On September 24, 2024, the People’s Bank of China Governor Pan Gongsheng held a rare press conference. He announced a plethora of measures with the express intent of halting a deflationary spiral deepening China’s economic slump.
Policy tools, however, were mostly in the monetary realm. They included flooding markets with more cash, lowering interest rates, and looser rules on stock buybacks. The announcement immediately put Chinese stock markets on steroids. The CSI 300 index soared more than 30 percent in three weeks.
But doubts quickly reemerged. The purely monetary orientation of the stimulus was seen as insufficient to jumpstart the economy. A much more forceful package of fiscal stimulus measures was increasingly seen as necessary—one that would not only flood markets with money, but also spur new investments and consumption.
Subsequent press briefings during October 2024 by Chinese ministry and agency leaders, including finance, housing, and development & reform reverted back to a piecemeal approach. They focused on addressing local government debts, developer’s financing needs, and mega construction projects. Alas, they skirted expectations for a large fiscal stimulus.
Equity markets didn’t react well. Chinese stocks resumed their downward trend, while many commentators and analysts continued to implore the Chinese government to do more.
In the absence of the “big bang fiscal stimulus” investors have anticipated, the animal spirits so necessary to put a floor under domestic demand and investment are unlikely to return. And as recent Chinese trade data evidenced, exports are unlikely to help the economy much, especially when protectionist sentiments are rising globally.
The history on the application of Keynesian government stimuli is clear: they work, though there are important caveats. When faced with the incessant downward spirals of deflation during the Great Depression, the eminent British economist Sir John Maynard Keynes proposed that “the government should pay people to dig holes in the ground and then fill them up.”
There are naturally more productive investments, but what Keynes emphasized is the importance of government intervening during recessions, especially those with deflationary potential as tends to happen during housing slumps. Government has to act as the spender of last resort to create jobs, increase incomes, and thus strengthen consumption, engendering positive feedback loops.
Keynesianism got a bad rap during the stagflation of the 1970s. Its policies were blamed for inflation and yawning government deficits. Neoliberalism and monetarism won the economic arguments starting in the 1980s up to the Global Financial Crisis of 2008.
Ironically, Keynesianism has returned more powerfully than ever. Monetary tools so in vogue were insufficient to combat deflationary pressures after the 2008 crisis. Even the application of unconventional monetary policy, i.e., Quantitative Easing (QE) that floods markets with money, took an extremely long time to take effect.
The U.S. Federal Reserve’s balance sheet increased from around $800 million in 2008 to $4.4 trillion in 2014, an over five-fold increase. However, this was paired with lackluster fiscal support by the government. The result was an increase in asset prices, first bonds and equities, and then gradually real estate. But its effects on the labor market were tepid and very slow moving, creating a “jobless recovery” during the early 2010s. There was one major upside: despite warnings from hard-core monetarists and bond vigilantes, the flood of money didn’t cause a burst of inflation.
The 2008/9 stimulus – large monetary/small fiscal – stands in stark contrast to the 2020 stimulus enacted due to the COVID-19 pandemic. Once more, the monetary stimulus was massive, increasing the Fed’s balance sheet from around $3.8 trillion to $8.9 trillion, an increase of $5.1 trillion. This flood of money also continued for far too long, lasting from March 2020 until the fall of 2021 when the economy was already recovering and real estate and stock markets were soaring.
Most importantly, there was a big difference compared to 2008/9. Monetary stimulus was paired with massive fiscal spending enacted by the U.S. Congress that pushed money directly into the hands of consumers and small business owners. Consumers got direct financial support and enhanced unemployment benefits, while business owners could seek compensation for financial losses due to the pandemic.
This time the labor market recovered immediately, economic growth accelerated, and investment boomed. But the inflation that never appeared a decade back reared its head with a vengeance. The United States experienced the roughest patch of high inflation since the early 1980s, souring the national mood despite a good economy.
America’s recent experiences hold important lessons for China. Monetary stimulus on its own is insufficient and creates economic imbalances by enriching capital-holders. Monetary stimulus combined with fiscal stimulus clearly works, but if too large, or too sustained, it will produce strong inflationary pressures. And naturally, large fiscal stimuli built upon unsustainable government finances will not only spur inflation, but potentially bankrupt a nation.
There are therefore important trade-offs, but if governments wait and enact piecemeal measures that never quite sway the public, even more danger awaits. Simply put, without a major jolt to confidence, it's hard to ease deflationary pressures. In particular, real estate slumps are very difficult to turn around since they feed heavily into consumer spending, producing the long-lasting negative feedback cycles so commonly seen in other housing busts like Japan’s.
Although it was used to address unlike circumstances, there was a certain genius behind Mario Draghi’s statement that “the ECB is ready to do whatever it takes to preserve the euro.” China requires a “whatever it takes” moment. A truly big bazooka aimed squarely at the root of the problem: housing.
The outlines of this solution are already apparent in Chinese government pronouncements and recently announced policy packages. The government is creating a “white list” of real estate projects. This program will be expanded to four trillion yuan ($562 billion) from about 2.23 trillion yuan already deployed, Housing Minister Ni Hong recently specified. These are projects in various stages of development that hold commercial potential and are deemed as worthwhile completing.
However, despite their good intentions, these policies are insufficient. Beijing has to deploy a “heavy punch combo,” resetting market sentiments. First of all, top government officials need to state that they will do whatever it takes to revive the housing market and complete all unfinished housing projects.
A large number needs to be included to set expectations, somewhere north of 10 trillion yuan, ideally 20 trillion. These monies should be gradually expended with the clear intent to finish the thousands of unfinished projects dotting Chinese cities, especially those located in third and fourth tier cities. As is the intent with the “white list” much of this housing will be converted to low-cost rentals supported by local governments.
Additional policies, some already announced, could create new demand for such housing by opening up the hukou (residency) system further, creating portable pensions and medical care, and putting in place various incentives for retirees, indeed, whole families to relocate to much cheaper inland cities. The high-speed rail system has already laid the infrastructure to make such demand plausible.
Three to four years of booming construction and real estate markets, especially in lower tier cities, will also create much needed policy space to address local government debts. Policies to convert hidden debts to actual local government debts are much more likely to be successful with a buoyant economic backdrop.
Overall, policies announced so far already go a long way towards stemming some of the problems in the housing market and the broader Chinese economy. But Beijing leaders need to leave their piecemeal incremental approach behind and roll out a bazooka so large, it resets consumer and investor expectations.
A whatever it takes moment is needed, one that focuses on putting a floor under the housing slump, reviving construction on a sustainable scale over several years, and creating the incentives for all this new housing stock, even that in third and fourth tier cities, to be gradually absorbed.
In the end, finished flats could be given away by lottery. Better than thousands of uncompleted construction sites blighting the Chinese landscape.
