We have warned for some time that China risks entering a debt trap, as the fallout from the collapse of its property bubble intensifies:
- As the Apollo charts show, housing was more than 1/3 of China’s GDP at its peak in 2015; today it is just 20%
- This is having a major impact on local government finances, as land sales are their major source of revenue
Caixin, China’s main business paper, summed up the crisis:
“Chinese local governments are desperately seeking new revenue streams by leveraging government-owned assets to address mounting debt pressures and dwindling coffers. A document from Bishan District in Chongqing, southwest China, went viral online, outlining the formation of a “Sell Everything to Save the Day” task force aimed at monetizing state-owned assets.”
CHINA’S DEBT IS AT WORRYINGLY HIGH LEVELS…
China’s property bubble was based on borrowed money, mainly financed through its ‘shadow banking’ system. Essentially, it was ‘subprime on steroids’:
- House price/earnings ratios reached an eye-popping 50x in Tier 1 cities like Shanghai
- By comparison, New York prices were ‘only’ 14x when the US subprime bubble burst in 2008
The reason is that the state owned all land in China till 1998. So people have never been through the normal peaks and troughs of a property cycle.
Instead, as they began buying property for the first time, they assumed the government would never let prices fall. But today, this wishful thinking has been exposed.
Now, the shadow banking system is disappearing. And as the chart shows, local government debt is rising rapidly. Essentially, China risks falling into a debt trap, where new loans have to be taken out to service old loans.
Even worse, as the Apollo chart confirms, total debt is now >350% of GDP. The issue, as Prof Michael Pettis of Peking University noted in the summer, is that China’s stimulus programme has financed vast amounts of “non-productive investment.“
…AND ITS POPULATION IS NOT ONLY AGEING, BUT FALLING
CHINA BIRTH BY SEX
This level of debt has never been seen before in the modern world, even in wartime.
It is highly unlikely that it could have been repaid even if the population was young and growing quickly. But China is at the other end of the spectrum, as the chart shows. Its population is now falling, and birth rates are half what they were before 1980.
The rise in China’s median age is therefore accelerating. This is now 40 years, double the level in 1980 before the One Child Policy was introduced.
And as we have noted before, older people are essentially a replacement economy. They already own most of what they need, and their incomes reduce as they move into retirement.
This is a particular problem in China, as the female retirement age is only 50/55 today, and male retirement age is just 60.
ALMOST INEVITABLY, CHINA IS MOVING INTO DEFLATION
CHINA PPI, CPI%, 2018-2024
China is now inevitably going to get old before it gets rich. Its export-oriented economy is facing the prospect of major trade barriers, as the US and Europe look to preserve jobs for their own populations.
And so China’s overcapacity problem is getting worse rather than better, even in areas where it has global market leadership:
- Its solar industry has 80% of global demand, but is operating at just 45% of capacity
- Its auto industry is operating at <50% of capacity. NIO’s boss says it is entering “the most fierce and brutal phase of competition”
Unsurprisingly, as the chart shows, Producer Prices have now been falling for 2 years, and Consumer Prices are poised to follow.
This creates a major risk for the economy and financial markets. Deflation means the real value of debt increases. This is the opposite of what happens with inflation, when its real value reduces.
China’s ageing and falling population makes it very difficult to exit this debt trap. More and more money will be needed to refinance existing debt, accelerating the slowdown in the wider economy.