China is 'Band-aiding' its economy

We need to talk about China.

Because a few days ago, the Chinese government announced a bazooka of money moves. It’s going to pump money into the economy?—?it’s cutting interest rates for homes, it’s doling out cash to local governments to buy properties, it’s giving money to institutions to buy stocks, and it is even handing out a rare cash envelope to its poor.

But wait…why is China doing all of this?

Well, in case you didn’t know, the country is in a bit of an economic slump. Okay, not a ‘bit’ but a pretty big one. Its growth rates have plummeted to below 4%. It’s a far cry from the nearly double digit returns of just a decade or so ago. And its citizens are feeling quite pessimistic about their future.

So, will these monetary measures help? Will China’s fortune cookie read, “recovery imminent”?

To figure that out, we need to take a step back first. We need to dive into what really went wrong in the country. And depending on whom you ask, you’ll probably hear about the big 3 mishaps.

Let’s start with what’s considered the primary guilty party?—?real estate.

And this part of the story starts in 1998. Back then, the Chinese government decided to relinquish some of its control and finally leased state-owned land to private developers. It was a great way for the government to finance its budget.

You could imagine what happened next. These developers couldn’t hold themselves back at the new opportunity in front of them. They went hell for leather and began to set up residential facilities across the country.

Naturally, all this was backed by debt. Massive amounts of loans were taken from China’s various financial institutions?—?the banks and non-banks?—?to set up these high rise buildings.

Millions of Chinese citizens who’d dreamed of finally owning bigger homes also lapped these properties up.

And for two decades, this went on.

House prices rose because of this rampant speculation. No one believed that real estate prices would fall. So they were willing to pay higher and higher prices. At one point, real estate prices tallied up to more than 50 times the average national income.

Until one day, the clock struck 12 and the government decided that ‘houses were meant to live in, not to speculate on’. It tightened the rules when it came to lending to property companies.

And that triggered a collapse of the real estate market.

Lenders tightened their purse strings. And that meant developers began to fall short of cash and projects remained unfinished. Also, when Chinese citizens pulled back from their real estate investments, there was nowhere to hide?—?developers had no option but to default. Evergrande, Country Garden, and a host of others couldn’t pay back hundreds of billions of dollars worth of loans.

The real estate market capitulated and Chinese households were caught in this melee?—?nearly 70% of their wealth was in real estate and this took a big tumble. Some estimates say that it has wiped out $18 trillion in wealth from households.

Pretty grim, eh?

Alright, so what else happened?

Oh yeah, China’s infamous ‘shadow banking’ industry was hit by all this too.

What’s that, you ask?

Okay, so they’re sort of like banks. They can dole out loans but often the regulator doesn’t allow them to take deposits from the public. And since they do good work by making loans accessible to riskier folks that banks don’t lend to, the regulator doesn’t impose stringent rules on them too.

In China, these shadow banks accounted for between 40% and 60% of China’s GDP.

And a couple of years ago, cracks began to develop in a unique structure called ‘trusts’. These trusts would mix some banking, wealth management, and investment offerings together for wealthy individuals.

Some folks say that around 10% of the money these trusts raised from the public was channelled to real estate companies.

Oops.

So when the property sector crashed, these trusts began to topple too. People began to lose their money and even took to the streets in protest.

And then, in November last year, one of the biggest wealth management firms in China said it was insolvent. Just imagine the tremors that these massive failures sent across China.

Not a good thing, no?

Finally, there was also the time the government decided to interfere in the tech sector.

Remember Jack Ma and the Ant Group?

It wasn’t pretty. Jack Ma, the founder of Alibaba, openly criticised the Chinese government. And when it came time for the company to go public, the regulator threw a spanner in the works and stopped the IPO.

But it didn’t end there. The government then tightened the screws on everybody?—?video gaming, edtech, e-commerce…everyone. It imposed fines and made them sell off subsidiary companies.

And no prizes for guessing what happened next:

From 2021 to 2022, the total investment capital in Chinese internet industry plummeted by an astonishing 80%, from $49 billion to a mere $10 billion. Simultaneously, the total market capitalization of Chinese internet companies shrank from $2.5 trillion at its 2020 peak to $1.4 trillion in 2022.

People who invested lost money. Tech startups slashed tens of thousands of jobs. And youth unemployment in China soon jumped to unprecedented levels.

And that’s the backdrop for the economic malaise that has plagued China in the past few years?—?compounded by the impact of Covid too.

So the Chinese Politburo had to do something.

And that’s why they’ve announced a slew of measures to get the economy back on track.

Now the only question that remains is?—?will it work?

Well, it’s tough to predict that. Because the complication is that China seems to be in the middle of what economists call a balance-sheet recession.

What’s that, you ask?

Okay, so a balance sheet is nothing but a table that has assets on one side and liabilities on the other. When you borrow money, it’s a liability because you have to pay it. But you list the house you buy as an asset.

Now think about what happens when real estate prices tumble. The asset side falls in value. But the ones who borrowed still owe a high amount to the lenders. So the liabilities side remains high.

And that has an adverse impact. People get worried and cut back on spending in order to bring down their liabilities. So they don’t do much else. They don’t eat out, they don’t shop. They’re too worried.

If you want proof of that, look at the restaurant scene in China. It’s dismal.

In the first half of the year, at least 74 food and beverage brands in China announced the closure of over 400 shops, according to Linkshop, a retail business information platform based in Zhejiang.

The psyche has been hurt. People are pessimistic. And once they get into that mindset, it’s hard to turn things around.

So even if the government slashes interest rates to zero, people may not borrow and spend anymore. Even if they’re given cash handouts, they might save it for a rainier day.

Battling that fear could well be the hardest thing China’s government will ever do.

What do you think will happen?