In fall 2007 I was backstopping Newsweek’s reporters in Beijing as they toiled under the crush of China’s looming summer Olympics. The bureau was in Jianguomen in the center of town and each night on my way home I’d stroll through Ritan Park, an enclave of calm amid Beijing’s relentless clamor. Along the way I’d pass a vacant lot that was used as an open-air movie theater for itinerant workers. They had been recruited from far away - Shenyang province in the northwest perhaps, or central Shaanxi - as shock troops in a hell-for-leather charge to complete the city’s Olympian make-over.
There were scores of them, all men and of all ages. Most appeared to be in their late teens and twenties but there were also boys who, in a true workers’ paradise, would have been in school, as well as slumped elderly men ripe for the mahjong circuit. The sense of wonder in their faces, illuminated by the flickering light from the make-shift screen, revealed the enabling power of China’s economic growth. A generation earlier they would have exhausted their lives in the villages where they were born, having never seen a feature film let alone one in the imperial seat. Now they were part of the biggest cotillion in human history and on the emperor’s generous terms: work, pay, dinner - and a show.
Of course, scenes like these were common long before China entered its Olympic chrysalis. For decades rural laborers migrated to the cities by the busloads on contracts negotiated by provincial and city officials, their local dialects collaborating with the blasts of pneumatic drills in an ear-splitting ode to modernization. Hand-wringing over what might happen when the music stopped was largely ignored, particularly as China’s economy continued to deliver healthy rates of growth.
Today, economists and investors are sounding the alert about China’s billowing housing bubble, and reasonably so. Having multiplied residential property space at Malthusian rates, supply has finally outstripped demand. Largely as a result, debt as a percentage of GDP has risen to some 230 percent, far higher than it was before the global financial crisis. And because housing accounts for a third of China’s investment and 16 percent of GDP, according to the business-news website Quartz“a housing crash will be more devastating for the economy than many realize.”
Like many emerging markets, China’s financial sector is underdeveloped relative to its manufacturing and services industries. As a result, fixed assets like apartments and houses assume an outsized role in credit allocation. Should property prices collapse so too might loans backed by rents and sales in secondary and tertiary markets. At least one default has already rattled China’s bond markets. Late last month, the Financial Times reported that China’s biggest banks last year wrote off bad loans at double the rates they did in 2012 amid fears that a property overhang may deplete growth to its lowest level in nearly twenty-five years.
What of it? Unlike many of the heavily indebted economies that capsized in 2008, most of China’s debt is denominated in its own currency, the renminbi. Not only that, the country maintains a thicket of currency controls that seals it from capital flight. Withdrawals of investment from one sector of the economy have to be invested into another. Also, it is important to remember how much of China’s economic activity is hidden given the prevalence of “under-invoicing” to the state among provincial governments and exporters - a significant factor in China’s high rates of liquidity. This alone, say some economists, will spare China the crash landing that is the inevitable end of most asset bubbles.
There is nothing more tedious and - up until now, premature - than heralds of China’s economic denouement. In the early 1990s, even as the West grappled with the magnitude of the country’s export-led growth- “they’re taking our jobs,” cried members of Congress, a sure sign that somewhere in Asia an economy has arrived - commentators were forecasting its demise. China was too big and unruly to cohere within its traditional borders, I was told by diplomats and financial analysts, and would eventually split into three separate countries. (Whether it would fracture laterally or longitudinally depended on who you talked to.) Unless the economy grew at double digits rates, an economist told me in an interview almost breathlessly, it would collapse for lack of jobs. “There will be a thousand people on top of a train going nowhere,” he said. “It's the emperor's worst nightmare.”
As it turned out, China’s economy continued to grow at double digits rates - still at 10 percent over the last three decades despite its gradual slowdown since the 2008 global crash. (The apocalyptic image of all those Chinese on the train stuck with me, however.)
But make no mistake: China is due for a reckoning. The government forecasts the country will maintain a growth rate of about 7 percent over the next year, strong enough to maintain employment levels but still a full thirty percent slower than it was averaging a decade ago. Given how a growing share of investment is being financed on credit - amid projections of slowing property sales - demand has only one place to go: south.
The result will be crisis - painful, disruptive and country-wide, perhaps China’s first national economic upheaval in its modern era. Until recently, a financial meltdown in one province - free-wheeling Fujian, for example, has had several over the decades - would go unnoticed everywhere else. Today, thanks to the growing integration of China’s financial system, the concussion from a bank default in southern Shenzhen will ripple through markets as far as northern Heilongjiang. Even China’s informal, or “shadow” credit systems are deep and extensive enough to go viral should several fail at once.
There will be violence. It will be contained.
China is lucky enough to have sidestepped not one, but two global financial meltdowns that occurred within a decade of each other. It survived the 1997-1998 Asian currency collapse - and famously resisted the urge to devalue the renminbi in response - as well as the 2008 crash. Soon enough the bell will toll for China, and when it does Beijing could learn from a tale of redemption close to home. In 1998, South Korea was digging itself out of the wreckage of the regional currency crisis with a large share of its debt denominated in dollars. With little margin for error, it paid down or wrote off much of its debt, replenished its foreign exchange reserves, reformed its banking sector and established open and transparent credit markets. Thanks to these efforts, it survived the 2008 calamity more or less unscathed.
Unlike South Korea a generation ago, China’s debt is locally raised and its capital markets largely captive. While this served the country well in the past, it is now part of the problem. The coming crisis will make this abundantly clear. Bur China will emerge from it stronger than ever.