What is Going on in China?
Written by Paul Siluch
September 11th, 2024
In 1992, China accounted for just 1.6% of the world economy (globaleconomy.com). By 2022, it was close to 20%.
What happens in China matters.
In 2001, China joined the World Trade Organization. Commodities exploded in price as China industrialized. China’s oil imports alone grew from 1.2 million barrels per day in 2001 to 11.29 million barrels per day in 2023 (Reuters). This sent oil prices to over $140 per barrel and benefitted Canada as an oil exporter.
Then the boom ended. China’s growth moderated. Canada slumped.
Hope springs eternal, though. Canada is always hoping for another commodity boom, though. And why not? Demand for copper, lithium, and nickel are exploding with the introduction of electric cars even as supplies are tight. It can take ten years or longer to bring a mine from discovery to production. And no one wants a mine in their backyard, anyway.
As a result, there shortages forecast for everything from uranium to copper to silver - even helium is rationed (NBC news). Fill your party balloons now!
Despite China now commanding 20% of the global economy, oil prices have fallen over 40% from their highs in 2022 and are back to 2018 levels. Even with two regional wars happening, which usually push commodity prices higher.
Commodities have fallen 35% since 2022. The commodity index is back to the same levels as 2014.
Growth Hangover
China is the growth miracle of the last 30 years.
Millions left their farms to earn more in the cities, and the country industrialized at an incredible pace. Real estate prices soared, such that Chinese real estate is now worth 21% of all real estate in the world (Savills).
A bubble? Yes. But there was a bubble before called Japan. And there are painful lessons there.
Japan industrialized rapidly after WWII, aided by a cheap yen and friendly ties to the U.S. By 1985, America had had enough of cheap Japanese exports (sound familiar?) and demanded a currency revaluation. The yen was pegged to a higher rate in the 1985 Plaza Accord. Japan cut interest rates to keep it from going higher.
When rates drop, loans get cheaper. Japan borrowed to buy real estate…in a big way.
Households bought houses. Companies bought buildings - Manhattan skyscrapers, shopping malls. Even the Pebble Beach golf course.
At one point, it was estimated that the 1.5 square kilometers of land around Japan’s Imperial Palace was worth more than all of California.
All bubbles pop, and Japanese real estate popped spectacularly.
Japan tried everything to slow the bleeding: 0% interest rates, quantitative easing, forced mergers of bad banks to support all the bad loans. Even negative interest rates.
Nothing worked. Japan’s stock market took 30 years to reach the highs of 1989.
A Man’s Home is his Castle
Like food and clothing, shelter is a human necessity. A person’s house is a sacred investment. Governments ladle all sorts of inducements so that people can afford a home.
In some ways, China’s property bubble is worse than Japan’s. Chinese residential real estate peaked at 20% of its GDP in the last decade and is about 13% today. Canada, also overly reliant on real estate, sits at 7.7% (World Bank, Statistics Canada).
After the 1990 peak, Japanese real estate prices fell and jobs dried up, especially for young people. As they struggled to repay their mortgages, they had fewer children and Japan’s aging problem began.
Where do we see this happening again today? China.
China’s working age population is shrinking even as house and apartment supply continues to grow. Sales of apartments are down:
Years of overbuilding, falling affordability, and soaring debt have put Chinese real estate in a tough position.
Ripping off the Band-Aid
No country is better at exploding bubbles than the United States.
Few remember, but Texas had a property bubble in the 1980s. Thousands of small community banks lent money wildly, then lost it all in what came to be known as the Savings and Loan Crisis.
Did the government save them all? Not even close. They let the banks fail but kept people in their homes. The bad loans were bundled packages and sold off. New investors figured it out.
The net result was that old banks vanished, new ones emerged, some people lost money, most stayed in their homes, and the economy recovered quickly.
Similarly, in the 2008 crisis, the U.S. allowed millions of homeowners to default on their mortgages. They bailed out the banks (some say they should not have, but that is another story) and by 2012, the banks were recapitalized and lending again.
Japan chose to remove the bandage slowly.
It made its banks carry bad loans for decades. No new loans were made because the old ones were tying up their capital. It became known as “the lost decade.”
Is China in the same position today? China now accounts for 20% of the global economy – far more than Japan ever did.
And China has an even more severe population problem because of its one child policy of the 1970s. A home in a large Chinese city can cost 20 times your annual income versus 10 times in Canada and 3 times in the U.S. (Seeking Alpha).
Few people in the cities can afford a child.
Back to Commodities
China is clearly slowing. Estimates for 2024 oil consumption growth have been pared back at the International Energy Association. Demand for copper and other materials is slipping because China is building less housing.
What are the outcomes?
- Other countries will eventually fill the gap. India imports 4.8 million barrels/day (Reuters) today – 1/3 of what China imports. Demand from India will only grow. Expect to read more about Indonesia and Africa in the years ahead.
- A recession is coming. Likely relatively mild and may be here already.
- Commodity shortages don’t matter in a recession. But when it ends and demand resumes, shortages make the rebound that much sharper.
After Japan’s collapse in 1990, commodities fell 20%.
- It took about three years for commodities to bottom before new growth replaced Japan.
Since the post-Covid boom? Commodities are down 19%.
- A three-year bottom today would end in 2025.
Canada should get another commodity boom. But we may have to wait until next year.
Markets This Week
U.S. markets have dropped close to 4% in September, which means the month is living up to its reputation as the worst month of the year for stocks.
The U.S. election is still too close to call, and stocks have been pulled wildly in both directions as each candidate pulls ahead then falls back.
One day, clean technology stocks go up (a favourite of the Democrats), and the next it is energy (Republicans).
It will make for an interesting October.
Meanwhile, interest rates are tumbling. This helps bonds, utilities, dividend stocks, and gold.
