Known in the past for being bearish on China, Peking University finance professor Michael Pettis has been fairly optimistic of late. He has argued that China is mostly likely going to have a long landing, shedding 100 – 150 bps of growth per year while transferring wealth back to households, and that all Beijing has to do now is deliver on promised policy reform to prevent a crash. As concerns mount about a Chinese real estate bubble, Pettis explains that falling housing prices aren’t nearly as dangerous as people seem to think.
“The danger is that a decline in property prices could have a negative impact on consumption,” says Pettis in an interview with to Goldman Sachs senior strategist and Top of the Mind editor Allison Nathan. “I am not saying that a fall in housing prices won’t reduce consumption, just that it might not drop as much as it has in other countries.”
Two factors supporting Chinese consumption
Pettis says there are two important mitigating factors to bear in mind when considering the impact of falling real estate prices in China. First, the real estate market was partially driven up by speculators whose consumption will be less sensitive to falling prices, so the wealth effect shouldn’t be quite as pronounced. At the other end of the spectrum, working class families in China have been under a lot of strain to save money to help their sons buy an apartment before prices go up even more. As expectations shift, that pressure to save will ease up a bit and could leave more room for consumption.
If the Chinese government can manage to transfer wealth to households as it intends (with land reform, deposit rate liberalization, and other measures announced at the Third Plenum) alongside falling real estate prices, the impact on consumption will be even more muted.
Beijing likely to explicitly guarantee deposits, says Pettis
Falling prices don’t have to be a major problem for the Chinese banking sector either. According to Pettis, the sector is probably insolvent already but so were most American banks in the 1980s. The real issue is whether there is a run on the banks that pushes them from insolvency into illiquidity. It didn’t happen in the US because deposits are insured, and people take that guarantee seriously.
“Chinese bank deposits are implicitly guaranteed and will likely soon be explicitly guaranteed, and Beijing’s credibility is also very high,” says Pettis. “As long as it remains high, deposits will remain in the banks and the financial system will continue to function…the likelihood of a financial crisis is pretty low.”