Xi Jinping’s New Political Economy: Part 2

Source: Author’s calculation based on data published on the website of the National Bureau of Statistics of China.

Homebuyers - often middle-class investors buying multiple units - kept their blind belief that prices could only go up, and simply began borrowing instead of using their own savings for deposits towards purchases. In March 2021, loans to individuals, largely driven by real estate, increased by 12.6% YoY. The strict credit rules for real estate lending, promulgated in December 2020 by the PBOC, had clearly very little effect on the housing bubble.

It is therefore clear that the government has had to choose between ineffectiveness leading to even higher future risks from a debt bubble, or teaching a lesson that may backfire, create snowballing defaults and a deflationary cycle. This is exactly where things stand in September 2021. 

The breakage is already very large. Since October 2020, Alibaba alone has lost 378 billion USD of capitalization, and the lesser known Tencent has lost 308 billions. As mentioned before, China’s private tutoring sector was worth 120 billion USD. Xi’s rhetorics cost the five largest international luxury companies 67 billion USD of stock value in 48 hours. By comparison, the 27 billion USD loss within two weeks for international investors in Didi Chuxing’s IPO appears to be pocket change. Whatever happens to Evergrande, an outright bankruptcy or a restructuring with a huge "haircut" on promissory notes and debts, the 300 billion plus pile of debt of the company will impact three categories of creditors: the home buyers who plucked down their money in advance, said to be currently 1.2 million households, the Chinese investors who bought stock offered for sale by the company and by its officers, including in the months before the crash, and the international owners of VIE shares listed in the Cayman island or Hong Kong.

Even more importantly, it is the psychology of domestic investors and consumers alike that is impacted. Perhaps this is precisely the end that was sought. There has been enough assault on the interests of the urban upper middle classes as to warrant that assumption. Like learning English with the help of private tutoring or preparing for university entrance, or traveling abroad, buying real estate as a hedge for retirement extends beyond these upper middle classes. In 2020, only 0.53% of private employees had any corporate retirement plan beyond the basic national pension system. 

The requirements for capital bail-out in the form of ensuring continued interest payment or restructuring are therefore growing day by day, as other real estate companies and their suppliers are likely to fall under, and as consumers grow ever more cautious. The small resumption of delta variant Covid cases and the sledgehammer approach to their eradication is not helping China’s stock market either. This had seen increased transaction volumes in the summer as domestic investors began shifting their money away from real estate. It is now down as defiance is taking over. 

As of now, none of the above portends a broader financial crisis, as the government holds many levers over the market. But the balance between teaching a hard lesson and risking a crash is getting more delicate, as the amounts necessary to restructure debts and preserve at least a modicum of the financial assets of real estate companies and builders is growing quickly. 

In this dark perspective, there is a persistently shining light: China’s exports. The bonanza that the Covid pandemic started - with other Asian producers partly inacapacitated, and exports slots that match global demand - has kept on giving throughout August 2021.

China’s Import and Export, Two-YoY, 2015-2021

Source: Statistics published on the website of the National Bureau of Statistics of China

Future gains can be guessed from the following example: since August 2019, China’s auto parts exports (which do include batteries) have been multiplied by nine as of August 2021.

It is evident that Xi Jinping and the financial authorities chose to break with the domestic debt spiral, a large part of which is associated with the real estate bubble. Given the Chinese connected entrepreneurs’ and individual investors’ taste for speculation, their belief in implicit guarantees for businesses that have delivered over the years, a hard lesson is being taught. It chimes with other publicized measures against some of China’s billionaire class, as well as the sudden limits placed on the lifestyle of the upper middle class. In China, the joke goes: you never own a share, you merely take care of it for the Party-state…

All of this has international implications, including for foreign investors. Depending on the source, we find that foreign holdings of domestic bonds, whether public or private, have kept increasing, or on the contrary that the acquisitions have begun to slow down over this summer. Much short term investment advice will be to forget about present losses and to focus on the sectors that the Party-state now prioritizes. But these - whether IT hardware or biotech - have very high price-earnings (P/E) ratios. And the lesson being taught is also about uncertainty, not only about heeding government orders. To this day, China has seen increased capital flows from abroad, regardless of the so-called "trade war" or of Western tech purchase restrictions on Chinese companies. Will this hold true for much longer?

In the short term, there is a benefit to the international economies that do not have a large energy or material export component. A large dip, if not a crash, in China’s housing sector should evidently end China’s thirst and dampen prices for these commodities. It also benefits CO₂ emissions - whether this was one of the intended targets or not. 

Several trends should give us food for thought: the priority given to the "stability" of the financial system over GDP growth, the narrative about national security, the move towards ever higher self-sufficiency while exports are being strongly promoted, the shift from a more cosmopolitan middle class towards populist policies.

Not only has regime security been reconfirmed by Xi’s new political economy, but economic and societal decoupling is bound to accelerate from its various components and from the ideology that underlies it.

Copyright: AFP