.2%, far from the 1.2-1.5% growth range recorded in 2019.

But what makes this figure really interesting is that it has been made public. The Chinese government can claim that its economy has grown at the rate it wants, but it has chosen to present a figure that shows a Chinese economy in great difficulty.

Investment bank Citi is even more concerned about China’s growth prospects, predicting a short period of stagflation driven by high energy prices and the biggest increases in producer prices in decades.

With Chinese retail sales growing just 2.5% over the past year, down from 8% before Covid, the Chinese Communist Party’s dream of a consumer-driven economy looks increasingly fragile.

A collision course – Beijing does not deviate

If the Chinese government continues its current momentum and pursues a restructuring of Evergrande with heavy losses for investors rather than a more traditional bailout, the Chinese real estate sector and the economy in general will suffer a big impact.

In a article written by Harvard University Economics Kenneth Rogoff and Peking University Yuanchen Yang Tsinghua, it was concluded that in 2016, real estate related activities in China accounted for 28.7% of GDP.

While house prices are now falling in the 51 main markets monitored by the China International Capital Corporation at a rate of 1.7% in September, the stakes of the Evergrande saga and more generally the problems of the Chinese real estate market continue to increase. .

Rogoff and Yang concluded that Chinese household consumption was “significantly more sensitive to a fall in house prices”, compared to that of other countries such as the United States or Japan.

A “20 percent drop in (Chinese) real estate activity could lead to a 5-10 percent drop in GDP, even without amplifying a banking crisis, or taking into account the importance of real estate as guarantee ”.

For an economy that has grown accustomed to 6-10% growth year over year over the past decade, any prolonged decline in growth of this magnitude would be a real shock to Chinese households.

What if Beijing swerves in its chicken game?

Currently, it seems unlikely that President Xi and the Chinese government will stray from their pool game with the real estate industry, but it is worth exploring what could happen if they did.

What if a more serious than expected deterioration in the real estate sector forces the Chinese government to fall back into its old ways? Throwing in the kitchen sink once again against a construction stimulus, as it did during the global financial crisis.

If Beijing were forced to pursue this type of strategy again, it is likely that commodity prices would rise significantly, although they are already at or near record levels.

It would not be the first time.

For example, in December 2007, just before the GFC, world prices for iron ore stood at just US $ 36 (A $ 48) per tonne. Less than 2.5 years later, soaring demand had pushed them to over US $ 180 (Australian $ 240) per tonne.

Rising commodity prices would be a huge boon to the Australian economy just as it was during the GFC era.

But there would be risks for China and the world.

As it stands, Chinese producer prices are currently increasing at a rate of 10.5% over the past 12 months – a high in 26 years.

Were Beijing to reject caution and pursue another construction-focused stimulus, it is likely to lead to even higher levels of inflation than the world is already experiencing.

This would put more pressure on households and businesses already facing the challenge of rising prices, as well as additional pressure on central banks to raise interest rates.

There are no easy answers to the problems of the Chinese real estate sector. Beijing might kick the box once again, but now that also comes at significant costs and further fuels systemic risk.

Or Beijing can build on its momentum and accept the inevitable damage that a significant downturn in the real estate sector will bring, in the hope that it will avert an even more severe crisis in the future.

Tarric Brooker is a freelance journalist and social commentator | @AvidCommenter