Why China's Economy is Finally Slowing Down

Summary

Before China's economic boom, it faced a severe housing crisis, with urban areas extremely cramped and lacking basic amenities. Housing, seen as a state responsibility, was cheap but inadequate. The introduction of economic reforms by Deng Xiaoping in 1988, allowing the transfer of land use rights, sparked a real estate revolution. This shift led to explosive growth in housing development, turning a crisis into a thriving market. However, this growth eventually resulted in a bubble, with sky-high prices and a significant portion of homes remaining vacant. The Chinese government's introduction of regulatory 'red lines' aimed to control financial risks but led to challenges for major developers like Evergrande, highlighting systemic issues within China's property sector.

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Outlines

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Keywords

💡Economic reforms

Economic reforms refer to policy changes intended to improve the economic efficiency of a country. In the context of the video, China's economic reforms initiated in the late 20th century, notably under the leadership of Deng Xiaoping, transformed its economy from a centrally planned system to a more market-oriented one. These reforms included opening up to foreign investment, reforming state-owned enterprises, and allowing private businesses to operate, significantly boosting economic growth and improving living standards.

💡Housing crisis

The housing crisis in urban China, as detailed in the video, was characterized by cramped living conditions, inadequate infrastructure, and a lack of modern amenities. Prior to the economic reforms, urban residents often lived in overcrowded conditions with shared facilities, underscoring the urgent need for housing development and improvement.

💡Urban migration

Urban migration refers to the movement of people from rural areas to cities in search of better employment and living conditions. The video highlights the world's largest domestic rural to urban migration in China, which placed additional pressure on the already strained urban housing supply, exacerbating the housing crisis.

💡Real estate revolution

The real estate revolution in China, sparked by policy changes in the late 1980s and 1990s, transformed the housing landscape. By allowing the transfer of land use rights and encouraging private development, China experienced a boom in housing construction, leading to significant improvements in living conditions and the emergence of a vibrant real estate market.

💡Economic growth

Economic growth, as discussed in the video, refers to the increase in a country's economic output over time. China's housing development played a crucial role in fueling its economic growth, with the construction and real estate sectors contributing significantly to GDP and job creation.

💡Home ownership

The surge in home ownership in China, driven by the real estate boom, reflects the growing middle class's ability to purchase homes. This shift towards private home ownership marked a departure from the era when housing was predominantly provided by the state or state-owned enterprises.

💡Housing bubble

A housing bubble occurs when property prices rise rapidly to levels not supported by underlying fundamentals, leading to unsustainable market conditions. The video illustrates how, despite high development rates and vacancies, housing in China became an attractive investment, detaching its value from its utility as a place to live and contributing to a speculative bubble.

💡Three red lines

The 'three red lines' policy introduced by China's central government in 2020 aimed to curb financial risk in the property development sector by imposing limits on debt levels. Developers had to comply with these rules or face growth restrictions, which significantly impacted heavily indebted companies like Evergrande.

💡Evergrande crisis

The Evergrande crisis, as highlighted in the video, exemplifies the risks of high-leverage strategies in the real estate sector. Faced with the 'three red lines' policy and changing market conditions, Evergrande struggled to meet its financial obligations, leading to default and symbolizing the broader challenges facing China's property market.

💡Demographic change

Demographic change in China, including a declining birth rate and aging population, has implications for the housing market and economic growth. The video discusses how these changes affect demand for housing and labor supply, contributing to the challenges faced by the property sector and the broader economy.

Highlights

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Transcripts

Before its economic reforms were called a miracle,  before its stubbornly shut doors opened to the  

wider world, before practically every single  economic and quality of life metric shot up and  

to the right, China faced a crippling housing  crisis. On the verge of a breathtaking rise,  

China, and especially urban China, was  impossibly cramped. This is about the  

average footprint of a one-bedroom apartment in  Manhattan, for example. This is about the average  

footprint of the average American kitchen.  And in 1980, this was the average living  

space per capita for urban China. Not until  1985 would this cross the 10 meter barrier,  

and not until the mid 1990s would it cross 15.  To put such density in perspective, these are the  

average living spaces for other urban areas the  world over in 1992, with only the likes of Tokyo,  

New Delhi, and Cairo in the neighborhood of the  average urban Chinese living space. Of course,  

available space only goes so far in quantifying a  housing crisis. Not only was urban China cramped  

at the onset of the world’s largest domestic  rural to urban migration, it was also dingy,  

dangerous, and decidedly anti-modern. In 1985,  90% of urban households didn’t have piped gas, 70%  

didn’t have sole access to toilets, and nearly 40%  relied on shared kitchens and shared water taps. 

Rapid demographic change was partly  to blame for China’s housing problem,  

and so too were corruption and general poverty.  But fundamentally there was simply no strong  

incentive to build. Through the ‘80s, housing in  China was the responsibility of the state. More  

specifically, housing came in one of two ways: it  was procured and managed by the local government  

housing administration, or it was provided by  state-owned enterprises. No matter how you got it,  

it was cheap too. Considered a right, rent cost  only 1 to 3% of average income and these dues  

were not tethered to the cost of construction  or maintenance. While ideologically coherent,  

this approach made additional housing  construction a hard sell to central planners,  

because unlike investing in infrastructure  or heavy industry, housing would generate  

no substantial revenue. With the state at  once obligated and uninterested, and private  

development outright illegal, China’s housing  was bad and only getting worse. Then came Deng  

Xiaoping, and with him a real estate revolution. The Chinese decade’s long development boom started  

with this: A simple, single- sentence addition to  chapter 1, article 10 of the Constitution of the  

People’s Republic of China in 1988—that the right  to the use of land may be transferred according to  

law. Vague and—in an era of economic reform and  economic miracles—easy to overlook, this line,  

justified in part by a series of smaller-scale  pilot tests by the party, opened the floodgates. 

Unlike in freehold countries such as the  US, all land in China is owned by the state,  

or in rural settings, collectives. This  was the case before reform in the 1980s,  

and this is still the case today. But with reform  came room for a host of middlemen. Now, the state  

still owned the land, but it granted smaller local  and municipal governments the right to use land,  

to develop it how they saw fit. Local governments,  in turn, looking to increase their own revenues  

for infrastructure projects or simply maintaining  operations, could now sell these land use rights  

on to property developers, who would then build  out housing for a growing Chinese middle class  

that increasingly had the means to finance the  purchase of a home at full cost. No longer was  

housing a need begrudgingly invested in  by the state, but an opportunity. Local  

governments now had steady income streams  through land sales, private developers  

had massive and growing demand to act on, and  increasingly wealthy urban Chinese had increasing  

housing options and investment opportunities. Suddenly, what hadn’t existed just years before,  

a private real estate and development  sector, was red hot. Urban living space  

shot upward. So too did home ownership. From  1998 through 2002, Chinese developers built  

enough stock to house the entire population of  the US. In the midst of an economic miracle,  

a housing miracle—two things that couldn’t be  separated, as housing development didn’t track  

alongside economic growth, but helped fuel it. According to the Sovereign Wealth Fund  

Institution’s rankings, of the world’s top ten  largest real estate companies by total assets,  

six are headquartered in either mainland China or  in Hong Kong but doing much of their business in  

mainland China. Of these, four of the largest  land development companies the world over were  

founded in the 1990s or later, making their  rise from nothing to the world’s biggest in a  

construction-based industry nothing less than  meteoric. Certainly, this rise can in-part be  

explained by simply stepping in and filling an  extreme void in supply, but it also has to do  

with strategy. Take the largest, for example. Evergrande’s rise effectively began with this  

project, when a 110,000 square meter footprint  formerly the home of a pesticide plant came up for  

sale in the Haizhu industrial district. Turning  the cheap land into aspirational apartments  

for a growing aspirational middle class, the  project sold out in just two hours. Immediately,  

the company reinvested the earnings  into 13 new projects across Guangzhou,  

and the push toward the top was unmistakably on.  They weren’t alone either as uniform high rises  

seemingly copied and pasted rose high into the sky  around burgeoning cities and industrial areas. To  

the outside world, it was a boom, but considering  Evergrande’s business strategy, for those on  

the inside it may have felt more like a race. To keep pace with competition, sky high demand,  

and seemingly endless opportunity, Evergrande  embraced a uniquely high-leverage strategy. Like  

any property developer, they’d fund construction  through the combination of upfront buyer payments  

and borrowed money from banks, but the difference  was just how much risk they’d tolerate. They  

didn’t keep big cash reserves in case sales slowed  down to make sure they’d make their bond payments,  

they didn’t wait to see if one project proved  profitable before taking on more debt for the  

next one. They truly just took on as much debt as  possible and built as fast as possible, summing  

to an incredible amount of risk, but this risk  was always rewarded because the projects always  

sold out. Growth was in hyper drive as Evergrande  went nation-wide, breaking ground on hundreds of  

projects, then in the 2010s, nearing a thousand. As private developers built and built,  

housing prices only continued to rise while buyers  continued to front down payments that—usually at  

35% or more—dwarfed those of much of the rest  of the developed world, signaling still that  

good times were only getting started. The impact  was much broader than companies getting bigger,  

too. It offered a rare opportunity for the Chinese  public to invest their money into an asset with a  

track-record of consistent growth. It offered  a major source of income to local governments,  

allowing for infrastructure development and social  services. It created millions of jobs in one of  

the world’s most active construction industries.  What was once a crisis had now become a pillar  

of one of the world’s mightiest economies. The only problem was, housing still wasn’t  

doing a good job of actually housing. All those  years of unimaginable growth inevitably led to  

unimaginable prices. Beijing’s property prices  per square foot were on par with Los Angeles’,  

Shenzhen’s were about the same as Paris, and  Shanghai’s were nearly as high as London’s. Yet  

this was all in an economy where the average  person earned somewhere between a fourth and  

sixth as much as those in the US, France, or UK. Globally, there are plenty of cities known for a  

fundamental mismatch between what people earn  and what it costs to live there. In New York,  

for example, it takes thirteen years of average  income to pay for an average home. In Vancouver,  

meanwhile, it takes sixteen, while in  London an eye-popping twenty-two. By 2018,  

in Shenzhen, though, it took forty-one years  of average income to buy an average house—a  

near-impossible proposition. And in Shanghai  and Beijing, that ratio was only worse. 

But perhaps most concerningly, from the  perspective of China’s central government,  

this did not appear to be the simple result of  high demand clashing with constrained supply—after  

all, supply was at an all-time high. Almost a  quarter of the country’s housing units sat empty:  

there were millions upon millions of completely  habitable apartments bought and paid for,  

but never inhabited. It just simply did not  make sense for a country to simultaneously  

have some of the highest housing development  rates in the world, some of the highest price  

growth rates in the world, and some of the  highest housing vacancy rates in the world. 

Unless, of course, one considers the rather clear  conclusion: the value of housing had decoupled  

from its actual utility. It had become so  attractive as a store of wealth that it was being  

traded based on its role as a financial asset,  rather than its role as a place to live. This is a  

familiar and growing phenomenon across the wealthy  world—institutional investors are as involved in  

residential real estate as ever—but the extent of  the issue in China was on another level. In 2018,  

a full 87% of homebuyers already had another  residence indicating that, in a lot of cases,  

they were buying almost solely as an investment. From the perspective of the central government,  

this presented two issues. The first was the  obvious: skyrocketing prices made it increasingly  

difficult for everyone but the country’s rich  to find a place to live which, as anywhere,  

has downstream effects in contracting labor supply  even where it’s in high demand. But the second  

issue was more the more pressing one: the rapid  expansion and vacancy rates demonstrated that  

the sales prices of property were stretching  far beyond their intrinsic value. The prices  

weren’t supported by the actual utility of the  housing itself, and they weren’t even supported  

by constrained supply: rather, they were almost  fully supported by the belief that prices would  

only continue to rise further. That’s to say:  the housing market had formed into a bubble. So,  

to avoid letting it burst on its own, the  only question was when and how to pop it. 

The answer was August, 2020. Then, the central  government rolled out three red lines: three  

rules the property development sector would have  to follow or else face severe growth restrictions.  

Each was about reining in financial risk: first,  developers couldn’t have more in liabilities than  

70% of the value of the assets the company itself  owns. Second, developers couldn’t owe more in debt  

than the totality of what the company itself is  worth in equity. And third, developers couldn’t  

owe more in short-term debt than what it has in  cash at a given moment. Even if a developer did  

not violate any of the red lines, they’d be  capped at 15% year over year growth in debt;  

while if they violated one, the cap would be 10%;  two, 5%; and if they violated all three red lines,  

they couldn’t grow their debt obligations at all. But these three red lines were far from a  

theoretical threat: Evergrande, after all,  had a debt to liability ratio of 81% and a  

cash to short term debt ratio of 67%—they  were over-leveraged and short on cash,  

meaning they violated two red lines. And  their net debt to equity ratio was 99.8%,  

just a hair’s breadth from the third red line. And thus, their cycle started to break. Evergrande  

had millions upon millions of apartments already  sold to buyers, yet not completed. To pay builders  

and suppliers and others to complete these  projects, they had to borrow more, yet faced with  

new restrictions due to their violation of the two  red lines, they just simply couldn’t. So, their  

cash reserves dwindled, their existing obligations  remained the same, yet they had little ability  

to reverse course by launching new projects. And even if they could, the market had changed.  

China was both the first and last major economy  with significant COVID restrictions. As much  

of the rest of the world regained a sense  of normality, China elected to vaccinate  

its population with generally less effective,  domestic-made traditional vaccines, as opposed  

to the more effective, novel mRNA-based jabs used  elsewhere. So to quell the various outbreaks that  

still arose after widespread vaccination,  the country maintained far stricter COVID  

policies than the rest of the world. Overall  economic productivity declined and therefore  

the entire economy, and each individuals’  finances, took a disproportionate hit. 

Simultaneously, the country’s migrant worker  class reversed course. Individuals who had  

previously moved from their rural hometowns to  cities, seeking brighter economic prospects,  

returned home—during the pandemic, for the  first time in recent history, the quantity  

of migrant workers in cities declined. While  this was accelerated by lower demand for labor  

in cities during the pandemic, many also pointed  to the high costs of housing as why the higher  

salaries in cities were no longer worth it. And finally, decades of demographic change  

were catching up with the nation. The  steady decades-long decline in birth  

rates meant those in China’s notably young core  home-buying age—centered at 29 years old—were  

beginning to represent a smaller and smaller  fraction of the overall population. Even if  

the overall population stayed steady,  for the moment at least, the proportion  

likely to buy a home had begun to shrink. So Evergrande not only was prevented from  

taking on debt, it also was starting to struggle  to generate money through additional sales of new  

projects. The two key money-generating stages  in the cycle just were not working like they  

used to. But they still had debt to pay off and  apartments to finish so, backed into a corner,  

the company started rummaging for cash. Rather inexplicably, in 2018 it had established  

an electric vehicle manufacturing division that  itself, perhaps even more inexplicably, included a  

major senior care division, but in 2021 it courted  Xiaomi to see if they would buy a majority stake.  

Talks eventually stalled and no sale was made. It  also reportedly courted buyers for its stake in  

the championship-winning Guangzhou FC soccer  club, but considering Evergrande was losing  

hundreds of millions of dollars a year through  that ownership, it also failed to sell. It was  

able to sell off its 18% stake in an entertainment  joint-venture with Tencent for $273 million, but  

this was ultimately a drop in the bucket compared  to what the company needed to right the ship. 

So ultimately, the death spiral began on  Monday, December 6th, 2021, not with a bang,  

and not even with a whimper, but rather with  just simply nothing. That day marked the end  

of a grace-period for already late payments on a  set of bonds, but it came and went without payment  

or even an explanation of when payment might  come. Then Tuesday passed with nothing more,  

and Wednesday, and by Thursday—with investors  still unpaid—Fitch Ratings, one of the world’s big  

three credit rating agencies, declared Evergrande  in default. This was effectively the official,  

although largely ceremonial signal to the  financial world that they should not lend money  

to Evergrande because they might not get it back. As a property developer—a business model almost  

entirely centered around debt—default is pretty  close to the end of the line. Even if the company  

could get loans, they’d be at such a high interest  rate, to offset the risk to the lender, that the  

effective cost of property development would be  uncompetitive relative to the market. In fact,  

Evergrande did have an easier time than the  average company in such a dire situation  

finding lenders since many believed the company  was too big to fail—such an instrumental part  

of the Chinese Economy that the CCP would  bail it out to avoid an economic crisis. 

But that bail out never came. After a year  or two sputtering along—restructuring debt,  

shedding off assets, cost cutting—in January,  2024, a court in Hong Kong determined that it  

was just simply impossible. Evergrande could  not be saved, the cycle could not be restarted,  

and the only option was to strip it for parts  and make creditors as whole as possible. 

But the crux of China’s challenge is that this  isn’t just an Evergrande issue. While it was  

the largest, most dramatic example highlighted  in international media, the forces that slayed  

the giant are putting pressure on almost every  single Chinese property developer. Country Garden,  

another giant, appears just months behind  Evergrande and after years on life support  

is teetering towards liquidation. Dozens of  other developers are in default and over a  

hundred billion dollars of debt payments from the  Chinese property sector have failed to get paid. 

There are quite a number of forces putting  pressure on the Chinese economy—their demographic  

shift, their deindustrialization, their increasing  insularity—but the way the property sector has  

weaved itself so integrally through the nation  means it serves to magnify every single one of  

those issues. At base, the fact that the sector  accounts for an outsized portion of its gross  

domestic product means it simultaneously can  account for an outsized drag on gross domestic  

product. But it also has a propensity for  negatively impacting the demographic of people  

most central to China’s economy. Stock market  crashes, for example, have an impact on all,  

but impact those who have a higher portion  of their income in the stock market most,  

which tends to be wealthier individuals and  institutions. The Chinese property sector,  

however, is a key source of savings and investment  for the nation’s middle class. This demographic is  

the one most likely to have an outsized portion  of their net worth tied up in a single Evergrande  

apartment that might now never exist. Money has  just simply disappeared and there’s a gaping  

hole in the middle of the Chinese economy. The Chinese property sector was always going  

to collapse. Its highly-leveraged debt-fueled  foundation was never strong enough to support  

itself in anything but the most gangbusters  periods of growth. It was fundamentally flawed  

from the get-go, so some sort of crisis always  had to happen. So what’s happening in the Chinese  

economy is essentially a controlled demolition.  But this does represent a uniquely tenuous  

position for the central government. The Chinese  social contract—unsaid, but always understood—is  

that individuals sacrifice personal liberty in  exchange for common economic prosperity. While  

dissent of course appears since nobody truly  gets a choice whether to make that trade off,  

a huge portion of the population wholeheartedly  believes in this social contract. After all,  

it’s hard to argue with the means when the end  is 800 million lifted out of poverty. But that’s  

now history. If Xi Jinping can’t deliver his  end of the bargain, if the common economic  

property wanes, then the question in everyone’s  minds is why they should have to deliver theirs. 

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