Why China's Economy is Finally Slowing Down

Wendover Productions

Pre-Reform Housing Crisis (1980s)

Urban China extremely cramped living conditions
- 1980: Average living space per capita below 10m² until 1985
- Mid-1990s: Crossed 15m² barrier
- 1992: Only Tokyo, New Delhi, Cairo had similar density levels
Poor housing quality and infrastructure
- 1985: 90% urban households lacked piped gas
- 70% didn't have sole access to toilets
- Nearly 40% relied on shared kitchens and water taps
State-controlled housing system problems
- Housing responsibility of state/state-owned enterprises
- Rent only 1-3% of average income
- No incentive for construction - generated no substantial revenue
- Private development illegal

Deng Xiaoping's real estate revolution
Key constitutional amendment: "right to use of land may be transferred according to law"
Land ownership structure
- All land owned by state or rural collectives (unchanged)
- Local/municipal governments granted land use rights
- Could sell these rights to property developers
New economic model created
- Local governments: steady income through land sales
- Private developers: massive growing demand
- Urban Chinese: housing options and investment opportunities

Dramatic improvements in living conditions
- Urban living space shot upward
- Home ownership rates increased significantly
- 1998-2002: Chinese developers built enough stock to house entire US population
Major developer emergence
- 6 of world's top 10 largest real estate companies headquartered in China/Hong Kong
- 4 largest land development companies founded 1990s or later
Evergrande case study
- Started with 110m² footprint pesticide plant conversion
- Project sold out in 2 hours
- Reinvested earnings into 13 new projects across Guangzhou
- Went nationwide with hundreds of projects, then nearly 1,000 in 2010s
High-leverage strategy
- Combination of upfront buyer payments and borrowed money
- No big cash reserves kept
- Took on maximum debt, built as fast as possible
- Down payments usually 35%+ (much higher than developed world)

Price escalation vs. income disparity
- Beijing property prices per sq ft: on par with Los Angeles
- Shenzhen: same as Paris
- Shanghai: nearly as high as London
- Chinese incomes: 1/4 to 1/6 of US/France/UK levels
Affordability crisis metrics
- New York: 13 years average income for average home
- Vancouver: 16 years
- London: 22 years
- Shenzhen (2018): 41 years
- Shanghai/Beijing: even worse ratios
Supply vs. demand paradox
- Almost 1/4 of country's housing units sat empty
- Millions of completely habitable apartments bought but never inhabited
- Highest development rates + highest price growth + highest vacancy rates simultaneously
Investment-driven market
- 2018: 87% of home buyers already had another residence
- Housing decoupled from utility, became financial asset
- Value supported by belief prices would continue rising (bubble formation)

Policy objectives: controlled demolition of bubble
Three financial restrictions for developers:
1. Liabilities couldn't exceed 70% of company's asset value
2. Debt couldn't exceed company's total equity worth
3. Short-term debt couldn't exceed available cash
Growth restrictions based on violations:
- No violations: 15% max year-over-year debt growth
- One violation: 10% cap
- Two violations: 5% cap
- Three violations: 0% debt growth allowed

Red line violations
- Debt to liability ratio: 81% (violated first red line)
- Cash to short-term debt ratio: 67% (violated third red line)
- Net debt to equity ratio: 99.8% (barely avoided second violation)
Restricted growth capability
- Violated two red lines = 5% debt growth cap
- Had millions of sold but uncompleted apartments
- Couldn't borrow more to complete projects
Market conditions deteriorated
- China maintained strict COVID restrictions longer than other countries
- Used less effective domestic vaccines vs. mRNA vaccines elsewhere
- Economic productivity declined disproportionately
- Migrant worker class reversed course, returned to rural areas
- Demographic changes: core home-buying age (29) representing smaller population fraction
Asset liquidation attempts
- 2018: Established electric vehicle + senior care divisions
- 2021: Courted Shell for majority stake (talks stalled)
- Attempted to sell Guangzhou FC Soccer Club stake (failed)
- Sold 18% stake in Tencent entertainment joint venture for $273 million (insufficient)
Default and liquidation
- December 6, 2021: Failed to make bond payments after grace period
- Fitch ratings declared default
- January 2024: Hong Kong court ordered liquidation

Widespread developer failures
- Country Garden (another giant) months behind Evergrande, teetering toward liquidation
- Dozens of developers in default
- Over $100 billion in failed debt payments from Chinese property sector
Economic impact amplification
- Property sector accounts for outsized portion of GDP
- Creates outsized drag on economic growth
- Middle class heavily invested in property (vs. stock market affecting mainly wealthy)
- Money disappeared from middle class savings/investments
- Gaping hole in Chinese economy

Chinese social contract under pressure
- Traditional bargain: sacrifice personal liberty for economic prosperity
- 800 million people lifted out of poverty (historical success)
- Current question: if economic prosperity wanes, why deliver on liberty sacrifice?
Controlled demolition vs. uncontrolled collapse
- Property sector collapse was inevitable due to highly leveraged foundation
- Government chose timing and method of intervention
- Represents uniquely tenuous position for central government

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