Since China embarked on major economic reforms in 1978, its GDP growth has averaged a stunning 9.14% per annum.
But not all’s well these days. After decades of unprecedented debt leveraging, and as the global economy slows, China sees its economy following suit and possibly crashing.
That has implications not just for China, but for markets across the world. Last year, China’s economy accounted for 18.56% of world GDP, according to the International Monetary Fund (IMF). And even with the economic slowdowns it’s experiencing, IMF’s estimates claim that China will account for 30% of aggregate global growth in 2023.
The Chinese Communist Party (CCP) is finally taking some steps to address two major issues that have stymied China’s economic growth – the fallout from their “zero Covid” lockdown policies and an overleveraged property market on the brink of collapse.
It could be too little, too late. But in the meantime, there’s money to be made betting on the Chinese economic machine to miraculously keep on trucking.
Let me tell you what you need to know, and then I’ll show you how to do it.
Why China’s Real Estate Woes Could Have Global Impact
China’s explosive economic expansion can mostly be attributed to the country’s cheap labor pool and state-owned, state-financed, and internationally financed mining and manufacturing industries. Since 1978, China has increasingly become the “world’s factory,” producing all manner of components and finished goods for global export.
In fact, cheap Chinese imports kept inflation at bay around the world for more than four decades.
Internal growth lifted standards of living and drove hundreds of millions of Chinese from rural farms into manufacturing cities around the country, where they needed homes and apartments.
To meet that demand, property developers bought land from local governments, built like mad, kept on borrowing, and kept on building. They leveraged themselves to unheard of levels and built ghost cities on bank loans, bonds, and more frighteningly through local government financing vehicles (LGFVS), essentially off-balance sheet loans made to local governments from state-owned national and regional banks.
The property sector now accounts for as much at 30% of China’s GDP of $17.73 trillion at the end of 2021, according to the World Bank.
Well, right before Covid unleashed its terror on the world, Chinese authorities tried to rein in excessive speculation and leverage in the property sector by instituting three “red lines.”
For property developers that meant: 1. liabilities could not exceed 70% of assets; 2. net debt should not be greater than 100 percent of equity; and 3. cash reserves had to be more than 100 percent of short- term debt.
None of the country’s biggest developers could meet the three red lines or even one of them. They were, and still are, all facing a liquidity crisis and technically insolvent.
If the CCP doesn’t succeed at avoiding what some analysts suspect could be China’s “Lehman moment,” not only will the Chinese property sector come crashing down, but the country’s banking system also could implode alongside it, throwing markets around the world into an instant quasi-depression.
“Zero Covid” and the Stalling of Chinese GDP
Starting in 2020 with the Covid pandemic, China’s manufacturing engine has been in a state of upheaval along with its property sector.
Manufacturing slowed to a crawl because of the Communist Party’s “Zero Covid” policy, which had entire cities locked down and tens of millions of workers and plants idled for weeks and months at a time. Tens of millions of Chinese had put huge down payments on under-construction apartment projects, construction which was stalled under the restrictions.
And while property developers struggled to borrow more and raise cash (which was impossible), regulators also began cracking down hard on the country’s biggest tech companies, launching “Operation Cyber Sword,” a widespread action meant to reign in what the CCP considered unfair business practices in the tech sector.
Most of the biggest targets of Cyber Sword had U.S. ADRs (American Drawing Rights) and traded on U.S. exchanges. When regulatory action crushed their tech ecosystems, the market tumbled, hitting millions of Chinese investors who had loaded up on the high-flying stocks.
So let’s add it all up: savings and investments being devastated, factories closed, cities locked down, billions in property development in limbo, and crashing tech stocks tanking the whole market. It’s no wonder Chinese GDP began shrinking at an alarming rate.
China’s recently released third quarter GDP growth came in at 3.9%. That’s down from the country’s 8.1% GDP growth in 2021.
The IMF estimates China’s GDP growth in 2023 will come in at 4.4% for the year – a slight improvement, but a far cry from the highs of their astonishing 40-year run.
The First Sign of CCP’s About-Face
Chinese President Xi Jinping just gave the first signal that the CCP is intending to reverse course on these problem areas, and it’s likely to grant beleaguered tech companies some relief.
The about-face came last week when the new Central Committee, fresh out of the Party Congress, came out with new “parameters” to guide future lockdowns, essentially easing the strict Zero Covid rules and reopen factories and the country. How that will work in the face of newly spiking Covid infections remains to be seen.
But there’s also been a very visible easing of the three red lines, to the point where they’ve been shelved, at least temporarily. At the same time, regional banks have been told to lend to property developers and start to clear up the trillions of dollars of LGFVs they ran up off their balance sheets.
The only way they can lend more to property developers and start to sell debt against those off-balance sheet loans – which they’d do in order to put those loans onto their balance sheets properly, where they can be measured and presumably reserved against – is for the PBoC (People’s Bank of China) to loosen conditions dramatically, lower rates, and have the country’s biggest state-owned banks finance the attempted recovery.
But the hole China’s in is huge, and there’s no guarantee they’ll navigate themselves out of it despite the latest reversals and flimsy property sector pillars being erected.
Still, right now positive sentiment is driving markets up, and if you want to bet on that trend continuing, there are some simple things you can do.
The easiest is buying the Chinese tech ETF, KraneShares CSI China Internet ETF (KWEB), which we’re playing in my Hyperdrive Portfolio service, and are already up nicely on. Or you can play some of the big Chinese tech stocks traded directly in the U.S., like Alibaba Group Holding Ltd (BABA) and Baidu Inc (BIDU).
The safer way to play them would be by buying call options or call spreads as opposed to buying the stocks, where you’d have a much greater capital outlay and greater risk if they fall backwards.
As far as China “reopening” there are tons of ways to play that too. Global miners and materials stocks as well as energy plays would serve you well as long as the Chinese are able to turn their ship around.
But just in case it goes the other way, you better have your stops in place and be ready to buy put options across the board, because if China fails, all markets will feel the rip.