China’s two-decade growth surge prior to COVID was greatly aided by three forces — the liberalization of land development, accelerated urbanization and increased homeownership; entry into the WTO and resulting foreign investment, and industrial policies that created global competitors in next-generation industries. To varying degrees, all of these forces were built on shaky financial foundations.
For land development and urbanization, China’s municipal governments created Local Government Financing Vehicles (LGFV). These entities borrow to build roads, factories, utilities, airports and other infrastructure. They were a way to power demand and investment whenever the national economy threatened to falter.
But LGFV often have invested imprudently, required operating subsidies from local governments. Collectively they’ve amassed $9 trillion in debt — equivalent to half of China’s total GDP. Moreover, many projects didn’t generate anticipated revenues, and many LGFVs are in financial distress. Beijing has reportedly approved $206 billion in new provincial debt to prop up faltering LGFVs, but that only exacerbates local governments’ longer-term debt and prolongs the fiscal challenges.
Local governments rely on land sales to developers for significant shares of their revenue. But housing prices have been falling in the wake of COVID. China’s property sector is seeing slower growth and growing fears that homebuilders will collapse and not deliver promised new residences.
Private real estate developers, such as now-bankrupt Evergrande and troubled Country Garden, borrowed from trust companies and banks to build homes and office buildings. Many of these projects have since become white elephants, both in China’s ghost cities and outside China, for example, Forrest City in the straits between Malaysia and Singapore.
Now China’s real estate developers are left with unsold new apartments in ghost cities and are unable to deliver prepaid-for new homes in places where housing is in demand. Prospective buyers are wary, driving down real estate values and municipal land sales, and threatening the resources of local governments needed to shore up LGFVs.
Trust companies sold exotic products to wealthier clients by promising outsized returns and lent that money to real estate developers and invested in stocks, commodities and other non- transparent assets. Prominent among them is Zhongrong, which has missed payments to investors.
China’s banks have about half of their assets tied up in local government debt and various property-backed loans — credit to real estate developers, trust companies and mortgages. The biggest chunks are mortgages, but many of those won’t get paid if promised homes are not delivered or real estate loses its value.
A Country Garden bankruptcy could strand 1 million buyers who have paid on so-far undelivered homes, and home prices across major cities have fallen in double-digits since Evergrande missed bond payments in 2021.
“ Cracks are emerging in China’s vaulted industrial policies. ”
Cracks are emerging in China’s vaulted industrial policies. Although it has accomplished parity or superiority in manufacturing process technologies, supercomputers, artificial intelligence, solar panels, electric vehicles and batteries, much of this is driven by protectionism, subsidies and technology theft.
Some 400 Chinese electric vehicle manufacturers have failed, and American multinationals are getting cautious about China. The EU will likely levy hefty subsidy-countervailing duties on Chinese EVs.
Apple is diversifying its iPhone supply chain out of China, and new foreign investment into China is at its lowest level in 25 years. More capital is leaving the country than coming in.
China’s exports are shrinking and are becoming more dependent on Russia — not a good strategy considering Western sanctions on that economy. U.S. purchases from China are down about 25% from last year. Its share of U.S. imports are down by a third from just before former President Donald Trump took office. Since July 2022, exports to the EU have fallen as well.
Coming off the COVID lockdowns, China’s economy could expand about 4.5% this year but going forward, Beijing will have to continue band-aid measures that risk creating zombie enterprises among LGFVs, trust companies and industrial enterprises, and a Japanese-style lost decade. Or China will have to pump an awful lot of liquidity into its banks, trust companies and LGFVs that risk turning the nation’s deflation problem into rapid inflation.
Don’t sweat China’s meltdown
U.S. President Joe Biden and many commentators are right to assess China’s economy as a ticking time bomb. But growth is slowing not tanking, and China is not the global economy. Plus, the impact of China’s troubles on the major advanced industrialized countries will not be huge, because China has focused more on exporting than buying our products.
It’s tougher for South Asian trading partners, but these markets form a sounder basis for intra-regional Asian trade and organic growth, are more receptive to U.S. and European exports, and are safer places than China for Western investment.
The West’s trading partners including India, Vietnam and Mexico are attracting that investment and seizing opportunities for new growth. Western consumers are not noticing many shortages as new sources of supply replace many Chinese products. So don’t sweat China’s meltdown — leave the sleepless nights to President Xi Jinping.
Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.
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