The next few months put Japan in line for a series of anniversaries that it would probably rather forget. But these are dates that the leadership in China may do well to mark: the detonation of time bombs with meters set off by a housing bubble.
Because these are, some would say, clearly resonant times. New research suggests that if care is not taken, China may be on the way to a new wave of Japanification.
In 2003, Japan could no longer fool itself into thinking that all was well. The 1990s had taken the country off a trajectory in which it once seemed capable of overtaking the United States. His subsequent mishandling of the mountain of bad loans built during his vainglorious days of the 1980s put an end to the idea that the country could easily recover.
The massive bank mergers, encouraged by Tokyo over the previous three years, were not enough to disguise a collection of interlocking and unresolved crises. In March 2003, Sumitomo Mitsui Financial Group carried out a panic reverse merger with a subsidiary amid huge losses. In April, the first signs began to emerge that one of the country’s largest lenders, Resona, was going bust. In May, taxpayers had bailed it out with a $17 billion nationalization program. Later that year and with emergency horns blaring, Ashikaga, a once blue-chip regional lender, went bankrupt. All of these events were delayed explosions that could have caused much less damage if they had gone off earlier.
The problem, as a team of Citigroup analysts declared last week, is that China today looks “strikingly similar” to Japan in its post-housing-bubble era. The respective country demographic profiles, with China’s population now shrinking as Japan’s did years earlier, provide a reminder that after 1990, Japan’s house price index fell as the cohort of 35 to 54 years. The report focuses its warnings on potential risks to China’s banking system.
Citigroup identifies several areas of similarity. Both countries entered extended phases of strong GDP growth (Japan’s began in the postwar era and China’s after joining the World Trade Organization in 2001) through investment in infrastructure and fostering exports. Between 2010 and 2020, capital formation accounted for an average of 43 percent of Chinese GDP growth, according to the World Bank. When its bubble burst in 1990, Japan’s capital formation ratio was about 36 percent and considered very high.
Japan and China also financed their growth in a similar way. Japan’s bubble era was fueled by indirect financing provided by commercial banks, which were pushed by the authorities to channel soft loans to favored industrial sectors. Similarly, Citigroup says, China has developed a financial system that relies primarily on indirect financing. In addition to the tools available to the People’s Bank of China, the government can direct the lending activities of commercial banks through a number of mechanisms.
Japan’s 1987-89 stock and housing bubble expanded more rapidly after the authorities introduced easing policies to boost domestic demand. Loans expanded dramatically and liquidity was funneled into stocks and property to the point where financial speculation became more profitable for companies than running a business.
China, decades later, has also allowed the real economy and the financial system to become decoupled. The country’s clearly bubbly real estate market, according to Citi estimates, reached $65 trillion in 2020, surpassing those of the US, EU and Japan combined. By 2021, 41 percent of China’s banking system’s total assets were in property-related loans and credit. The run-up to the housing bubbles in both countries was hastened by the existence of a vast shadow banking market, which evolved to circumvent state-imposed lending limits and other restrictions.
Citi analysts even see a parallel between the two nations’ relations with the United States. As Japan’s trade surplus soared, competitive friction with the United States escalated into an open trade war in the 1980s, with technology, intellectual property and security concerns at the center. There are parallels in the way, for example, that recent legislation and other measures in the US have sought to restrict the access of non-Americans to advanced technology.
These similarities may not be exact equivalents, but their overall effect could be. Twenty years ago, Japan was just reaching the bottom of its post-bubble depression. Debt from zombie companies colonized the balance sheets of strained financial institutions, businesses and households were in a long-term deleveraging phase, and interest rates stayed low. This is Japanization with Chinese characteristics, Citi concludes, and the risks investors need to pay attention to are those in the banking system.
leo.lewis@ft.com