Challenge

China's property bust is sending shock waves through the country's middle class of 400 million people, many of whom are cutting spending and delaying life decisions like getting married, according to Bloomberg. 

Home prices fell the most in seven years in October, and the country has enough empty apartments to house 90 million people, illustrating the depths of the downturn that's prompting policy makers to bail out the residential real estate sector. 

The unique nature of China’s housing market creates even more pressure on the sector. New homes are often sold before they are built with mortgage payments starting almost immediately after the buyer makes a deposit. And the industry plays an essential role in the economy, with 70%-80% of household wealth in China coming from real estate. According to Bloomberg, the value of China’s residential housing sector is estimated at $52 trillion.

If the Chinese real estate bubble pops, could that force China into a recession, and drag the rest of the world with it?

Like much of Europe, Germany’s economy has become increasingly linked with China. In 2016, China replaced the US as Germany’s top trading partner, and almost half of German manufacturing companies are dependent on key inputs from China, according to the IFO Institute.

A recent PGIM survey found that China’s real estate bubble creating a global recession—a low-probability event with outsized potential to derail markets—is a top tail risk for institutional investors in Germany.

Impact

Already, Europe is seeing a slowdown in demand from China, according to Joerg Wuttke, President of the European Union Chamber of Commerce in China. In the first eight months of 2021, Europe shipped 1.2 million containers to China. In the first eight months of this year, Europe shipped just 1 million containers, a 17% decline. And imports from China are going down, too, Wuttke says, from 4.1 million containers last year to 4 million this year. 

That reduced trade presents a potential risk to supply chains, but Wuttke says the Chinese government is able to constrain the effect of a real estate bubble in a manner that Spain or the US couldn’t in 2008 because the Chinese government has so much control over the country.

"The bubble is not bursting, it's deflating because the government owns everything," Wuttke says. "They own the banks, many of these construction companies are heavily state-owned, and then they own the news. It's very important because if you are on top of the news then people get less excited about it."

Germany shouldn't feel too much pain if China's real estate bubble pops, according to Jurgen Matthes, Senior Economist, Cologne Institute for Economic Research and Head of the Research Unit “International Economics and Economic Outlook.” 

Matthes notes that just 3% of German jobs depend on China. However, he says that the German auto industry in particular could suffer as a result of a recession in China in terms of profits, though not jobs, since most of China's cars are built in China.

The China market still matters to German companies, and Matthes sees one area where China could have an outsized impact on its biggest European trading partner: critical goods. China plays a dominant role in supplying rare earths like magnesium and other raw materials that are key inputs for Germany’s pharmaceutical and manufacturing sectors.

“In general, I think Germany’s dependence on China on the economy level is limited, but in critical goods, it's a huge dependency and it can be weaponized by China,” Matthes says. “The dependence of some German firms on the Chinese market is also large.”

Takeaway

Nobody wants a decoupling with China, Matthes says, but Germany is looking to boost trade with other Asian partners like India, Indonesia, Singapore, Vietnam and other Asian countries.

“The strong view here in Germany from the policy side, but also more and more from the corporate side, is that diversification is the game to play,” Matthes says.

That diversification also needs to apply to suppliers of rare earth products as well. Reducing reliance on China for these critical goods is a key topic for all businesses, and governments around the world should support this goal, he says.

For Wuttke, China’s real estate bubble and the Chinese government’s response demonstrates a shift in China policy away from economic growth and toward state control that investors and business leaders should watch closely.

“We have to wake up to the fact that China is willing to shed economic growth for the sake of control and security, and then ask, How does that translate into your sector?” Wuttke says.

For those heavily exposed to China, these shifts may warrant adoption of a more preparatory mindset when it comes to protecting their portfolios.