China’s property slowdown could have a domino effect on global commodities

China’s property sector has slumped in 2014. Construction and house prices have dropped rapidly, and shockwaves are being felt across the global commodities market. Rita Lobo wonders whether the real estate sector is the first teetering tile in a row of dominos

Workers on construction sites in Beijing. China’s construction industry boomed for many years, but appears to have stalled
Workers on construction sites in Beijing. China’s construction industry boomed for many years, but appears to have stalled 

When Bill Gates tweeted that China had consumed more cement in the three years leading to 2013 than the US had in the whole of the 20th century, Twitter went into overdrive. Some speculated that he was misusing statistics; others assumed that he was just wrong. But not only was Gates entirely correct, the statistics tell a very alarming story.

Between 2011 and 2013, China used 6.6 gigatonnes of cement; 1.1 gigatonnes more than what the US used between 1901 and 2000, according to Vaclav Smil in Making the Modern World. “Concrete is the foundation (literally) for the massive expansion of urban areas of the past several decades, which has been a big factor in cutting the rate of extreme poverty in half since 1990,” Gates wrote about Smil’s findings on “In 1950, the world made roughly as much steel as cement; by 2010, steel production had grown by a factor of eight but cement had gone up by a factor of 25.”

The sharp increase in the global consumption of cement over the latter half of the 20th century was driven by the vast improvements in quality of life experienced in the West but also by unprecedented levels of rural-urban migration in industrialised nations. This is an ongoing trend globally, as more people join the middle classes. Over the past three decades, China has experienced phenomenal growth – much faster than anywhere else in the world.


of Mongolia’s exports go to China


of Turkmenistan’s exports go to China


of Gambia’s exports go to China

The emergence of the Chinese middle class over the past couple of decades has impacted more than anything else in history the world’s building and commodities market. Suddenly, rural workers were moving in droves to industrial centres; factories, railways, highways, energy infrastructure and entire towns had to be built where previously there was nothing. In part, it was this huge investment that kept the Chinese economy ticking upwards so fast; increased demand fuelled increased investment.

Building for growth
Since the onset of the financial crisis in 2007/08, though, the story behind China’s rapid investment in the property sector and infrastructure completely changed. Investment in infrastructure became a way to keep the economy growing, as foreign demand plummeted. In addition, the Chinese Government relaxed its attitudes toward credit in a bid to fuel domestic demand. So, as the rest of the world contracted, China continued to build skyscrapers, mansions, high-speed rail lines, theme parks, and anything else it could shape concrete into – with little or no regard for commercial viability.

In 2013, this cycle of investment started to unwind. The Chinese economy grew at its slowest rate since the end of the 20th century: 7.7 percent. Shockwaves were felt globally. A slowdown in China directly impacts a lot of other countries, and can have a domino effect on global growth. China imports 88 percent of all Mongolia’s exports, 20 percent of all Brazil’s exports, and 10 percent of the US’, to name a but a few.

Though the slowdown was driven at least in part by weak global demand, the domestic repercussions have been monumental; and growth is unlikely to pick up significantly any time soon. One of the hardest-hit industries in China has been the real estate and property sector, once responsible for driving growth. In the first four months of 2014, real-estate sales were down 7.8 percent compared with the same period a year earlier. If that wasn’t bad enough, construction on new projects was down 22.1 percent during the same period, compared to a year earlier, according to official government figures.

The figures are bad enough when taken at face value, but Gate’s tweet reminds us exactly how catastrophic this 22.1 percent decline actually is. The sheer scale of the Chinese construction industry means that any decline, however small, can have consequences globally. According to Moody’s, the residential property sector in China accounts for 24 percent of the country’s steel consumption, and as the sale and outfitting of apartments has plummeted 23 percent, it has taken with the it the price of iron ore. The consequences have been dire for Australia, which relies on the its copious iron ore exports, and has suffered tremendously as prices dropped 23.3 percent in 2014.

Bringing down the house
Australia has also experienced robust growth over the past decade, and most of that success is inextricably linked to China. Around 80 percent of Australia’s exports are commodities; 30 percent of the country’s total exports are bound for China (see Fig. 1). The slowdown in the Chinese economy has already had severe implications for Australia. “If you had a serious slowdown in Chinese property, which we are sort of seeing at the moment, you could easily shave off a percent or so from the real GDP numbers [for Australia],” Damien Boey, a Credit Suisse analyst, told The Sydney Morning Herald.

In early June, shares in Australian mining companies dropped to their lowest since 2012, as the price of commodities exported to China continued to drop. Australia has been investing heavily in infrastructure to support its mining sector, including building new ports approving controversial new mines. A lot of these developments depend on strong demand from China to be economically viable. It is likely that Australian commodities exports will eventually find another home, and the country will be less exposed to China, but in the meantime it’s not looking good.

It might seem like Australia is stuck between a rock and a hard place, but other countries are even more dependent on China. Mongolia, Turkmenistan and Gambia, for instance, rely on China to pick up 88, 73 and 68 percent of their exports respectively – and these countries have much less diversified economies than Australia. For Mongolia, in particular, the slowdown of the Chinese property market is nothing short of catastrophic.

Historically, when times have gotten tough for Mongolia economically, it has looked to China for support and trade, but as China slows down, it will inevitably drag down its neighbours too. Mongolia’s chief advantage is that its main exports are actually coal briquettes, widely used in China as fuel for home cookers and heaters. Up to 70 percent of China’s primary energy supply comes from coal, and though the country produces much of it internally, the briquettes imported from Mongolia are a vital source of energy for Chinese households, particularly in rural or poorer areas, where it has replaced firewood.

Source: Australian Department of Foreign Affairs and Trade
Source: Australian Department of Foreign Affairs and Trade

Though the Mongolian economy has been performing very strongly over the past few years – as it begins to explore its rich copper and iron ore deposits – the sheer volume of exports into China means the country could run into some trouble. Because of its location, nestled between China and Russia, Mongolia can certainly expand its trading horizons, but so far it has failed to do so. Only 2.1 percent of its exports make it to Russia.

Over-reliance on real estate
China’s overreliance on real estate to fuel its economy is not news, but the scale at which this had been occurring was unprecedented. The sale and outfitting of apartments accounts for almost a quarter of the country’s GDP, a worrying statistic; at the peak of their respective housing bubbles the US, Spain and Ireland did not rely on the property sector as heavily as China does today. This overexposure to the property market is also having problematic repercussions on the local financial services sector, as would be expected. Lenders, in both the conventional and shadow banking sectors, have been left terribly exposed as house prices fall and construction stalls on new projects. Debt levels in China have been increasing rapidly, and in 2013 there was more corporate debt issued there than anywhere else in the world. A large portion of those loans will inevitably have gone to the many property developers who are now watching their investments fail.

The images of ‘ghost’ cities, peppered about the Chinese countryside, have made the rounds online for the last couple of years. The deserted skyscrapers and unkempt gardens, though really quite shocking, only tell part of the story. According to analysts at Gavekal Dragonomics, it is actually the coastal cities like Beijing, Shanghai, Guangzhou and Shenzhen, which are driving the price decline: Rosealea Yao and Thomas Gatley have noted that house prices in these overheated markets have increased by 20-30 percent per year over the past few years; the decline in house prices is in part driven by the market correcting itself from these previous gains.

“And when sales growth slowed in late 2013,” Yao and Gatley wrote in their analysis, “developers starting cutting prices in some cities to boost sales and cash flow. The price cuts were focused in cities with high prices, because that’s where they had the best chance of boosting sales. Unfortunately, those large, high-profile cities serve as bellwethers for the national market, and as word of falling prices spread, sales and sentiment were hurt across the country.”

According to research by the Nomura Group from Japan, the downturn is actually a sign that a property bubble that has already burst. “To us, it is no longer a question of ‘if’ but rather ‘how severe’ the property market correction will be,” three Nomura analysts wrote in a report released in May, and for them there is little the Chinese government can do to halt the crash: “There is no policy that is universally right.”

According to the Nomura analysts, property investment in China began to slump in four of the 26 provinces in early 2014, and in two of these provinces, the decline was greater than 25 percent. The analysts predict that the fallout could be so severe that GDP growth will be pushed below six percent this year, for the first time in decades. For Nomura, China might even be heading for a hard landing, with growth dropping below five percent for four consecutive quarters.

So far, the Chinese Government has not taken significant steps towards mitigating the effects of the property market slowdown, even as other industries are beginning to be dragged down as well.

Industrial production, which is heavily correlated with the property sector, has already started slowing down. Retail growth sales have also been weak, dropping from 12.2 percent in March to 11.9 percent in April. A significant number of international companies are exposed to these industries in China, and if output continues to drop, it could trigger another global downturn. The clock is certainly ticking for the Chinese Government to make a move, but so far it has been curiously reluctant to intervene. Meanwhile, all the rest of us can do is wait with baited breath as the dominos topple.