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Japanification of China

Ichiro Suzuki

By the summer of 2023, it has become almost public knowledge that China’s economy is in trouble, mired in a ‘balance sheet recession’. Growth rates of the People’s Republic has been failing to meet market expectations and inflation has evaporated. Stories of real estate developers’ woes no longer surprise anyone. The People’s Bank of China keeps interest rates low at a time when central banks around the world are tightening their monetary policy. (Even the Bank of Japan has recently allowed the country’s long-term interest rates to rise, albeit by tiny 10 basis points or 0.1%.) The renminbi is under pressure and the authority is pressing Chinese banks not to sell the currency. On top of it, China’s working age population has peaked out by the middle of the last decade and the peak of overall population is approaching.

From one perspective, the authority has been successful in containment of what could erupt as a crisis. No banks and shadow banks are going under, at least not yet. Even China Evergrande is still traded as a public company even if its share price is as close to anything as zero. This can be a proof that China is containing adverse effects of the a bubble’s bust better than Japan did three decades ago. So far, so good.

Absence of a visible crisis, however, does not mean that everything is fine. Quite contrary, it can prolong a period of a crisis without a heightened drama. If a stock market is any indication, China’s unprecedented boom peaked in the final quarter of 2007, ten months ahead of the Olympics in Beijing, with the apex of the Shanghai Composite Index. Today the Shanghai market is trading about half of what what it once was. Sixteen years later, the Communist Party is yet to embark on genuine restructuring of the Chinese economy that is today plagued with weights of excessive debts and non performing loans (NPLs) in the banking sector.

Japan was notoriously slow in tackling the aftermath of the bubble’s bust after years of denial or half-hearted recognition of the problem. Nonetheless, aggressive efforts to recapitalize the feeble banking system got under way at last in 2003, fourteen years after the height of the Nikkei Index at the Tokyo Stock Exchange. Prime Minister Junichiro Koizumi called for a drastic policy to bring the economy out of doldrums even if a radical policy meant dismantling of his own party, which was tied to vested interests. PM Koizumi’s right hand man Professor Heizo Takenaka ruthlessly executed a variety of policies that included recapitalizing the fragile banking system, as well as privatizing the postal system.

The CCP has not reached the point of sincerely admitting the problem of the over-priced real estate market and the financial system that is so acutely exposed to the inflated house and office markets. The real estate market probably reached its peak at around the time of the stock market’s peak in 2007, and the CCP made every effort to keep it artificially high for fear of devastatingly negative effects of fallen real estate prices.

Banking crises in the developed world routinely cost 20-25% of GDP on a cumulative basis by the time they were over entirely. Japan was no exception and probably hit the high end of the cost range due to a prolonged period before the government made up its mind. The longer the period, the greater the cost becomes, because weak performances of the economy keep generating new NPLs. China would not escape this fate. While the country has racked up huge write-downs of NPLs by now. It keeps going on until the real estate market sees its bottom and the banking system is recapitalized with tax-payers money.

The CCP hopes to revitalize the Chinese economy by promoting private sector consumption, which has been suppressed at the expense of public sector investments/ infrastructure projects. It sounds a sensible policy move. The problem is, however, China’s household sector is already burdened with a fair amount of debt. China’s household sector debt-to-GDP ratio is already up at 63% at the end of 2022. This is lower than the U.S.’s 65% but China is still a middle income country. Households in the U.S. and the rest of the developed world accumulated debt on their way to higher income, but Chinese households have already leveraged up to get to where they are. Chinese households are already carrying not so insignificant amount of debt because of inflated house prices, finding it hard to stretch their balance sheets further. Those who don’t own a house yet are in no position to spend freely if they plan to buy a house in the future. They cant’t expect their income to grow rapidly, in a way it once did, in an economy that has lost its luster. They might want to see materially more affordable house prices. Lower house prices, however, would damage the balance sheets of those already own a house and mortgage. Their liabilities’ size remains unchanged in the face of fallen house prices, thus damaging their equity position. This is how the Japanese household sector receded into a spending strike in the 1990s, pushing the economy into rolling recessions.

In the corporate sector, presence of state-owned enterprises (SOEs) is growing. Among private corporations, entrepreneurship met an intense attack by Xi Jinping’s tech bashing. They are down though not out, even if President Xi says monumental assault is already over. Their animal spirits would not be the same. Worse, at SOEs or private corporations, the Communist Party requires employees and managers to spend an hour a day to study Xi Jinping thought. This is hardly a way to enhance productivity amid slowing economic growth rates.

There is no alternative to readjusting (or deflating) real estate prices to right levels and recapitalizing bank balance sheets that are adversely affected by NPLs. Paying the price of debt accumulation is unpleasant, but not even the CCP can be exempted from the law that ruled what is now the developed world for decades and centuries.

About the author: Mr. Suzuki is a retired banking executive based in Tokyo, Japan.


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