Just How Bad Is the Economy Getting in China?

Tracy Alloway (0:09)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.

Joe Weisenthal (0:14)

And I'm Joe Weisenthal.

Tracy Alloway (0:16)

Joe, what is going on in China right now?

Joe Weisenthal (0:18)

That is a good question, and it's a question we actually haven't been talking about enough.

Lots of focus on energy, lots of focus on Europe, back road, the Fed, recession. But my understanding is that things aren't great in China either.

Tracy Alloway (0:32)

I feel like in a normal year where everyone wasn't distracted by domestic US inflation and the question of whether or not interest rate hikes are going to spark a recession, I feel like China would be taking center stage with everything that's going on. But it feels like it's sort of been tangential. You hear a little bit about what's going on, but people aren't really focused on it.

Joe Weisenthal (0:56)

Well, I would say it feels contained in a way. So obviously one of the big stories is the country's ongoing commitment to Covid Zero, which obviously has a negative impact just on sort of economic activity, sort of measured broadly. But then there are other things happening.

The real estate sector seems very troubled with more and more people basically refusing to pay mortgages on houses that have yet to be completed. I know that's a big story. There's a big drought happening, a really intense heat wave, so they're having their own weather climate stress. But yeah, I still don't totally get how it all fits together.

Tracy Alloway (1:32)

Right, I feel like people have been warning of a Chinese property bust for so long and it hasn't happened that we've all sort of become inured to the idea that it could actually happen and maybe we're seeing the beginnings of it, but again, maybe we're not because China is very good at coming in and rescuing particular sectors when it needs to.

Joe Weisenthal (1:54)

That's the key thing. And of course we've talked about, say, Evergrande a few times on the show. So there are these busts that happen and there are all these troubles, but it always seems like in the past that the government has been able to use its balance sheet to prevent some wholesale collapse.

Tracy Alloway (2:11)

Yeah, but now of course we know that Xi Jinping is on a mission to pop a lot of bubbles in the Chinese economy to crack down on certain sectors that he thinks are not economic or efficient. And so maybe it's different this time, but maybe it isn't.

Joe Weisenthal (2:28)

So let's see, let's find out.

Tracy Alloway (2:29)

I have to say, we really do have the perfect guest to discuss this. We are going to be speaking with Tom Orlik. He's the chief economist at Bloomberg Economics. He is also the author of China, The Bubble That Never Pops. So we get to ask him if it is going to pop this time. There is a second edition of the book coming out in September. So it really is a great time to catch up with him. Tom, thanks for coming back on Odd Lots.

Tom Orlik (2:53)

Great to be here. Thanks for having me Tracy, Joe.

Tracy Alloway (2:56)

So maybe just to set the scene, let's start with the big question, which is, I think most people at this point know that China's economy is heavily, heavily reliant on real estate and property. Something like 30% of total GDP is accounted for by real estate.

How did that come to be? Why is China's economy so leveraged to this one particular sector?

Tom Orlik (3:20)

That's a really good question, Tracy. And there's a bunch of factors at work. So the first thing to think about is the strength of fundamental demand. So remember that in the 1980s and early 1990s, China did not have a private property market. If you lived in a city, you almost certainly lived in a dilapidated government apartment or dingy house.

And so when the private market sprang into life in the late 1990s, there was enormous pent up demand for real estate.

Adding to that, China's households have enjoyed decades of strongly rising incomes. And of course, when your income rises, one of the first things you want to do is buy somewhere nice to live.

And China has had an urbanization boom with hundreds of millions of people moving from the countryside to the cities. So the first reason why real estate has been so important in driving China's growth is just that there's been enormous demand for real estate. The second contributing factor is that speculators got in on the game. China's investors don't have brilliant options. There isn't much of a kind of retail financial market. There aren't a lot of money market funds and things like that you can park your cash in. If you put your money in a bank deposit, very often the interest rate is below the level of inflation. So you're essentially losing money. If you put your money in the stock market, it's a roller coaster. So a lot of investment funds went into real estate and that speculative demand added substantially to the fundamental demand. By some estimates, as much as 30% of property in China is sold to speculators who hold it empty, hoping for capital gains. So those factors together drove China's real estate boom and pushed its contribution to GDP, taking account of all the construction activity, all of the impact on steel and concrete and home electronics and furniture and a car to put in the garage, up to that 30% number which Tracy mentioned.