China Following Japanese Pattern of Debt and Real Estate Crisis

November 30, 2021 Updated: November 30, 2021

News Analysis

Just like with Japan’s meteoric rise to the world’s number two economic power, followed by a crash and stagnation, many experts believe it is not inevitable that China will displace the United States.

Following a similar path, during their rapid economic expansion, both Japan and China experienced a debt crisis and real estate bubble. In Japan, this led to the “lost decade” of lifeless economy during the 1990s. China may be headed the same way.

Beginning in the 1960s, the Japanese economy was growing at an average rate of 10 percent per year. By the 1980s, Japan was the Asian miracle, having moved from one of the poorest to one of the richest countries in the world. The growth, however, was fueled by debt and an inflated real estate sector. The house of cards eventually came crashing down, and the term “Japanification” became synonymous with stagnation.

Japanese property prices skyrocketed, peaking in 1990 at 168 percent above their 1985 value. At that time, Tokyo real estate could sell for as much as $139,000 per square foot, nearly 350 times as much as the same parcel in Manhattan. Real estate prices had become so inflated that they still have not recovered.

China is facing a similar real estate bubble, with the industry accounting for roughly 30 percent of China’s GDP. Troubled property developer Evergrande, and its looming $200 billion in possible defaults, represents about 2 percent of the country’s GDP. And this is just one of several distressed real estate companies.

To put China’s property market in perspective, over the past 20 years, the average apartment price in Beijing went from $55 per square foot to $813. A measure of home affordability, the housing price-to-income ratio, rose from 5.6 in 1996 to 7.2 in 2020, with the average mortgage costing 397.36 percent of income. At its peak, in 1988, Japan’s housing price-to-income ratio was only 3.0.

China’s banks lent proportionally more to the property sector, with real estate accounting for approximately 30 percent of outstanding loans. The ratio of home loans to GDP in China is three times Japan’s. Household debt in China, which is closely linked to real estate loans, now stands at 128 percent of household income and 56 percent of GDP. By contrast, the Japanese household debt to income ratio peaked in 2000 at only 78.7 percent.

After the bubble burst, the Japanese economy was caught in a quagmire from 1991 through 2000. During this “lost decade,” the country suffered from both a credit crunch and a liquidity trap. Part of this economic slowdown was caused by the Bank of Japan (BOJ) increasing interest rates to bring the real estate market under control. The Japanese government also used public funds to restructure bank balance sheets, in an attempt to regulate both deflation and inflation, and to avoid stagflation.

One of the most difficult problems for central banks to address is stagflation, an economic condition marked by both rising prices and unemployment. When the central bank increases interest rates, this will reduce borrowing and bring inflation down—but this will also slow the country’s economic growth and exacerbate unemployment.

Epoch Times Photo
The Japanese national flag is seen at the Bank of Japan headquarters in Tokyo. (Kazuhiro Nogi/AFP via Getty Images)

By 1989, the total value of the shares traded on Japanese stock exchanges increased to 1.5 times gross national product (GNP), up from 0.6 times GNP in 1985. The Nikkei 225 stock market index peaked at 39,000 in 1989.

The BOJ found itself facing inflation and skyrocketing property prices. Consequently, it tightened up on lending in order to reduce the money supply, which brought down inflation. The reduction of lendable funds, however, may have caused the real estate bubble to burst. As interest rates climbed, property values fell, as did the price of Japanese stocks. By 1992, the Nikkei 225 was down to 17,000.

During the 1990s, Japan’s GDP growth slowed to 1.14 percent annually. The real estate market collapsed, losing 70 percent of its value by 2001.

Faced with the reverse of inflation and an economy headed into recession, the BOJ cut interest rates in order to increase the money supply and restimulate the economy. But it was too late as Japan was facing a liquidity trap, a situation where individuals and companies, fearing deflation, sit on their cash because they are afraid to spend or invest. Fear of deflation actually caused deflation, and the economy ground to a halt. The central bank cut the discount rate to .5 percent, but there were no takers for 10 years.

Similar to 1980s Japan, the People’s Bank of China has maintained a loose monetary policy for some time in order to encourage economic growth, but this has most likely fueled the housing bubble. Now, as the Chinese economy is slowing, if Beijing restricts the money supply to bring the property sector under control, it will risk causing a decline in investing and spending, which would further deteriorate an already sluggish economy.

According to Leland Miller, chief executive officer of China Beige Book, China’s third-quarter economic data was worse than many expected. Consumer spending is still not reaching levels necessary to buoy the economy. People are reluctant to spend because of reduced incomes, owing to COVID-19 lockdowns and the unpredictability of future lockdowns, as well as general price inflation. The economic uncertainty over the past two years has destroyed consumer confidence. Additionally, China lacks the social security nets that many developed countries enjoy. As a result, Chinese consumers are holding on to their cash, anticipating a rainy day.

Chinese leader Xi Jinping is looking for consumption to take the place of real estate as the backbone of the economy, but that is not happening. So China must find some other business activity that can take the place of real estate in the economic mix.

One of the biggest differences between Japan and China is that, when the Japanese bubble burst, Japan had high-tech innovation, advanced manufacturing, and world class automobile exports to fall back on. China, by contrast, has nothing to replace the real estate sector.

Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.

Antonio Graceffo, Ph.D., has spent more than 20 years in Asia. He is a graduate of the Shanghai University of Sport and holds a China-MBA from Shanghai Jiaotong University. Graceffo works as an economics professor and China economic analyst, writing for various international media. Some of his books on China include "Beyond the Belt and Road: China’s Global Economic Expansion" and "A Short Course on the Chinese Economy."