China's Economic Landscape
While central banks in the United States, Canada, Europe, and the United Kingdom have been increasing interest rates and signalling their intention to maintain higher rates for an extended period, the People's Bank of China took a different path in August. They reduced the one-year loan prime rate to 3.45%. This decision was driven by China's distinct macroeconomic circumstances, marked by deflationary pressures, yuan depreciation, and a struggling real estate sector.
Real Estate Crisis Unveiled
Recent reports and geopolitical analysts have shed light on the challenges facing China's property market. As of 2019, the Chinese real estate sector boasted a staggering $52 trillion valuation, surpassing even U.S. treasuries, valued at around $25 trillion.
Evergrande, often considered the face of China's property sector woes, filed for Chapter 15 bankruptcy protection in New York on August 17th. This development followed a series of troubles it encountered the previous year, with the ripple effects of Evergrande's troubles extending to global economies.
Simultaneously, Country Garden, China's largest property developer (four times larger than Evergrande), teetered on the brink of default. The company faced a $15 million interest payment deadline tied to an offshore bond and narrowly avoided defaulting twice in the past month. Country Garden now has a 30-day grace period after missing the September 18th deadline to pay the coupon before it would be considered in default.
The company had previously warned of default risks if its financial performance continued to deteriorate. With approximately 108.7 billion yuan ($14.9 billion) of debt due within 12 months but only about 101 billion yuan ($13.9 billion) in cash as of June, it faced significant challenges. Fortunately, Country Garden averted default by securing approval from its creditors to extend payments for an onshore private bond, providing much-needed relief to both the beleaguered developer and the crisis-stricken property sector.
The problems faced by Country Garden and other developers are underscored by the massive $390 billion owed to small businesses that once thrived on the property market but now struggle due to developers' inability to meet their obligations.
Impact on Chinese Citizens
Within China, a whopping 70% of wealth is invested in the housing market. Moreover, 90% of homes are sold through a pre-sale mechanism, wherein properties are purchased before they are constructed, with developers committing to building within a specified timeframe. However, Country Garden, for instance, promised to deliver 700,000 units this year but completed less than half that number in the first six months. The company still has 1,000,000 homes to construct and has not announced any plans to fulfil its commitments.
Adding to the concerns, the price-to-income ratio for homes in China's major cities stands at 14x, double the average U.S. ratio of 7x and 1.5 times that of San Francisco's Bay Area (9x). This means that Chinese citizens are assuming substantial risk by investing 70% of their wealth in properties that have yet to be built.
It is increasingly likely that Country Garden will fail to complete the majority of its property developments, resulting in significant debt among Chinese citizens who may never receive the homes they paid for. This has led to individuals withholding mortgage payments, which, in turn, impacts banks since mortgage payments are owed to banks rather than developers. In turn, has created issues for banks, as we will discuss further.
House prices have also experienced sharp declines, eroding the wealth of many homeowners and causing them to halt mortgage payments. With home prices falling by 10-25%, and given that 70% of Chinese wealth is tied up in property, Chinese citizens are cutting back on investments, family planning, and consumption as they witness significant portions of their wealth vanish.
Shadow Banks in Crisis
As mentioned earlier, banks are grappling with the absence of mortgage payments, a situation that poses significant challenges to any banking system. However, the impact on the Chinese banking system is particularly severe. This is because a substantial portion of China's banks are shadow banks—financial intermediaries that engage in credit creation without regulatory oversight. Consequently, there is no government safety net for these shadow banks. Shadow banks in the Western world are akin to payday loan providers and Lehman Brothers.
When these shadow banks cease to receive payments, they face severe cash flow problems, exacerbated by the lack of regulatory oversight, which often results in fractional reserves.
Additionally, Zhongrong, one of China's largest shadow banks, which traditionally had substantial exposure to real estate, began missing payments on numerous trust products in late July. This development roiled markets and raised concerns about China's financial system's vulnerability due to the property sector crisis. Zhongrong had lured consumers with promises of 7-9% yields via a cash pool, effectively resembling a Ponzi scheme where new entrants' funds were used to pay existing members.
Due to the housing crisis and troubles in the shadow banking sector, many middle and upper-class residents in China are attempting to withdraw money from banks, leading to what can be described as mini bank runs. These bank runs have triggered protests in Beijing, a rare occurrence. The Chinese government has taken measures such as visiting protestors' homes to quell the unrest but has yet to provide comprehensive commentary on the challenges faced by shadow banks.
Zhongrong recently announced an agreement with Citic Trust and CCB Trust, the shadow banking arms of state-owned firms Citic Group and China Construction Bank, for "entrusted management services." This agreement enables the two financial firms to provide professional services for Zhongrong's operations and management without affecting debt ownership and legal relationships in trust products.
Analysts warn that a wave of defaults on trust products could have significant ripple effects on China's broader economy, as individual investors who sought higher returns would experience acute impacts on their consumption.
China's Youth Unemployment Crisis
In urban areas, the unemployment rate among 16- to 24-year-olds reached a record 21.3% in June and has risen each month this year. While economists had anticipated further increases in the following months, the Chinese government, anticipating a seventh consecutive monthly rise in youth unemployment, suspended the release of this data.
China's youth unemployment rate has doubled over the past four years, a period marked by economic volatility due to "zero Covid" measures imposed by Beijing. These measures hindered companies from hiring, disrupted education for many students, and limited access to internships that often led to job offers.
Even securing an entry-level civil service position in the government has become more challenging. Last year, a record 2.6 million people applied for the national civil service exam, vying for only 37,100 entry-level positions.
Chinese leader Xi Jinping has called on young people to seek employment in remote areas and endure hardship, a sentiment expressed in the Chinese saying, "eat bitterness."
China's Population Conundrum
China, with a population of 1.4118 billion people, is grappling with a demographic quandary. The nation's population is dwindling, aging, and suffering from a skewed gender balance, with more men than women. These demographic shifts pose unique and complex challenges to the world's second-largest economy.
Despite the relaxation of China's one-child policy and recent incentives to encourage larger families, the country's population is steadily declining. This shift has propelled India to the position of the world's most populous nation and has far-reaching implications both domestically and globally.
For years, China's vast working-age population fuelled the global economic engine, providing cheap labour that manufactured goods exported worldwide.
In the long term, a shortage of factory workers in China, driven by a better-educated workforce and a shrinking pool of young people, could increase costs for consumers in countries heavily reliant on imported Chinese products, potentially exacerbating inflation.
A shrinking population could also translate to reduced spending by Chinese consumers, posing a threat to global brands that rely on sales to China, from Apple smartphones to Nike sneakers.
Impact on Global Economies
A. Commodities
The downturn in the property sector, which had been a primary driver of economic growth, exemplifies China's campaign to deleverage its economy and reduce dependence on debt- and investment-driven growth. This downturn has far-reaching implications, as commodities-exporting countries closely tied to China's end market are bearing the brunt of the fallout.
Economists anticipate that this situation will continue to depress global demand for commodities and drive down prices. According to Robert Gilhooly, Senior Emerging Markets Economist at Abrdn, "Commodity exporters, such as Chile, Peru, South Africa, and Australia, could witness reduced demand from China, leading to cooling global prices and affecting investment, tax revenues, and overall business sentiment."
Over the long term, the ongoing deleveraging effort aims to transition China's economy toward consumption-led growth rather than investment-led growth. Gilhooly explains that "since investment relies heavily on imports, China's shift toward domestic consumption is unlikely to provide a substantial boost to its trading partners."
B. Global Inflation
Exports to China may come under pressure, but cheaper Chinese products are a boon for importers of Chinese manufactures. This is especially relevant for economies grappling with persistent high inflation, as they welcome lower prices from China, a global manufacturing hub.
China's deteriorating economic fundamentals have generated deflationary pressures, which are already moderating inflation both in China and in global markets reliant on Chinese goods.
Sustained deflation in China could spill over into developed markets. A weaker yuan and elevated inventory-to-sales ratios reduce the cost of Chinese goods abroad—an outcome that central bankers in developed markets would likely welcome.
Implications on Crypto
Goldman Sachs economists have revised down their estimates for Chinese GDP growth to 5.4%. They cite "challenges from the property market, pervasive pessimism among consumers and private entrepreneurs, and only moderate policy easing" as factors contributing to this adjustment.
With China's economy facing increasing difficulties, entrepreneurs, the middle and upper classes may be seeking alternative avenues to park their wealth. Notably, China's stock market shows a stronger correlation with Bitcoin than the S&P 500, with both reaching lows at similar times in November 2022. Historical trends indicate that when the Chinese economy falters, so does Bitcoin.
However, the landscape could change; China’s struggling economy and the introduction of Central Bank Digital Currencies (CBDCs) presents the perfect storm for a paradigm shift. One of the most effective ways to promote CBDCs is through stimulus measures. Furthermore, the weakening economy presents a compelling case for the Chinese government to provide stimulus to the populace.
As faith in the Chinese economy erodes and distrust towards CBDCs grows, it is increasingly likely that capital from China will flow into cryptocurrencies (despite mass perception, you can easily invest into crypto in China despite it being illegal) and this will only be expedited with Chinese Stimulus.
China is Binance’s largest market, amounting to 20% of worldwide volume. Data from the Journal shows that China is a $80.6 billion futures market and a $9.4 billion spot market for Binance. South Korea provides $56.9 billion in futures volume and $1.39 billion in spot volume. - CoinDesk
We can examine data from the stimulus checks offered by the U.S. government following the COVID-19 pandemic and their impact on the crypto markets.
In 2020 and 2021, the U.S. federal government distributed significant amounts of stimulus money to American families, including two checks under the Trump administration and a subsequent payment under the Biden administration. Notably, after the first stimulus checks of $1,200 were distributed in April 2020 under the CARES Act, there was a significant uptick in Bitcoin buy trades.
The Federal Reserve Bank of Cleveland found that trading volume of Bitcoin increased by approximately 3.8% in response to the distribution of the first stimulus check. Most individuals using their first COVID-19 stimulus payment to buy Bitcoin were found to be without families and were primarily non-professional investors. Furthermore, the Federal Reserve's analysis of countries offering similar stimulus programs revealed increased interest in Bitcoin in those regions as well.
Could China's weakening economy usher in a new era for the cryptocurrency market? Only time will tell, but the convergence of economic challenges, CBDC experimentation, and growing distrust could potentially reshape the landscape for crypto currencies in China and by extension the globe.
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