O6 CTOBER 1979 was a beautiful Saturday in Washington. It wasn’t the kind of day that heralded a heartbreaking change in economic policy. But on that date, Paul Volcker, then president of the US central bank, announced a radical plan to crush persistent inflation. Before the battle was won, US interest rates hit 20% and unemployment exceeded 10%. Car dealers sent him the keys to vehicles they could not sell, in coffins.
China is now facing its own “Volcker moment,” according to Ting Lu of Nomura, a bank. The government’s goal is not to stem an inflationary spiral (consumer prices in China are rising only modestly) but to break the vicious circle of real estate speculation and credit expansion. Regulators are making it harder for developers to raise money and for households to buy homes. The new rules have already pushed several real estate companies, including the country’s largest homebuilder, Evergrande, to the brink of collapse and have helped lower home sales. But are China’s leaders ready to endure something like the economic malaise Volcker inflicted to achieve their goals? The world may be about to find out.
The home of an English man is his castle. In China, a house is much more than that. In addition to providing shelter and security, housing often serves as collateral, nest egg, speculative investment, dowry, and ticket to a good school. Housing accounts for three-quarters of household wealth, according to the China Household Financial Survey, a data set compiled by Chinese academics. It accounts for the bulk of household debt, which by one estimate was over 70% of GDP at the end of last year. Local authorities collect 30% of their income by selling land to developers. And policymakers often rely on housing construction to jumpstart the economy during a downturn.
Ownership also takes on other appearances. The high price of housing is often equated with a “big mountain” (alongside expensive healthcare and education) and a “gray rhino” (an obvious but overlooked risk). In March, Guo Shuqing, the head of China’s banking and insurance regulator, warned that if house prices were to come down, people with multiple properties would not only suffer “huge losses”, they could also be in arrears. their mortgages, endangering banks and leading to “economic chaos”.
The government wants property to play a smaller role. In December 2016, President Xi Jinping said the houses were meant to “live, not speculate,” a phrase officials now repeat often. In 2019, the Communist Party declared property not a tool for short-term economic stimulus, a commitment reiterated at a ruling Politburo meeting in July.
Authorities are facing the gray rhino more clearly in trying to tackle the industry’s financial weaknesses. Last year, regulators capped the share of mortgages and home loans that banks can hold. They also imposed “three red lines” on leading real estate developers, limiting the amount of their debts relative to their assets, equity and cash. Now, when the president of Country Garden, a high-end developer, talks about his goal of “going green”, he’s not referring to the environment, but to staying away from those lines.
The impact of curbs on the real estate market is increasingly evident. New home sales in 30 cities tracked by Wind, a financial data company, fell 23% in August from a year earlier, after declining less sharply in July and June. Sales were also lower than in the same period of 2019, before the pandemic (see graph). Mr. Lu de Nomura said investors should prepare for “a much worse-than-expected growth slowdown, more loan and bond defaults and potential stock market turmoil.”
Will the regulators blink? In the past, policymakers quickly relaxed real estate restrictions during downturns. A sharp drop in sales or house prices over several months “would probably push the government to adopt a more accommodating position,” argues Rosealea Yao of Gavekal Dragonomics, a consulting firm. But Mr. Lu thinks it will be difficult for the leaders to back down. They publicly committed to a stricter policy and created a bureaucratic dynamic behind it. Earlier this year, the central government fired officials in the southern city of Shenzhen for failing to contain prices.
The restrictions can be seen as part of the government’s new concern to create “common prosperity”. Unaffordable housing defeats this goal. Research by three Chinese academics – Guanghua Wan, Chen Wang, and Yu Wu – found that the cost of housing is responsible for around 75% of China’s wealth inequality. This may also be one of the reasons why Chinese families now have so few children, a trend that the government is increasingly concerned about.
To support growth, China could try to build more subsidized housing. He has ordered 40 cities to build nearly a million low-rental housing this year. But it will take time to accelerate this work on a sufficient scale. Meanwhile, China’s growth will face other threats. Service industries may suffer from lockdowns linked to the pandemic. Exports may grow more slowly as the manufacturing sector recovers abroad. And infrastructure spending will weaken if local governments can’t sell so much land to developers.
It’s hard to imagine China pushing things almost as far as Volcker did. But Volcker himself had not foreseen all the economic pain that would follow this beautiful Saturday. Chinese developers at bay could find themselves with a lot of unsold properties in the months to come. Where are they going to send the keys? ■
This article appeared in the China section of the print edition under the title “Red lines, gray rhinoceros and great mountains”