China is in the midst of a profound economic crisis. Growth rates are flagging as an unsustainable mountain of debt piles up; China’s debt-to-GDP ratio reached a record 288% in 2023. But even that eye-popping figure does not capture the uncomfortable fact that much of it was borrowed to buy assets that no longer yield enough income to repay the debt. This is especially true in the housing sector, where sales have fallen by a third since the pre-pandemic peak, and new construction is down 60%. This is one of the worst housing crashes in the world over the last three decades.
Many Western pundits and politicians view this crisis as a sign of the bankruptcy of China’s leadership and economic system. But it is more akin to the cyclical debt crises that have plagued capitalist countries throughout history. An apt comparison is Japan’s crisis of 1989, which ended decades of high growth and rising asset prices, fueled by a ballooning debt bubble. Japan’s Nikkei stock index peaked in late 1989 and fell almost 80% over the next 13 years. Real estate prices fell for two decades starting in 1991. Neither of these major asset classes has exceeded the pre-crisis price peak ever since. Japan transitioned from being the fastest growing major economy during 1954-73, typically growing over 10% per year, to the slowest, with growth averaging only 1.75% per year from 1981 to 2023. China may be facing similarly prolonged difficulties.
China’s astonishing rise was propelled by an even greater expansion of debt following Deng Xiaoping’s market-oriented “Four Modernizations” in the late 1970s. Like Japan during its postwar “economic miracle,” China’s growth was led by an export and real-estate boom. In less than a half century, China went from an impoverished centrally-planned economy with minimal international trade to the world’s leading exporter and close second to the U.S. in the number of billionaires.
The eventual collapse of China’s bubble has always been inevitable. All boom-and-bust business cycles must end, because the rapid expansion of debt creates opposing interests: bull and bear parties. The bullish developers in China today want ever rising mortgage lending so real estate prices continue rising. Yet the bearish creditors—mostly big banks and bond owners—are concerned that price inflation reduces the value of their debt assets.
The bubble is already bursting. Chinese creditors have now scaled back new lending and raised interest rates, following government guidance announced as the “Three Red Lines.” As the most indebted Chinese bulls go bankrupt or panic sell to repay their loans, prices are falling further as their bear counterparts jump back in and buy assets at fire-sale discount prices. That will eventually put a floor on the price collapse but it is also redistributing wealth rapidly from debtors to creditors. Bears feast on the bulls during every crash.
There is an added wrinkle in China’s case. Most provincial and local governments have been profiting and gaining prestige by financing real estate development on a massive scale—Goldman Sachs economists put the figure at $8.4 trillion, or nearly 50% of GDP. Local governments profit much like any real estate developers would. But the central government in Beijing is increasingly siding with the bear party, because it is concerned about the value of the renminbi, which hit a 16-year low in September. Beijing has intervened to prevent the Chinese currency from falling too far too fast by selling foreign reserves and buying renminbi. Although it has ample foreign currency reserves, if the real estate boom had continued unchecked, these would have eventually dwindled.
Beijing’s policy dilemma is intense. Rising real estate prices have slowed consumer demand, especially young people hoping to buy their first home. This is one reason for the recent precipitous drop in marriage and birth rates. Brick-and-mortar businesses are plagued by the high cost of property, driving more and more business to the internet. On the other hand, falling prices afflict all those who bought real estate with mortgage debt, whether homeowners, speculators, or businesses. They may find themselves under water when their property value falls below their outstanding debt.
China’s government bears much blame for “causing” this crisis, but the scale of the crash is largely based on private incentives to borrow and lend. When the economy seemed excessively overheated, Beijing actually assisted the bears with its Three Red Lines policy in August 2020. These credit restrictions were draconian for bulls, given the enormous overextension of many of the biggest Chinese property companies as well as millions of individual investors. As soon as prices start to plateau and then fall, speculator demand evaporated. Consumers might need to buy real estate for use, but speculative investors only want to buy if they are confident prices will continue to rise. The current slump is a victory for the bears, not a policy failure.
The slump won’t end anytime soon, but the government might at least redistribute the losses. Staunching the fall of prices is difficult because of the massive inventory of unsold or partially constructed apartments. Reasonable estimates of the number of empty apartment units (many unfinished) range from 50 to over 100 million. Even if no more homes were built, it might take a decade or more to utilize the existing inventory. Recently, Beijing has tried to preserve the jobs of construction workers by pushing state-run banks to resume lending for the completion of construction projects halted when their developers lost creditworthiness, but this policy will increase the supply of unsold units, intensifying the price slump.
If the government is determined to let prices continue to fall until consumers and speculators start to believe they are “low enough,” a price floor will be found, but that floor might be too low and sales too slow to enable real estate developers and investors to repay the loans borrowed to build or buy those units, bankrupting many. Such a wave of bankruptcies would endanger the Chinese financial system, especially the unregulated “shadow banks” that have aggressively invested in China’s housing bubble.
Many pundits blame governments whenever economies crash, but the real cause of China’s slump is the long period of fast growth that piled up vulnerable and unsustainable debts. The higher they fly, the harder they fall.
