Blame the Chinese housing market.

Like clockwork, China has jolted the global economy out of its malaise every three years since the global financial crisis —each time by implementing massive stimulus.

It happened in the aftermath of the global financial crisis in 2009, during the Eurozone crisis in 2012, and again at the end of the commodity super cycle in 2015: China flooded its economy with credit and government spending. That lifted the global economy out of its rut and boosted the outlook for emerging markets, commodity producers and European exporters.

Yet despite market hopes earlier in the year, meaningful Chinese stimulus has failed to materialize. Despite five reserve requirement ratio cuts since 2018, total credit growth has fallen to new lows. In both year-on-year growth terms as well as a percent of GDP, total borrowing is at the lowest level since 2008.  So far, stimulus measures have been mostly talk with little action.

Chinese credit growth has slowed to historic lows

Source: National Bureau of Statistics, People’s Bank of China, Haver Analytics. Data as of July 31, 2019.
A line chart showing aggregate credit growth from March 2007 to April 2019.

As a result, Chinese and global growth continues to slow. Global trade is contracting. All the usual beneficiaries of Chinese stimulus are feeling the pain—most notably Asian economies and Germany. 

There are many potential reasons: They could be saving ammunition in the event the trade war worsens. Or perhaps they are applying lessons learned from Japan’s trade war with the US and don’t want to overstimulate. Alternatively, maybe they are finally serious about deleveraging.

The most likely reason is the housing market. Property prices across many Chinese cities rose so rapidly during the previous round of stimulus that they now constitute a threat to economic and social stability. And perhaps more importantly, for the global economy at least, high house prices constrain Chinese policymakers’ ability to stimulate the economy. The People’s Bank of China likely fears that looser monetary policy could further enflame the housing bubble, making prices even more unaffordable for first time homebuyers and increasing financial risks of growing household debt. With a firmly closed capital account and limited domestic opportunities for investment, stimulus has historically flowed into housing and the previous stimulus round may have been the final straw. It is also certainly not lost on Chinese officials that sky high house prices in Hong Kong are one cause of the ongoing unrest. In other words, Chinese policymakers can’t stimulate, and they can’t because of housing.

Why was the last stimulus such a game changer? It was not just the sheer increase in house prices, but also the indiscriminate flow into third- and fourth-tier cities. To put this in perspective:

  • Between 2015 and 2018, house prices on average grew over 30 percent and at least 12 lower-tier cities saw price growth over 50 percent.
  • The average weighted price-to-income ratio across China is now 11.9, higher than Sydney, Australia.
  • Mainland Chinese cities now make up the most unaffordable cities in the world, with 15 cities having a price-to-income ratio higher than the next most expensive city, Vancouver, Canada.

Rising incomes not keeping pace with runaway house prices

Sources: China National Bureau of Statistics, CEIC Data, China Index Academy, Soufun, Haver Analytics.
A bar chart showing house price growth (blue bar) and income growth (orange bar) in various cities in China.

You thought New York City apartments were expensive?

Sources: China National Bureau of Statistics; CEIC Data; Wendell Cox and Hugh Pavletich, 15th Annual Demographia International Housing Affordability Survey (2018: 3rd Quarter)
A bar chart showing the price to income ratio in various cities in the United States, Canada, United Kingdom, New Zealand, Australia and China.

What is more alarming is how the toxic mix of massive easing and city-specific restrictions pushed speculative money out of the global cities of Shanghai, Beijing and Shenzhen into smaller cities simply because they didn’t have purchase restrictions. For example, when house prices in Shenzhen rose 75 percent between April 2015 and September 2016, concerned local policymakers implemented strict restrictions on sales and purchases, essentially grinding the market to a halt and freezing prices.

However, almost to the month that these restrictions went into place, the massive amount of liquidity sloshing around the system started to flow elsewhere. In nearby Jiangmen, a city unremarkable except for its proximity to Shenzhen and lack of purchase restrictions, prices rose nearly 25 percent from September 2016 and Jan 2018—after having been flat for as long as prices have been available. Even cities far from the major metropolises of the coast saw a significant jump in prices -- as long as they didn’t have housing restrictions. Luoyang, a dusty city known for its ancient history and heavy industry, saw prices jump nearly 50% precisely from the month when restrictions went into place in major cities such as Beijing.

These massive, seemingly indiscriminate, increases in house prices directly resulted from China’s unique situation of a closed capital account, a flood of liquidity, and few opportunities to earn a return on investment, causing money to flow into housing wherever restrictions didn’t exist. For policymakers, dealing with a very expensive Shanghai or Beijing is a lot easier than dealing with fifty cities more unaffordable than San Francisco.

Luoyang tells the story

RMB/Sq. meter (both sides) Sources: China National Bureau of Statistics, Haver Analytics. Data is as of July 31, 2019.
A line chart showing the property price in Shenzhen and Luoyang from 2010 to 2019.

With house price (un)affordability at levels rarely recorded, it’s no wonder the PBOC has refrained from larger stimulus measures. And if China can’t launch substantial stimulus it means the global economy, which has relied on a China boost during every past downturn, has few other triggers to lift the economy out of its manufacturing-led malaise. Chinese policymakers will likely continue to fight slowing growth with piecemeal fiscal measures aimed at boosting domestic consumption and lowering the tax burden for indebted corporates. The type of Chinese stimulus the global economy has become accustomed to – large-scale housing construction and infrastructure – is largely a thing of the past. However, growth in China is still credit-driven. In the absence of monetary stimulus, growth will continue to slow, imports will stay weak and China will continue to be a drag on the global economy.

This means a more persistent slow-trend growth environment until inventories draw down and trade and manufacturing eventually improve. While China sparked the global cycle during previous manufacturing downturns, they are less likely this time - and the housing market is to blame.