America Risks an ‘Evergrande Moment’
Like China, most of the developed nations have relied too much on property to fuel growth.
By Joseph C. Sternberg
Sept. 23, 2021 1:29 pm ET
China Evergrande Group in Shanghai, Sept. 22.
PHOTO: ALY SONG/REUTERS
Global investors suffered a bad moment earlier this week when they belatedly started to worry the financial fiasco engulfing Chinese property developer Evergrande Group might spread beyond the country’s borders. After a one-day drop in the Dow Jones Industrial Average, they got over their unease—but only because most observers view this situation entirely the wrong way.
The question is not whether an exploding debt bomb at a Chinese company will spread financial shrapnel abroad. It won’t. The explosion would detonate within the concrete bunker of China’s closed financial system, which will dampen if not entirely mute any shock waves. The better question is whether similar explosives lie ticking in other developed economies. The answer is that there’s probably some version of Evergrande in most of them. China’s dysfunctions are not as unique as outsiders want to believe.
Most folks already seem to be forgetting that from Beijing’s perspective, Evergrande’s potential implosion is as much a solution as a problem. There’s a reason the Chinese government was willing to set in motion such a predictable series of events by cracking down on property-related debt. The problem Beijing needs to solve, stated in its simplest form, is this: An aging and potentially shrinking population finds itself fantastically overreliant on property-linked borrowing to fuel current economic growth, and on the underlying property as a store of savings from which to finance the middle class’s needs in its impending retirement.
Endless complications arise from that basic dynamic. The most interesting is that chronic redirection of the economy’s savings into property “investment” saps productivity growth over time because real estate is a less productive asset than a factory or an research-and-development lab.
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But since the middle class especially relies on this asset to provide for its future financial needs, policy makers feel compelled to make up somehow for the low productivity that otherwise might restrain appreciation of the capital investment. The traditional response is some combination of credit subsidies for home buyers to goose demand (in China and elsewhere) and artificial constraints on new supply (in many parts of the world, although not so much in China).
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This unbounded price appreciation eventually blossoms into a social problem as new buyers are priced out of the market—not least because their parents wasted their savings investing in housing stock rather than on economic activities that otherwise would have boosted productivity and wages. Meanwhile, because of the mismatch between property’s relatively muted productivity and the rising property prices on which middle-class savers have come to rely, governments face constant pressure to find new mechanisms to sustain high prices. This often means encouragement of ballooning debt levels.
At this point one might ask whether the preceding paragraphs describe China or the U.S. or the U.K. or Canada or Japan or Denmark or take your pick of any other developed country. They all have come to rely in one form or another on property to fuel the economic engine, with all the monetary and policy supports—and credit risks—that entails. The uncomfortable truth is that despite manifold local differences, many modern economies are alike in this important regard.
Evergrande is in extremis because Beijing is trying to jump off this merry-go-round. The Communist Party regime under Xi Jinping has endeavored for at least a year to curb China’s property market as part of a program to break the feedback loop between rising property prices, falling productivity, lagging economic growth and social instability.
Most elements of Mr. Xi’s proposed solutions to these problems are poorly conceived. His renewed emphasis on large state-owned enterprises as vehicles for economic growth will not enhance productivity and serves a political purpose more than an economic one.
Nor is it obvious that the chaotic unwinding of one of the country’s largest companies is a helpful way to pop a property bubble. Especially since Chinese households are likely to pay one way or another, either directly via taxation for a government bailout or indirectly via artificially low returns on their savings to subsidize the state-owned financial institutions that get tasked with absorbing Evergrande debt.
But China finds itself grappling with a problem—how to wean itself off property permanently—that may confront many other economies sooner or later. Market economies will have some advantages, including well-developed financial markets that offer households alternative means of saving. But don’t imagine it will be a pain-free process, if and when it happens.
This week saw speculation as to whether Evergrande’s implosion might trigger a “Lehman moment” for China, i.e., a financial-market implosion. It would be better to watch out instead for America’s “Evergrande moment”—that point at which a generations-long property boom no longer looks quite so sustainable.