As China teeters on the edge of a balance sheet recession, it’s clear Australia can no longer rely on its largest trading partner to pull it out of trouble. By Mike Seccombe.

‘It’s breaking down’: Can China contain its economic crisis?

Skyscrapers under an overcast sky. In the foreground, a man wearing a mask and holding an umbrella.
Rain clouds hover over Beijing’s CBD.
Credit: Reuters / Thomas Peter

For decades past, whenever Australia has looked to be stuck in the economic mud, China has been the tractor that pulled us out.

When the global financial crisis threw much of the world into recession 15 years ago, Australia escaped. Much credit goes to the then government, to then treasurer Wayne Swan and treasury secretary Ken Henry, for responding with a big stimulus package that kept the economy ticking over. Much credit also goes to China.

When the crisis struck, China suffered a brief, sharp shock before embarking, in late 2008, on a package of spending measures that dwarfed that of Australia and every other nation. According to the OECD, the Chinese government threw the equivalent of US$590 billion, or 12.5 per cent of GDP, into stimulating its economy – three times as much as the United States.

While other big economies floundered, China’s grew by 8.7 per cent in 2009 and 10.4 per cent in 2010. China built things – railroads, airports, residential and commercial property – and built them with Australian commodities. The resources boom here was enormous. China helped save us from economic collapse.

Now, with Australia, like much of the world, again skating the edge of recession, it would be nice to think that could happen once more. Yet it is unlikely the Chinese tractor will do it this time.

Massive economic stimulus like we saw during the GFC is not going to happen. In the face of this crisis, China cannot just build things, because it is saddled with enormous costs, economic and social, incurred as a result of all the stuff it has already built. Consequently, Australia can’t hope for a resources boom. Indeed, policymakers now see China as the biggest threat to the global recovery. China is in deep trouble, rapidly getting deeper, and its problems are quite different from those facing Australia and much of the world. Elsewhere, the main economic problem is inflation. In China it is deflation. A different disease, manifesting different symptoms.

In Australia, economic policymakers worry – rightly or not – that the labour market is too strong. In China, the labour market is tanking. Youth unemployment hit a record 21.3 per cent in June and last week China’s National Bureau of Statistics (NBS) announced it would no longer release data on the number of jobless young people.

That response speaks not just to the tendency of command economies to hide that which they cannot address, but also China’s deep fear of the potential challenge to the existing order from disaffected young people.

Here, interest rates have been sharply raised to try to cut consumption. In China, consumers are not spending.

This week, the loan prime rate in China was trimmed from 3.55 per cent to 3.45 per cent. Some economists see risks in cutting further – capital flight as money chases higher rates elsewhere.

In Australia, governments struggle to increase the supply of housing, in large part due to strong population growth. By contrast, China’s population is shrinking. NBS figures released in January showed the country’s total population fell some 850,000 in 2022 – although the working age population had been falling for some years prior. The demographic decline will only accelerate in coming years.

The number of marriages in China has halved in less than a decade. Last week, new data from China’s Population and Development Research Centre showed the country’s fertility rate had slumped to 1.09 in 2022, barely half the replacement rate of 2.1.

Furthermore, the mass migration of the past several decades from rural areas to cities has dropped off.

Fewer people need fewer homes, yet China has kept on building them. By some estimates, there are now 60 million to 80 million empty apartments in the country.

With an oversupply of new dwellings, the price of existing homes is also falling – down as much as 14 per cent in the past two years, according to some surveys.

In Australia, rents are soaring. In China they are falling. Landlords are getting returns of 1.5 per cent or less, way below their costs of borrowing.

The litany of China’s economic woes goes on and on. Demand for its exports has declined sharply over the past few months. Their value was down 14.5 per cent in July, compared with a year earlier, all the more troubling when you consider that a year ago China was still in its protracted Covid lockdown.

The trade war with the United States played a big part: Chinese exports to the US were down 25 per cent. Imports also are down, due to lack of demand. Foreign direct investment was down 87 per cent in the three months to June, year on year.

According to Louise McGrath, head of industry development and policy with the Australian Industry Group, it is not just the current economic problems that are causing investors to rethink China. It is also the erratic and increasingly unfriendly approach of the Chinese leadership. “Our members are very cautious now,” she says. “The action against Australian exports to China really shook a lot of our members…

“Then with Covid [lockdowns and travel bans] it really made a lot of our members rethink their exposure to China as a significant supplier.”

Another factor is the general suspicion of foreigners within China.

“A member of my team has just come back from China. Everywhere, she was just constantly observed, you know, needing to show a passport to go in anywhere. Everything was constantly double-checked, you know, extra photos were taken at every airport … This monitoring, it’s everywhere now. She couldn’t use her Australian-issued credit card anywhere but at her hotel.”

China, McGrath says, seems to be progressively “cutting itself off [from] global financial instruments. It’s like Myanmar or Syria or something. I’ve been to both.”

McGrath says China used to be the most efficient and reliable of suppliers. The country made a conscious decision to supply the world and make it easy. That has changed. Increasingly, her members are looking to Vietnam as a more reliable alternative.

The heart of China’s problem, however, is the ailing property sector, built on a model that has elements of a Ponzi scheme.

“The way it works,” says Richard McGregor, senior fellow for East Asia at the Lowy Institute, “is I say, ‘I will build a building, I sell all the apartments ahead of time, then I use the money I got from the sales to borrow more to build the next building.’ It just goes round and round.”

Until it stops. Then buyers are left owning dwellings that don’t exist or are worth far less than they paid, and developers are left with properties they can’t sell and debt they can’t service.

Last week, Evergrande, the world’s most indebted property developer, with borrowings of more than US$300 billion, filed for bankruptcy in the United States, having posted cumulative losses for 2021 and 2022 of US$81 billion.

Another giant property developer, Country Garden, could be heading the same way. Like Evergrande before it, it has begun missing repayments. It can’t raise more money. Workers are going unpaid, construction sites sit idle. Its bonds are trading at 10 cents in the dollar.

Two years ago, Yang Huiyan, the company’s biggest shareholder, was reckoned to be Asia’s richest woman. According to Bloomberg’s billionaires index, she has since become the world’s biggest loser, having seen her personal fortune fall by 84 per cent, or US$28.6 billion.

All over China, other developers are experiencing similar crises.

“The old model of ‘build it and they will come’ doesn’t work anymore,” says McGregor.

It’s not only the property sector that is in trouble, either. It’s much broader than that.

“When they think of China, people think of it as an export-led economy, when actually the biggest component of Chinese GDP growth is investment – new residential and commercial property, airports, freeways, rail, train stations, et cetera,” McGregor says.

Over time, the economic return from that investment has declined, but the debt on it has continued to grow – affecting not just developers but also households and government.

“Local governments, which provide health services, education services and the like, are laden down with massive amounts of debt,” McGregor says.

He cites a term coined by economist Richard Koo more than a decade ago to describe Japan’s decades of stunted economic growth, which economists are increasingly attaching to China’s predicament: a “balance sheet recession”. An alternative term is “Japanification”.

Koo’s term describes a situation in which households and businesses divert more of their income towards paying down debt, rather than consuming or investing. Like China now, Japan in the late 1980s was an investment economy whose GDP was growing rapidly, until the bubble burst.

Says McGregor: “The issue is, is it just going to be a recession? Or is the model irretrievably broken and are they moving into a period of lengthy stagnation?”

It’s a hot topic of debate among economists. Last month, in The New York Times, Paul Krugman set out the parallels between Japan in the 1980s and China now: “a wildly unbalanced economy, with too little consumer demand, kept afloat only by a hypertrophied real estate sector”.

He noted Japan was a richer and more developed economy when the bubble burst. It got rich before it got old. He predicted China “will do worse” in part because of its declining working-age population.

Others take a different view. James Laurenceson, director of the Australia–China Relations Institute at the University of Technology Sydney, see great potential for China to keep growing.

“If you look at the people exiting the Chinese labour force, many of them never even got to middle school, whereas the new entrants to the labour force are tertiary educated,” he says. “So the quality of the human capital in China’s labour force is still increasing, even if the number of real bodies is declining.”

There remains scope, he says, to change the retirement age, to increase women’s workforce participation and to improve productivity. “China leads global demand for robots and so on. And demographics is a slow-moving train.”

He remains pessimistic, nonetheless, “because I’m not seeing Beijing putting in place the positive, the policy framework, it needs to unlock that growth potential”.

In particular he laments the fact that the central government is not moving to shift to an economy based more on consumption. “At some point, they need to realise that supply can’t indefinitely race ahead of demand.”

If there is to be a solution to China’s crisis, Laurenceson says, it will not be through an old-style stimulus package. “There’s been no GFC-style stimulus rolled out and I think that Beijing is of the view that it just can’t afford that approach again, because of existing debt levels.”

McGregor agrees: they can’t build their way out of this. “And they can’t export their way out.”

The central government could do as many other countries do in times of economic crisis and instead put money in the hands of householders, so they might spend their way out. The trouble is, McGregor says, the current Chinese regime under Xi Jinping thinks “consumerism is a form of welfare, and the Communist Party has this idea that welfare is the kind of poison in Western societies and it’s making them weak”.

Despite the Chinese government’s policy failures, though, he sees big strengths.

“Parts of the Chinese economy remain fantastically competitive. They dominate the world in batteries, solar panels, the stuff that goes into solar panels. In the last year, China has become the world’s biggest car exporter. And it’s just unbelievable what they’ve done with EVs. Australian roads are going to be full of Chinese EVs.”

As to what China’s economic trouble means for Australia – the likelihood is we’re going to be selling them less iron ore in future.

This week BHP reported a 37 per cent slump in full-year underlying profit to US$13.4 billion ($20.9 billion). Revenue was down by US$11.3 billion, largely as a result of falling iron ore and metallurgical coal prices.

It was still a very healthy result but, says Paul Bloxham, chief economist for Australia, New Zealand and global commodities at HSBC, “the weaker property sector is going to weigh on demand for things like iron ore, which is our single largest export”.

Bloxham says property and infrastructure profits will not be as strong in the future. Instead, Australia’s resources future will involve greater investment in critical minerals, in lithium, copper, nickel, “the whole supply chain for production of things that go into the renewable story”.

Laurenceson sees other impacts on Australia in the near term from China’s crisis. Tourism, for example, will likely decline, “because travel is obviously a discretionary item”.

The bottom line for this country is that we will have to find our own way out of the current economic mire. China is not going to help.

For the Chinese government, the situation is even more tenuous, not just economically but in terms of social cohesion.

If a quarter of the country’s young people come out of education and onto the unemployment lines, if they cannot afford to marry or have babies, what will happen?

McGrath says the “economic deal they made with the people seems to be breaking down”.

The promise of a brighter economic future was what made “all the surveillance and the restrictive sort of internet practices and all that kind of stuff tolerable. But if the people don’t get that economic deal, then where does that leave them?”

This article was first published in the print edition of The Saturday Paper on August 26, 2023 as "‘It’s breaking down’: Can China contain its economic crisis?".

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