In the fall of 2007, I sat in a macroeconomics class at Simon Fraser University hearing my professor rave about the state of the Chinese economy. That year, China’s GDP grew by a whopping 14.2%. How? Well, there’s plenty of literature and plethora of documentaries on this subject so let’s just simplify it all.
The Early Beginnings
While the U.S. housing and stock bubble expanded in the 2003-2007 period, China, already a significant creditor nation to many countries across the world, wanted to further finance projects to boost their economy and get their rapidly expanding workforce working. In just 5 years, they built 30 new airports, 26,000 miles of roadways and an average of 1 skyscraper every 5 days.
When the U.S. economy crashed in 2008 and entered a recession, there went demand for all the goods cheaply produced in China – forcing the Chinese economy to take a hit. Most of these skyscrapers that were built remain empty, as noted by BBC economics editor Robert Peston. China went on a credit surge in 2009 to continue to finance development. How did they finance all this development? Credit – through the Chinese government and shadow banks. Shadow banks are a way to keep loans off the books. They typically charge high interest rates and in China, they lend to state-owned companies because the enterprises typically have the backing of the Chinese government. This incentivizes risky lending in otherwise unsafe industries.
China’s Slowly Tanking Economy
China has since taken a big hit. Last year, China’s economic growth slowed to just 7.7%. It’s expected that the Chinese economy’s growth projections this year of 7.4% won’t be met and could slow further to 7% in 2015.
Last month, China’s central bank cut interest rates for the first time in over 2 years. When central banks typically cut interest rates, it’s to stimulate borrowing in times of relatively weak economic activity. For example, the United States’ Federal Reserve Bank cut interest rates rapidly after 9/11 which stimulated lending and among many other factors, helped lead to the eventual housing bubble. After an incline, the Fed cut interest rates again right after the crash and those rates have remained near zero since. It was rumoured that China was considering another interest rate cut but would hold off until 4th quarter data came out.
Various sectors of the Chinese economy are dragging right now. Commodities like mining see declining demand and falling prices. The manufacturing sector in China continues to fall as the country’s Purchasing Managers Index (PMI) number is approaching a flat 50. Anything under 50 signifies a contraction in the manufacturing sector.
Last month, Peter Baum, a former Asian sourcing executive for Essex Corporation told CNBC that China’s economy was slowing faster than previously thought.
Too Much Debt In Chinese
No one knows whether China will be able to pay off their colossal debt. We do know that they plan on spending more on stimulus projects – to the tune of $8.3 billion, as announced last Friday. Will these projects work? Well, we now know that past ones didn’t. The Chinese government wasted $6.8 trillion in ineffective investment, according to a report from China’s National Development and Reform Commission and Academy of Macroeconomic Research.
It’s quite clear what the strategy is here: Spend massively on infrastructure projects, put all of it on a credit card and hope that they reap benefits in the form of economic activity and debt payments from other countries. However, the average Chinese family can’t afford to live in these new condos. Meanwhile, the commodities market is slowing and manufacturing has taken a hit. China has built a massive amount of debt and the bubble keeps growing.
How Will A Chinese Economic Collapse Affect Vancouver?
Once it bursts in China, it’ll have a gigantic impact all over the world, especially here in Vancouver. It’s been well noted that plenty of foreign investors have their hands on properties all across the Lower Mainland. Some attribute this foreign capital to the rise in housing prices – leading Vancouver to be one of the least affordable places to live in North America. Senior economist Robin Wiebe recently noted the connection between economic growth in China and the Vancouver housing market.
There’s no doubt that housing is the biggest issue in the Greater Vancouver area. With rising poverty levels, the need for more affordable housing units grows and even laneway houses are becoming an affordable alternative. When the Chinese economy sinks within the next 2 years, the expectation is that the levels of foreign investment here could topple and have an impact on local economies.
In his BBC documentary “How China Fooled The World”, Peston notes that where China’s economy currently sits is similar to where the United States was in 2006-2007. While all this may come across as somewhat alarmist, consider that recessions are part of the business cycle and they happen every 7-10 years. Think 1981-82, 1990-91, 2000-01, and 2007-2009. Now factor in that this would be another bubble-induced recession that could be far worse than the “Great Recession” and 2016 seems quite plausible.