China's radical new transformation is a boon for Australia

China’s radical new transformation is a boon for Australia

It’s been two years since China imposed a little-known policy on its property development sector that was to have a huge impact on Australia.

Dubbed the Three Red Lines, the policy aims to deleverage China’s heavily indebted real estate development sector. This should discourage them from overbuilding against basic demand to prevent ghost blocks and cities from becoming a drag on the Chinese economy with so much wasted effort.

With 90 million vacant homes, enough to support urban population flows for a decade, one could argue that Beijing has waited too long.

Still, the policy worked too well. The volume of construction collapsed because the leverage of the developers was so extreme that winding it up led to a veritable financial crisis for them.

In addition to the three red lines, China has also wrestled with Covid this year by deploying draconian lockdowns and controls. This has undoubtedly made sales of new property developments even worse.

Solving the problem with 36 new measures

However, this adjustment has come at the expense of Chinese growth, the scale of which is now stretching Beijing to the limit. As a result, she has announced 36 new measures to address the convergence of housing crisis and Covid-zero.

Twenty of the new guidelines aim to prevent excesses by local authorities when implementing Covid-zero. They don’t let Covid ‘tear’. And any reopening will likely be slow and painful given the heavy marketing investments President Xi Jinping has made in his management of the plague. But China is relaxing controls at the edge, likely indicating more to come.

The other 16 policies are aimed at reviving property sales and the areas are starting directly. The main purpose of this is to free up funding for developers so they can start completing more projects. This includes lowering mortgage rates locally to stimulate demand.

The problem is that the Chinese economy is in what has been dubbed a “liquidity trap” after Beijing hammered into people’s heads for more than two years that “houses are for living in, not speculation.” Nobody wants to take out loans and invest in real estate because the President has made it absolutely clear that he will not accept it.

The associated markets have recovered, but there is good reason to be skeptical. The three red lines are still in force. The need for them has not changed. Developers have been demonized. And property damage is common.

Perhaps most importantly, Xi’s dictum of “general prosperity” is intact, explicitly avoiding another new round of house price booms as “real estate is for living, not speculation.”

iron terrible

The three red lines policy was a massive shock to Australia’s main steel commodity. Iron ore, in particular, recently fell from $230 to $78.

In a way, Australia got off lightly. The shock to iron ore was cushioned by two factors.

First, there has been a large surge in Chinese infrastructure investment to offset the crashing construction of high-rise buildings.

Second, and more importantly, China stopped about 60 million tons of steel recycling annually, 6 percent of total steel production. This enabled recycling to absorb a 100 million tonne slump in demand for building materials that would otherwise have been lost.

The cause was a power shortage crisis that began before the Ukraine war and continued afterwards. Steel recycling uses a lot of electricity, which Beijing says is needed elsewhere.

So will the 36 new measures trigger another iron ore boom in Australia? Maybe in the short term when the increase takes effect. But probably not for more than a few months.

China’s power shortage is now largely resolved. International markets have calmed down and China is producing much more coal, so steel recycling growth should resume.

Real estate conservatism is ingrained in both demand and supply in Chinese markets. Covid-zero remains a major slowdown for China’s entire economy, with no easy fix in sight.

Most importantly, the reason for the imposition of the Three Red Lines is still there. China is quickly running out of people to move from country to city, and the empty homes are already being built to accommodate the rest.

David Llewellyn-Smith is Chief Strategist at MB Fund and MB Super. David is the Founding Editor and Editor of MacroBusiness, and was the Founding Editor and World Economy Editor of The Diplomat, Asia Pacific’s leading geopolitics and business portal. He co-authored The Great Crash of 2008 with Ross Garnaut and was editor of the second Garnaut Climate Change Review. MB Fund is underweight Australian iron ore mining companies.

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