Could China go through some sort of property bust?

Evergrande said its property sales will likely continue to drop significantly in September after declining for months, making its cash flow situation even more dire.

Over the past time, many experts have spoken about some of the historical comparisons that are being made right now. Examples include the stagflationary period of the 1970s and, in a US context, the debt ceiling crises of 2011, 2013 and more. There’s another historical comparison that might also be apt at the moment. It’s comparing China’s current situation with Japan in the 1980s. In the past, there are the similarities here; of nations rapidly industrialising, expanding trade voraciously and experiencing rapid asset price inflation and debt build-up in many areas like housing.

But in the 1990s, this all went into reverse in Japan as the bottom fell out of the property – and stock – markets. It matters if China’s current predicament with respect to Evergrande foreshadows a similar fate. But a key point is that the yen continued to appreciate rapidly through both the ups of the boom and the downs of the bust, and that could prove a template for the renminbi.

US economist Paul Krugman has made similar points about the economic similarities of China now with Japan in the 1980s and 90s1. As he would readily admit, there are also a huge number of differences and these could make the outlook somewhat dissimilar. Krugman makes no mention of the currency issue but that’s what we want to focus on.

In the early 1970s, dollar/yen came out of the prior fixed peg to the dollar at a level of just over 300. Through to the bursting of Japan’s property bubble in 1990, dollar/yen just about halved in value to around 150, and then it halved again, down to a low of near 75 in 2011. Since then, it has been more stable and has therefore retained the vast bulk of the appreciation that has occurred in the past 50 years. In some senses this might seem odd. For the yen strengthened through a period when its asset prices collapsed, its economy slowed significantly and deflation became an ingrained problem. Debt soared to over 200% of GDP and the political cost of this was a rapid turnover of Prime Ministers.

Mr.Steve Barrow, Head of Standard Bank G10 Strategy said that much of the strength was due to international pressure for a stronger yen because of Japan’s growing trade surplus. It seems that China has experienced a similar sort of pressure as the renminbi has rallied since it de-pegged back in 2005 at a rate of 8.28 to the dollar. These accumulated Japanese surpluses generated huge income receipts from foreign investments and this meant that when Japan’s trade surplus shrunk, and even moved into deficit, the yen was not pressurised because the surplus on the income account proved a useful nest egg. A corollary of this is that Japan did not rely on overseas investors to fund its growing budget deficit and this meant that the yen was not vulnerable to any souring of international sentiment towards Japan.

We could argue that similar things are at play in China. But there are also notable differences as well. One, of course, is that Chinese officials still have greater control over the movement of the renminbi. In our view, this has helped the country avoid the sort of rapid currency advance that Japan has seen through much of the past 50 years, and it could also help avoid significant losses should sentiment towards the renminbi sour. In the aftermath of the global financial crisis, for instance, we saw the Chinese authorities lock down the renminbi for a period of time as it let the dust settle. A second difference is that China seems to want to make the yuan an international currency, even if its commitment might have wavered from time to time. Japan never really sought this role for the yen and that might just serve to give extra momentum to the renminbi if China’s efforts continue to be successful. While we admit that we’ve barely scratched the surface of this issue, we do see salient similarities between China now and the Japan of 30/40 years ago. If we are right about this, and even if China does go through some sort of property bust, we’d still look for the renminbi to keep rising, said Mr.Steve Barrow.