In autumn 2018, a Chinese blogger, who  claimed to be a "veteran in China's  

financial sector," sent shockwaves through  the business community with an article saying  

that the historic mission of private enterprise  had achieved all of its goals in China and that  

communist ideology would be coming back in full  force – the era of private enterprise was over.  

The article was so widely shared and caused such  consternation that the Communist party spoke out  

to calm the nerves of the business community –  there was nothing for people to worry about.  

Shortly afterwards the crackdowns  began. Over the last few years,  

President Xi’s administration launched a  series of campaigns targeting different  

areas of business with the goal of reshaping  the business and cultural landscape in China.  

The government targeted the fintech industry,  private tuition and entertainment as well  

as perceived societal ills such as celebrity  culture, gaming and effeminate fashion trends.  

They also banned the beloved children’s  animated character Winnie the Pooh – i dunno,  

maybe you are not supposed to say poo.  I mean honestly… who named that bear..  

The severity of the action taken by Beijing  against private companies surprised people  

both in China and abroad, and while these attacks  on private enterprise were harming the economy,  

the real damage was yet to come. The three red  line policy in August 2020 essentially sucked  

all of the air out of the room for Chinas property  developers. This was a big deal as China’s  

property sector is estimated to make up almost  a third of the country’s total economic output.  

A number of developers – unable to refinance  - including Evergrande, Kaisa Group,  

Fantasia Holdings and Modern Land China have  since defaulted on their debt, and the property  

market has ground to a halt over the last few  months. The problem is bigger than that though,  

as local governments in China historically  raised about a third of their total revenues  

from selling land leases to property developers.  That revenue source evaporated in autumn 2021.  

Now just to be clear, there was a definite  problem of excessive leverage and real estate  

malinvestment in China, and this had been building  for fifteen to twenty years. My friend Hugh Hendry  

has pointed out that there are 55 million  empty housing units in China right now and  

93 million new homes under construction. Actual  housing demand is estimated to be 7 million new  

units per year. That is a lot of excess inventory  building up. Something did have to be done about  

the excesses in the real estate sector, but you  have to question if the brakes had to be slammed  

on that hard, and if it makes sense to hammer  other sectors of the economy at the same time?  

The government actions erased billions of dollars  of value for both domestic and foreign investors.  

It put unprecedented levels of pressure on  some of the country’s largest employers,  

local governments, and corporate contributors to  economic growth. The crackdowns left investors and  

Chinese businesspeople wondering if it made any  sense to invest in China at all going forward?  

So why did this have to happen right now? Well,  Chinese officials insist that all is going to  

plan. In April 2021, the party’s politburo said  China’s strong rebound from the pandemic had  

presented a “window of opportunity” to tackle  critical structural challenges in the country.  

They note that the Chinese economy is on  track to exceed the government’s full-year  

growth target of more than 6 per cent. They argue that this crackdown is a necessary  

element of a larger campaign  to eliminate financial risks  

that could blow up if not addressed immediately  and that these steps are needed to eradicate  

inequality and bring about “common prosperity”. There is something to be said for some of these  

arguments. Housing affordability in China  is right now amongst the worst in the world.  

It takes 40 years of income in Shenzhen  to purchase an apartment. That compares  

to thirteen years in London and eight in New York  Cities that are not famed for their affordability.  

President Xi has famously said that housing  is for living in and not speculation. And he  

considers housing policy as the central  part of his Common prosperity drive.  

China’s trade surplus reached its  highest level on record in 2021,  

It was 26 per cent higher than the  prior year and exports were 30 per  

cent higher. China’s manufacturing industry  benefited from a shift around the world  

from people spending money on services to buying  tangible goods over the course of the pandemic.  

There was a sudden drop in Chinese Exports  in early 2020 at the start of the pandemic,  

but Chinese exports of goods quickly took off once  domestic cases of the virus fell and lockdowns  

were imposed in other countries around the world. It doesn’t make sense to kick the can down the  

road as prior administrations have done  in China, and it possibly makes sense to  

implement reforms at a time when the rest  of the economy is experiencing growth,  

but it is not clear that a lot of planning went  into implementing the three red lines policy.  

It would appear that the Chinese government  were entirely unprepared for the repercussions.  

Since Xi has taken power, two big policy  mantras have been put forward by Beijing:  

common prosperity and dual circulation. Each  is likely to be further emphasized over time.  

Common prosperity signifies an  intent to raise the living standards  

of the approximately 600m Chinese “have-nots”,  while dual circulation entails a shift toward  

greater self-reliance - avoiding importing  goods from abroad – an attempt to achieve  

greater localization of China’s supply chain. In an online speech to the World Economic Forum’s  

annual meeting, president Xi struck a pro-growth  tone in his defense of the common prosperity  

policy. He said “The common prosperity we  desire is not egalitarianism. We will first  

make the pie bigger and then divide it properly  through reasonable institutional arrangements.  

As a rising tide lifts all boats, everyone  will get a fair share from development,  

and development gains will benefit all our  people in a more substantial and equitable way.”  

It doesn’t appear that many  of the recent campaigns  

have done much to grow the pie as he described,  and I struggle to imagine how any of them would.  

We’ll have to wait and see how  the more equal division goes.  

So, China is still growing, but it is growing  less than before. By most international standards,  

China’s 4 per cent year-on-year growth  in the fourth quarter of last year was a  

great performance. But while it was above most  analysts’ predictions, it was the slowest pace  

of expansion for 18 months — a slide from 6.5  per cent growth during the same period in 2020.  

This raises the question, as Xi seeks  a third term later this year, if the  

economic consequences of his common prosperity  campaign are beginning to spiral out of control.  

The three main factors putting a drag  on the Chinese economy right now are:  

Number 1. the crackdowns on businesses like in  the tech sector and education sector. Number two,  

the collapse of the property market. And number  three, China’s “zero Covid” strategy which goes  

far beyond social distancing and wearing masks.  It involves people being confined to their homes,  

closed roads, suspended transportation services  and it has left citizens short of food and other  

essential supplies. It is almost as bad as  Canada… China appears to be taking this action  

partly to prevent disruption to the  upcoming Winter Olympics, trading  

economic growth for international prestige. China’s slowdown is, to a certain extent,  

self-inflicted. But it doesn’t look like  Beijing will relax any of the policies  

affecting these three key areas as they appear  to reflect a strongly-held official conviction.  

On top of these problems, Chinese companies  are facing a number of additional headwinds.  

US Tariffs are still in place, and  there are new investment blacklists  

relating to human rights abuses. So, what is happening on the ground in  

China due to these policy-led slowdowns? Well, in  December China’s State Council accused the local  

government in Bazhou, of violating government  orders by going on a fee-collection spree  

from small and medium-sized businesses to make  up for its declining land-sale and tax revenues  

from the property slow down. The local government  ordered officials to collect $47m in new revenues,  

through the imposition of arbitrary fees and  fines on the local community. A factory owner  

describes being forced by the local meteorological  office to buy an expensive lightning rod from a  

government-designated supplier at a highly  inflated price. The central government,  

while outraged, said nothing about their own  policies that had forced the municipality  

to scramble for revenues in this manner. Local party and government officials in China are  

complaining that they, not the central government  in Beijing, have to foot the increasingly  

expensive bill for Evergrande’s collapse. As I  mentioned in a prior piece, they are being asked  

to complete Evergrande projects that buyers have  already paid for, but they do not appear to be  

receiving any government funds to get this done. An executive at a construction firm,  

told the press that his firm is refusing to  do any work on Evergrande projects for the  

local government unless he is paid in advance  – he is already owed money for work he did for  

Evergrande. In other cities local officials are  trying to auction their Evergrande problems away  

by selling off the developer’s uncompleted  projects in their jurisdictions.  

There are news reports of Chinese people who have  seen their home prices half, offering to give  

away their partially paid off homes to anyone who  will take over the remaining mortgage payments.  

There are other problems cropping up  too. In China developers often force  

their suppliers to accept commercial paper  – a form of IOU - instead of cash payments.  

They promise to pay this off by a future date. The  supplier is then able to use this commercial paper  

to pay its suppliers, provided it endorses the  document by stamping a company chop or seal on  

it. This commercial paper can easily be endorsed  ten times before it ends up with the final holder.  

If a company like Evergrande is unable to pay  upon maturity, the holder can sue every company  

that endorsed the document — potentially  freezing assets worth many times more than  

the original debt. This is a big problem. In 2020 the total amount of commercial paper  

issued by Chinese companies came to 3.5 percent  of Chinese GDP. Evergrande alone accounted  

for more than 60 per cent of commercial paper  issuance by the top-20 real estate developers.  

So is the government doing anything to ease these  problems? Well, so far, they are not doing much.  

China lowered its one-year loan prime rate  by 10 basis points and the five-year rate  

which is used to price mortgages was reduced by  5 basis points, the first cut since April 2020.  

The party’s year-end economic planning conference  reiterated that the government would continue to  

refrain from “flood-like stimulus” and would  continue its battles against “the disorderly  

expansion of capital” — party-speak for  the various crackdowns on private-sector  

businesses — as well as speculation and  high leverage in the real estate industry.  

What about the mostly state controlled Chinese  banks? Well, Chinese banks rushed to meet their  

state-required lending quotas last month by buying  up low-risk financial instruments rather than by  

issuing loans. They bought banker’s acceptance  bills, which are technically classified as loans  

and yield close to zero per cent. Chinese banks’  have a cost of capital of around 2.5 per cent.  

This means that they preferred to lose money  on low-yielding banker’s acceptance bills  

rather than risking greater losses by issuing  their own loans at higher rates of interest.  

Many of the problems being faced by President Xi  were in place when he took office, but it could be  

argued that better planning was needed in  order for these problems to be unwound in an  

orderly manner. Before implementing the three red  lines policy that would force Chinese developers  

to deleverage, the government could have made  plans for funding local governments that were  

reliant on selling land leases to developers to  fund their operations. A lack of planning can  

also be seen in the growing contagion that is  happening in Chinese commercial paper markets.  

It would appear that under these policies, Chinese  property prices will be in structural decline,  

and local governments will have to deal with  tight finances for the foreseeable future.  

The technology, education and  entertainment industries in China  

will also have to deal with growing regulations. For several years, China has contributed more  

to global GDP growth than any other  country and, before the coronavirus  

pandemic struck, it often accounted for close  to one-third of the world’s economic growth.  

Last year, China contributed about  one-quarter of global GDP growth  

as its property sector collapsed, birth  rates declined, and debt levels rose.  

These headwinds are unlikely  to dissipate any time soon.  

If you enjoyed this video, you should watch  this one next. See you again soon, bye.