The debt crisis unfolding in the second-largest economy’s public and private sectors is being televised all over the world. One area being closely monitored by global financial markets is corporate debt. The tropical storm of corporate defaults and insolvencies will soon metastasize into a tsunami that could trigger a significant economic event that will impact not only Beijing but also the entire global market. To understand the ocean of red ink submerging China, you must first look to the sky.
Skydiving in China
For nearly two years, the People’s Bank of China (PBoC) and the federal government have been accommodative to market needs. The leadership has expanded the money supply, cut interest rates, altered banking and credit requirements, and bailed out struggling state-owned enterprises (SOEs) This has all been done for the sake of staving off the inevitable decay of the debt-fueled, Ponzi-scheme economy.
In another sign that lenders are tightening credit, despite pushes by the communist authorities, work on one of the nation’s largest skyscrapers was suspended because the developer defaulted on a payment. You can add this project to the long list of unfinished skyscrapers.
The Financial Times viewed an Oct. 30 letter that confirmed China Construction Third Engineering Bureau Co would halt construction on a 1,558-foot skyscraper in Wuhan. Greenland Group, one of the largest property developers in China, failed to make a “significant payment to fund the ambitious project.”
Credit for property developers has substantially cooled off over the last 18 months. This comes as economic growth has tumbled to its lowest level in 30 years. While the Sino-U.S. trade war is the main culprit, the Chinese economy’s fundamentals are being exposed. Like The Portrait of Dorian Gray, the real image of the paper-tiger economy residing in an attic somewhere is a truly frightening canvas.
So far this year, a dozen or so skyscrapers taller than 900 feet either have been postponed or have fallen behind schedule due to credit conditions. Yan Yuejin, an analyst at Shanghai-based E-house China Research and Development Institution, told the business newspaper:
“Unfinished super tall skyscrapers, which cost a huge amount of funds to build, are a typical sign of economic recession. They are financed by credit and will run into trouble when lenders begin to scale back.”
Will Beijing fall to the Skyscraper Curse?
The Skyscraper Curse
In 1999, economist Andrew Lawrence developed the Skyscraper Index, a concept that draws a correlation between economic busts and the construction of the world’s tallest buildings. It suggests that investment in skyscrapers peak when growth has been exhausted and the economy is on the brink of a downturn. In 2007, the skyscraper theory became a reliable tool for students of the Austrian School of Economics and for anticipating major economic crises.
Economist Mark Thornton devised the Skyscraper Index Model, which borrows from Irish-French economist Richard Cantillon’s 18th-century teachings and examines several effects of the so-called skyscraper curse. The first is that a cut in interest rates boosts land prices and increases the size of companies to raise demand for office space. The second is that artificially low rates offer investment to construction technologies that push developers to break height records. Thornton posits that these factors peak at the tail end of the expansion period.
Ultimately, Thornton contends that man-made distortions to rates below the natural rate put “the economy’s structure of production in an unsustainable manner.” So, if developers want to erect record-setting skyscrapers, they will require a laundry list of new technologies, processes, and systems that need their own production, distribution, installation, and maintenance. All of this will further misdirect businesses, consumers, and investors.
In the end, the parties involved in every stage become more leveraged and prone to defaults. When the business cycle transitions from boom to bust, the demand for skyscrapers diminishes. This makes it difficult for the firms integral to the building of skyscrapers to survive. They are now under threat as profit margins tighten.
We saw this fascinating pattern happen in the United States during the Panic of 1907, the Great Depression, the dot-com bubble, and the housing bubble. This occurred in the United Arab Emirates several years ago. And now it is unfolding in China. It is a global and cyclical phenomenon.
Excuse Me While I Kiss the Sky
Some of the most iconic cities in the world have a skyline full of skyscrapers, from New York City to Beijing and Dubai. It seems counterintuitive to suggest that erecting these massive buildings could be a sign of an upcoming slowdown. But when you scratch beneath the asphalt surface, you notice patterns: low rates, more development, a recession. The next time a property developer lays the groundwork for a record-setting building, prepare your bank account and budget for the downturn.
Read more from Andrew Moran.