Forget the trade war. Beijing’s worst nightmare is a property market collapse, Japan-style

China’s biggest economic risk in 2020 comes from its efforts to deflate the real estate bubble, which is closer to collapse than any point since 2003. Failure to find a soft landing may spell the end of China’s economic dream

Shirley Ze Yu

Published: 12:00pm, 22 Nov 2019

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“The only force that can defeat China is from within. No exterior force can.” On October 2 this year, the Communist Party’s leading journal of political theory, Qiushi, published in full a 2018 speech by President Xi Jinping, highlighting in stark language China’s coming challenges as the People’s Republic enters its 71st year. Indeed, in 2020, China’s primary economic risk is most likely to come not from the trade war, but from its inflated property market.

“Black swans” and “grey rhinos” dominated China’s financial lexicon this year. Few in the population know what they are but most know what they mean. They mean fear.

China’s property market is the grey rhino, overfed on massive liquidity steroids. One injection was the massive stimulus introduced in response to the 2008 global financial crisis. Another injection was from the six consecutive interest rate cuts in the 12 months to November 2015. Awash in liquidity, Chinese stock markets took off too, but by late 2015, the bubble had burst and the benchmark Shanghai Composite Index tumbled about 50 per cent from its 2015 peak. Real estate, however, partied on.

At the annual Caixin Summit earlier this month, China’s top economic policymaker Liu Shijin said that the targeted 6 per cent growth in gross domestic product is still “within reach” this year but for next year, worryingly, “drastic measures would be needed”.

Experts have drawn comparisons between China’s overheated property market and Japan’s housing bubble that burst in 1991, plunging the economy into the “lost decades”. Like Japan, China has risen to become a major trading nation thriving on a massive trade surplus. Both are today among the world’s top creditor nations with a culture of high savings rates and heavy reliance on bank lending, creating a highly leveraged economic growth model.

Former United States Federal Reserve chairman Ben Bernanke concluded that Japan’s post-bubble deflation was due to ill-timed and ill-measured monetary-policy responses from its central bank. China, however, has attributed this to the Plaza Accord, a 1985 currency pact that set off Japan’s currency demise.

With Japan’s fate in mind, China is expected to resist any attempt by the US to introduce a Plaza Accord 2.0 in the interim trade deal under negotiation. Any clause on exchange rate stability will therefore remain symbolic in both language and execution.

Former finance minister Lou Jiwei warned recently that full capital account convertibility is still not a safe choice for China, drawing up the limits of its financial liberalisation.

Zhongnanhai’s worst economic nightmare is a Japan-style collapse.

Despite Xi’s caution that “houses are for living in, not for speculation”, China’s real-estate market value has risen to twice the size of the G7 economies combined. At US$65 trillion, it is almost five times China’s GDP in 2018, and more than 10 times China’s stock market capitalisation.

In 2019, China’s property bubble is being pricked – on both the supply and demand sides.

On the demand side, market euphoria that housing will continue to deliver stellar returns is diminishing. Beijing is aware that China may have reached its demographic tipping point two years ago. As the population starts to age and the labour force shrinks, structural demand for housing will weaken – a problem that Japan has been wrestling with for the last 2½ decades.

Meanwhile, as corporate profits get squeezed amid higher borrowing costs, supply-side dominoes have also started to fall, and the housing price downturn becomes a self-fulfilling prophecy. The pressure to deleverage brings the property bubble closer to a collapse than at any point since 2003.

Since 2017, conglomerate Dalian Wanda Group, the flagship of billionaire Wang Jianlin, has dumped US$25 billion in assets to keep afloat. More recently, major developer Soho China is looking to sell all core commercial properties in Beijing and Shanghai worth US$8.5 billion. The grey rhino is panicking.

Why China’s housing bubble won’t burst any time soon

China’s consumer price index surged 3.8 per cent in October. Any further monetary easing will run the risk of stoking inflation. Stagflation is the new devil in China’s economic house. Should the property bubble burst now, China’s monetary policy decisions – to ease or not, and by how much and when – will only be more complicated and harder to make than for the Bank of Japan in the late 1980s.

Whether one subscribes to Bernankian economics or the Plaza Accord conspiracy, risks abound.

Trade conflicts can always be addressed by recalibrating global trading routes over time. But China’s economic dream will be over if its property bubble bursts, Japan-style. All bubbles come to an end; the question for China is when and how. In 2020, the fate of the US-China economic war will be contingent less upon the trade deal and more on whether China can rein in its grey rhino at home.

Dr Shirley Ze Yu is a political economist, an Asia fellow at the Ash Centre, Harvard Kennedy School, and a former Chinese national television (CCTV) news anchor

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