China's housing boom is turning to bust — again — and it isn't clear how far it will fall this time. Nor is it clear how much we should worry about it. China's economy is big enough for everyone to feel it if it falters — it's surpassed the U.S. as the world's biggest trading country — but the good news is that the rest of the world isn't exposed to its housing market like they were to ours.
Now, as I've pointed out before, you probably think of manufacturing when you think of China, but that's out of date. The financial crisis reduced foreign demand for Chinese exports at the same time that slower urbanization — and with it, higher wages — has hurt export sales. So China has changed its growth model. Since its credit-fueled stimulus in 2009, China has gotten rich not by selling things to rich countries, but by building the things it needs to be rich. In other words, by rebuilding its cities.
There are three things you need to know about China's housing boom:
First, it's been enormous, and enormously expensive. As Simon Rabinovitch of the Financial Times points out, property investment directly makes up about 20 percent of Chinese GDP today. But the government hasn't been the one putting up the money for all this. So-called "shadow banks" — that is, unregulated lenders — have. Overall credit has grown from about 120 percent to 190 percent of GDP in just the past five years. As a point of comparison, U.S. credit "only" went up 40 percentage points of GDP in the five years before our bubble burst.
Second, China really does need all these new buildings, but its people can't always afford to actually live in them. That's why there are "ghost cities" in its less-developed interior: Local incomes can't support rents or down payments for these sleeker digs. Instead, wealthy Chinese are buying up multiple properties as investments, while simultaneously investing in the shadow banks that finance this property-building to begin with.
If this sounds dangerously circular to you, you're not alone. Because, third, the central government has been worried about a housing bubble for years now — and it's been taking steps to cool the market. There's always been a tension between building enough to keep GDP growing and keeping prices from growing so much that people can't afford them. Twice, in 2008 and late 2011, the government clamped down on lending to try to cool down the market.
And as you can see in the chart below from Tom Orlik of Bloomberg, it worked: Prices actually started falling a little in the big tier-one cities. Of course, it wasn't long before growth slowed so much that the government took its foot off the brakes and let the housing market go boom again.
This time, though, might be different. Now, it's true that China's central bank has engineered, or at least allowed, three credit crunches in the past year to purge some of the rottenness out of its rotten shadow banks — including one trust called, perfectly enough, "Credit Equals Gold #1," which needed a $469 million bailout.
But the government isn't trying to tighten lending standards like it has in the past — and prices and building are falling regardless. Home sales fell 7.8 percent in renminbi terms in the first four months of 2014 from a year earlier. And, as you can see in the chart from Matt Phillips of Quartz, property starts and overall property investment are falling fast — maybe into negative territory.
The problem, according to a top developer, is that the law of supply and demand is finally getting its revenge. China has built too much, and now prices and construction will have to come down. (The government, of course, could decide to throw more stimulus at the economy, in either infrastructure spending or bank reserve ratio cuts. If things get bad enough, it probably will, but not enough to keep growth from continuing its descent from double digits a few years ago to 5 or 6 or 7 percent a few years from now.)
An impending housing slump is bad news for the shadow banks that lent money to builders. It's bad news for the state-owned banks that, despite what they may say now, sponsored the shadow ones. And bad news for local governments that rely on land sales for revenue.
Now, as dangerous as it is to say "this shouldn't cause a financial crisis," it really shouldn't. China's government owns so many of its banks and big companies that it would almost certainly bail out whichever ones need to be bailed out. Combined with local government bailouts, and lower tax receipts in general, that would be a big fiscal hit for China. But it shouldn't be the end of the world as we know it. We might not feel fine, but we should be okay: The IMF estimates that a 1 percent decline in Chinese real estate investment would reduce global GDP by about 0.05 percent.
Well, most of us should feel fine. But outside of China, there are two groups that might not. The first are countries that have been busy feeding China's heretofore insatiable demand for raw materials. And the second is Europe. See, China's government is so reluctant to try more stimulus that it might prefer to devalue its currency instead. The yuan has already fallen 3.3 percent against the euro in 2014, and any more would only export more disinflation to Europe — the last place that needs it.
Hopefully, the rest of the world won't catch a cold when China sneezes — and it will only be a sneeze.