It’s a Lehman Moment, Not Volcker, That China Should Fear

(Bloomberg Opinion) -- There’s a paradox in worrying that China’s efforts to deflate its property bubble may trigger a crisis that would damage the economy and even go so far as to imperil the global recovery. Alert readers may even have spotted it right there. If the country’s leaders realize that the effects of cracking down on the real estate market are really so devastating, they could always decide… not to? 

That, in fact, has been the history of China’s campaign to restrain its never-ending boom in housing prices, which has been running on and off at least since this writer moved to Shanghai for a five-year stretch in 2004. Your correspondent bought a property in the city in early 2005, just before officials announced a range of anti-speculation measures, which caused some first-time-buyer anxiety. “Don’t worry about it, I’ve seen it all before,” one more experienced Shanghai investor advised. He was right.

The pattern has been stop-start. Administrative measures such as higher mortgage rates, sale restrictions or capital-gains taxes have some initial impact in restraining prices and demand, but don’t change the long-term trajectory. Once economic growth weakens and the money taps open, the political priority flips to supporting expansion, and the urgency of damping home prices is temporarily forgotten. Ultimately, credit growth trumps micro policies. Officials may wish to see loans directed to more deserving and productive targets such as small manufacturers or technology startups; somehow money still finds its way into the easier and safer profits of real estate investment.

All this makes the current alarm over China’s property crackdown a little hard to digest. The curbs could be China’s “Volcker moment,” signaling a much worse-than-expected economic slowdown, more loan and bond defaults, and potential stock market turmoil, according to economists at Nomura Holdings Inc. The credit squeeze is “unnecessarily aggressive” and may weigh on industrial demand and consumption, Bank of America Corp. opined. A potential crisis could result if home prices drop below mortgage values, state-linked economist Li Yang was cited as saying.

In other words, this time is different — sometimes known as the four most dangerous words in finance. Nomura has no doubts. “This time it’s different,” the bank says, a phrase its report goes on to repeat three times. Beijing is showing “unprecedented determination” to tighten property sector policy and tame prices. This is closely associated with its desire to achieve three long-term targets, Nomura says: reducing dependence on foreign high-tech goods, raising the birth rate and reducing wealth inequality.

The Volcker Moment comes from former Federal Reserve Chairman Paul Volcker, who raised U.S. interest rates to 20% in the early 1980s to squeeze inflation out of the system. The predictable result was a deep recession, though one that laid the foundation for the long U.S. economic expansion that followed. Similarly, Beijing “seems willing to sacrifice some growth stability” to achieve its long-term targets, in the view of Nomura’s economists.

There are some differences. For one thing, the U.S. wasn’t sitting on a giant credit bubble when Volcker started raising interest rates. The recession he triggered was severe, but short-lived. If China’s property prices plunge, that will cause a debt crisis and a balance-sheet recession, which is likely to be far longer-lasting. A better analogy than Volcker might be the collapse of Japan’s asset bubble at the end of the 1980s, which sent the economy into a decades-long funk.

The reality is that China’s real estate sector is simply too big, too overvalued and too important to the economy to reshape without risking incalculable, and potentially catastrophic, consequences. Analysts arguing that the property crackdown is here to stay are implicitly betting that Beijing can calibrate this process, choosing how much pain it’s willing to take in exchange for a progressively smaller and less overextended industry. If officials pull it off, it will be a hugely impressive feat of economic management. 

Politics mitigates against any radical near-term shift. President Xi Jinping will seek a third term of office at next year’s Communist Party congress, and any turbulence before then would be unhelpful. The rhetoric of “common prosperity” plays well with those left behind by China’s economic miracle; real estate has been a key driver of inequality, and cheaper home prices would please them. But the country also has hundreds of millions of property owners by now. How would they feel if the value of their apartments fell by 30%, or 50%, or 70%?

If signs of serious cracks or economic distress build, it’s far more likely that policy makers will reverse course and ease off, as they have in the past. There may be an enormous crisis coming in China real estate, as George Soros contends, but it’s one that’s more likely to be the result of a market accident than the product of a deliberate government policy choice. China’s Lehman moment is still the one to watch.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Matthew Brooker is a columnist and editor with Bloomberg Opinion. He previously was a columnist, editor and bureau chief for Bloomberg News. Before joining Bloomberg, he worked for the South China Morning Post. He is a CFA charterholder.

©2021 Bloomberg L.P.