…and why it’s so hard to get our arms around the extent of the current Chinese property crash.
people don’t trust the banks in China
This is a typical phenomenon in emerging markets.
Something like half the world’s demand for gold comes from developing countries in Asia, and specifically China and India. Some of it may be buried in the back yard. But a lot of it is worn as nam chuk jewelry, so you can break off a chunk to buy something in a stall or a store. No, you don’t collect interest. But, on the plus side, you
—defend yourself against possible devaluation of the currency
—don’t have to worry (so much) about counterfeits
—have immediate access
—don’t have to worry that your bank will fail
—retain anonymity. There may be a substantial barter or underground economy in a country, especially where official economic affairs don’t always run smoothly. Or a successful business may fear government punishment if the extent of its success were evident in bank balances
–may be able to earn much higher income on investments elsewhere.
Chinese commercial banks have been like government piggy banks
For any government official, getting ahead in the Communist Party depends on achieving economic growth. The easiest way for, say, a mayor to do this is to build something–housing or a commercial complex. Just the act of construction creates GDP growth–and maybe you’ll be promoted (and gone) before the success or failure of your projects are evident. And the easiest way to do this is to arm-twist your fellow Party official who runs the local bank into making a loan to fund construction.
Generally speaking, it’s very hard for an investor to see into the loan book of any bank, but Chinese banks are particularly opaque, I think, because of the power relationships between them and local governments.
speculation in property development
The basic structure: a developer acquires property to build a big apartment complex by leasing land from the government. Buyers put down a large initial deposit, maybe two years before anticipated completion, which gives them the right to buy a specified apartment at a given price on completion of the project. The developer then borrows from a bank (or issues overseas bonds) to get construction funds. The project is completed, final payments are made by buyers, loans are repaid and the developer moves on to another project.
Property is a bigger thing in China than in the US. Here, a bit less than half of individuals’ aggregate net worth consists of property ownership. Estimates for China are more like three-quarters.
Property speculation has been rampant in China for a long time, with–as always happens, everywhere–increasing amounts of financial leverage. Part of this is investor preference, part the lack of alternative investments, part a steady rise in housing prices over the years, part the “piggybank” relationship between governments and banks that has made loans flow like water–without much thought about the chances of repayment.
My Hong Kong experience suggests to me that speculation by potential retail buyers has been very big: I want to buy one unit for myself; I put an advance payment down on three (locking in a fixed price of all of them), with the intention of selling the other two in a year or so, when prices have risen and they may be worth 50%? 100%? more than today. Great when prices are going up, not so good today.
the three red lines
In the summer of 2020, Xi Jinping made explicit in his Three Red Lines rules governing financial leverage among banks and property developers, in an attempt to cap increasingly dangerous speculative lending. This, of course, started a slide in property prices.
ANT Financial
Shortly after that, Jack Ma announced that his Ant Financial consumer lending operation was going to, in effect, destroy the commercial banks’ consumer offerings. That got him disappeared so he could be “reeducated.” An almost incredible miscalculation by a presumably very savvy entrepreneur–indicating to me that the banking system’s solvency problems are much bigger than even the most well-informed outsiders are aware of.
my conclusions
We’re still in early days of this crisis. This is most likely worse for Chinese banks than the crooked mortgage derivatives scandal in the US in 2007-08 was for US-based banks. The only parallel I can come up with is the parlous condition of state-owned Chinese industry when Deng declared a new era of Socialism with Chinese Characteristics. Hard to imagine Xi doing something similar with the banks, though. So all we may see is slower than expected economic growth for the overall domestic Chinese economy.