China’s Shaky Financial System Could Be Our Best Chance For World Peace
Bad for global growth, good for world peace
When your own house is on fire, you’re less likely to try to set someone else’s house on fire. The logic being that you’re too busy taking care of your own to have time to worry about external things.
This of course doesn’t always apply. Russia’s economy was already looking shaky and imbalanced when it decided to attack Ukraine in order to fulfill Putin’s perverse ambitions.
But I honestly hope that this logic will apply to China and Xi Jinping.
Honestly (and unfortunately), the world’s best hope for peace over the next two to three years is for China’s economy to suffer a full-blown debt crisis. And for Xi to react rationally and not attempt to use an invasion of Taiwan or some other military action as a diversion to get his citizens’ minds off of the economy.
The financial tremors there are already starting. Large property developers like Evergrande that spent years oversupplying China with unneeded condos and high rises are now going bust. For years, Chinese banks funneled money from a population that saved a ton into infrastructure and real estate investment.
So in effect, Chinese citizens lent money to local governments and real estate developers so that they could build tons of new buildings. This worked because owning real estate is highly ingrained into Chinese culture (sorry, generalizing a bit here) — so there was a large population of natural buyers. Parents save their entire lives in order to be able to afford to buy a condo for their child. Real estate is the asset class of choice in China, much more so than stocks (much of the corporate sector is either government controlled or heavily government influenced) and bonds.
Thus, as long as property prices kept increasing, the system worked. But when prices stop going up, it becomes very dangerous. It’s important to recall how lending works — it’s not one for one where one dollar borrowed from citizens (in the form of deposits) is one dollar lent to developers. Rather banks can print money (create credit) based on the level of deposits they hold — as long as they feel like they’re protected by collateral (the property to be developed) and fall below the regulatory requirements for leverage, they can multiply each deposited dollar into many dollars of credit. And they have happily done this for years — according to the Economist, China’s private non-financial sector debt was 222% of GDP at the end of 2020 (America’s was 164%).
This means that when property prices fall even a little, thanks to the leverage, bank’s equity (and citizen’s deposits) can be destroyed extremely quickly — I imagine a broad 10% decline in property prices would put many financial institutions on the edge (or over it). Adding to the pain is the fact that land and property drive so much of China’s economy. Not only is it the major source of savings and investment, it’s also a massive source of jobs and local government funding (via land sales to property developers). These all get hit extremely hard if falling property prices cause the system to go into reverse.
I don’t wish economic hardship on anyone, but the world sits at a dangerous precipice right now (see my previous piece here). Xi Jinping and China’s government are convinced that their way is best and seem willing to go to extremes to force the rest of the world to acknowledge that. Hard evidence that their way is not best (e.g. a bursting of China’s debt bubble that they presided over) would hopefully force a rethink on their part and encourage China’s politicians to be more openminded and willing to compromise. And less willing to start a war. World peace might depend on it.