Nikkei Gets it Backwards: Beijing's Giant Fiscal Hole is From Real Estate Overexpansion

A July 18 headline for an editorial carried in the morning edition of Nihon Keizai Shimbun (Nikkei) declared, "China Not Hesitating in Providing the Stimulus Its Economy Needs."

I found that headline astounding. 

You see, when it comes to Japan, which has been in chronic deflation for more than 25 years ー since the collapse of the bubble economy in the Heisei era ー that same newspaper has adopted a very different posture. On the one hand, the Nikkei has called for austerity measures and consumption tax hikes at every opportunity here at home. In the case of China, however, it is preaching the necessity of fiscal spending. 

It is true that Nikkei is not the only party worrying that if the recent downturn in the Chinese economy. If the downturn becomes prolonged following the collapse of the real estate bubble, it could adversely impact economies globally, including Japan. 

However, the remedy required is probably too much to ask of the Xi Jinping dictatorship. 

Control of China's Economy

The cause of China's economic malaise lies in the peculiar structure of its economy. 

In Xi's China, the government is extremely dependent on a system in which the Chinese Communist Party (CCP) controls both the nation's money and its land. Real estate development has been leading the way in boosting gross domestic product (GDP). In fact, middle-class households in Shanghai and other large metropolitan areas have often purchased a second or third condominium. This investment, instead of savings, is based on expectations of price appreciation.

Up to now, it has proven a sound strategy. Even though there were spells of declines in apartment prices, they invariably rebounded after a few months. In other words, the government's leverage strategy worked and the real estate myth seemed unshakable.

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But things are different this time. 

The Story China's Statistics Tell

Chinese statistics tend to underreport the actual estimates for price declines. Yet, even according to official Chinese statistics, the used home market continues to slump after peaking in early 2021. This is the market that reflects housing supply and demand. And indeed, it has fallen by 20 percent from that peak as of May 2023. 

The huge China Evergrande Group, China's second-largest property developer by sales, is heavily insolvent. Unfortunately, its valuation losses are only increasing over time.

Undeniably, there is an oversupply of high-rise condominiums in cities across China.

China's Aging Population

Moreover, in the backdrop is an aging population structure that is roughly where Japan's was ten years ago. There is zero chance of a turnaround in demand for condominiums in the future. 

A vicious cycle is emerging. Even if sellers lower their prices significantly, buyers hold off on purchases in anticipation of a further drop in prices. There is more than enough to remind us of the situation in Japan after the Heisei bubble burst. 

Countermeasures to the recession caused by the burst of the bubble economy are all about stimulating demand from both monetary and fiscal perspectives. But in China's case, both approaches have their limitations. 

Wary Bank of China

A large interest rate cut would cause a sharp increase in capital outflows. In turn, that could cause the value of the yuan to plummet. Foreign companies and investors have been scaling back their investments in China since March 2022. As foreign investment in China sags, the foreign currency needed to support purchases of the yuan is drying up.

China's fiscal stimulus is led by spending by local governments. But 70-80% of local government fiscal revenue comes from the sale of land use rights. With the real estate market and real estate development in a slump, they have no choice but to issue more local bonds. To do so, the People's Bank of China (PBC) must first take quantitative easing measures to purchase government bonds already in the market.

However, PBC Governor Yi Gang, an economist by training, is wary of doing so. That is because issuing bonds unbacked by foreign currencies would undermine confidence in the yuan. In turn, that could trigger the depreciation of the yuan and capital flight. 

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Above, the graph tracks real estate investment and the unemployment rate for urban youth (16-24 years old) on a six-month basis. The unemployment rate is inverted on its axis so that the linkage between the two can be seen clearly. 

I see no decisive factor that could halt these trends.

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(Read the article in Japanese.)

Author:  Hideo Tamura, Senior Staff Writer, The Sankei Shimbun