For well over a decade, experts have predicted that China’s unprecedented string of economic growth would eventually end. That seems to be have finally come to pass, albeit largely by design.
Bloomberg (“Run It Cold: Why Xi Jinping Is Letting China’s Economy Flail“):
Xi Jinping’s quest to rewrite the playbook that drove China’s economic miracle for a generation is facing its sternest test yet.
The $18 trillion economy is decelerating, consumers are downbeat, exports are struggling, prices are falling and more than one in five young people are out of work. Country Garden Holdings Co., with 3,000 pending property projects up and down the country, is on the cusp of default and protestors have gathered at Zhongzhi Enterprise Group Co., one of the biggest shadow banks, demanding their money as payments are halted.
Many of those woes can be traced back to President Xi’s determination to shift away from the debt-fueled growth model of his predecessors. Even as the real estate crisis deepens, there’s been only limited measures to cushion the blow, prompting forecasters such as JPMorgan Chase & Co., Barclays Plc and Morgan Stanley to downgrade their projections for China’s economic growth this year to below the government’s 5% target.
Foreign investors are pulling money out, with the central bank boosting efforts to stanch the yuan’s tumble toward the weakest level since 2007. Treasury Secretary Janet Yellen this month termed China a “risk factor” for the US while her boss President Joe Biden called China’s economy a “ticking time bomb” at a recent campaign event.
But where Biden has opted to run his economy hot, spending trillions of dollars on household stimulus and infrastructure to goose the economy, Xi is running his cold in a bid to finally break China’s addiction to fueling growth with speculative apartment construction and low-return projects funded by opaque local borrowing. If China is a “ticking time bomb,” Xi’s aim is to defuse it.
The clash of economic philosophies between the world’s two largest economies is already shifting investment flows and may delay the date at which China overtakes the US, or perhaps mean that moment will never arrive. The risk for Xi and his team, led by Premier Li Qiang and Vice Premier He Lifeng, is that the determination to avoid excessive stimulus undermines confidence across the nation’s 1.4 billion people.
China is undergoing an “expectations recession,” said Bert Hofman, former China country director at the World Bank. “Once everybody believes that growth will be slower going forward, this will be self-fulfilling.”
They provide this graphic for context:
When three years of modest growth is a cause for concern, you’re in pretty good shape. But analysts have long argued that China needed to sustain much higher levels of growth just to keep up with the demands of the population because their system relies on performance-based legitimacy. (Some argue otherwise, though.)
In the worst-case scenario, this dynamic ends in stagnation, or “Japanification,” something some economists see a warning of in China’s latest consumer price data showing deflation. Falling prices are both a symptom of weak demand, and a drag on future growth as households delay purchases, business profits fall and real borrowing costs rise.
What Bloomberg Economics Says…
“The sharper downturn in the property sector, challenges in reigniting animal spirits among entrepreneurs and a deepening rift in relations with the US mean expectations on growth have been revised down. The old downside scenario has now become the base case — with expectations that by 2030 annual growth will have slowed to around 3.5%.” — Tom Orlik, Bloomberg’s chief economist
If global markets get spooked, a China slump could trigger an exodus of investors out of riskier assets around the world — as occurred in 2015, when a messy China devaluation and domestic stock meltdown unnerved Yellen, then the Federal Reserve chair, enough to call off an interest-rate hike. We’re not there yet, but a repeat performance could see expectations on the Fed upended again, with a pause turning into a cut faster than the markets expect.
One indication of the differing economic approaches between the US and China can be seen in nominal GDP, which doesn’t adjust for inflation. American nominal growth is clocking a 6.5% pace this year against 4.8% for China, according to Bloomberg Economics, which still sees the world’s second-biggest economy expanding faster in real terms. The strengthening US dollar against the yuan has also contributed to China’s rival pulling away, for now, in the global race when GDP is measured in dollars.
There’s a certain churlishness in analyzing the economy of a country of 1.4 billion souls in terms of great power competition but, alas, it’s the situation in which we find ourselves. We see the PRC as a revisionist power seeking to radically change the terms of the so-called liberal world order. A weakened China is good news in that light, even if it’s potentially a humanitarian disaster.
Or maybe not. Again, Xi has made a deliberate policy choice.
Xi and the Communist Party’s leadership haven’t sat on their hands. A drip feed of announcements followed a Politburo meeting last month, highlighted by proposals such as faster infrastructure spending, liquidity support for developers and lower housing purchase restrictions. Then came the surprise cut to interest rates last week.
But to understand why they haven’t done more, it’s important to assess how the economy looks from Beijing’s perspective — and Xi’s own views on the best way to achieve his overarching goal of turning China into a nation that “leads the world in terms of composite national strength and international influence by the middle of the century.”
Parts of the economy are booming: electric vehicles, solar and wind power, and batteries. In those areas, investment and exports are growing at double-digit rates, exactly the kind of hi-tech, green growth that Xi wants. Even amid its austerity in some areas, the state is devoting resources to foster this form of growth, issuing bonds to fund high-speed rail and renewable energy infrastructure on a scale unmatched anywhere in the world, cheap loans for businesses, and generous support for consumer demand through tax breaks for EV buyers.
Meantime, spending on services like travel and restaurants has rebounded strongly compared to a lockdown-hit last year. Starbucks reported 46% sales growth in China last quarter, domestic flights are running about 15% above their pre-pandemic level and travelers are complaining that budget hotels are hiking prices due to soaring demand. That generates a lot of jobs, helping ease the leadership’s fear of mass unemployment.
It was the longtime elite consensus, of which I was a part, that a growing China would inevitably be a more liberal China because we would see the rise of a middle class and the concomitant demands for more power from those people. It had proven true essentially everywhere on the planet, including among the “Asian Tigers,” which included Taiwan.
Alas, the CCP made sure that didn’t happen. Moving to more of an internal, consumer-based economy would seem like a very good thing. But, certainly, Xi is not planning the demise of his power base.
Trouble is, those new growth engines aren’t making up for the massive drag from the real estate slump.
Beijing estimates what it calls the “new economy” — its name for those green manufacturing sectors, plus other hi-tech areas like microchips — grew 6.5% on-year in the first half and accounted for a little more than 17% of GDP. By contrast, real estate construction spending slumped almost 8% in the first half and the property sector provides about 20% of GDP when related industries are thrown in.
The real estate industry was upended starting in late 2020, when authorities laid out “three red lines” detailing leverage benchmarks that builders had to meet if they wanted to borrow more. By the end of 2021, property giant China Evergrande Group had defaulted, followed by an unprecedented surge in debt failures at other builders. Fast forward to today, and Country Garden, which like Evergrande was once China’s top developer by sales, is warning that there are “major uncertainties” about its ability to pay off its bonds.
It’s not just the property companies and related industries — construction, steel, cement, glass — that are feeling the impact of real-estate sales falling some 50% below their peak levels in 2020. The contraction has also hammered household confidence. Home values are dropping, and in all likelihood much more than the modest, single-digit figures in official data. That’s a major risk when real estate accounts for as much as 70% of China’s household wealth, along with 40% of collateral held by the banks, according to estimates from Citigroup Inc.
The hit to wealth is leaving households feeling poorer, reducing their consumption appetite, in a second blow to growth. And as companies lower their expectations for profits and scale back investment and hiring plans, the impact mushrooms. Cities have been warning about an excess of gig-economy private taxi drivers, in a sure sign of weak labor demand.
Even planned economies are subject to bubbles, apparently.
Some are calling for Beijing to break the cycle with strong confidence-building measures. Central bank adviser Cai Fang recently urged direct stimulus to consumers. He and like-minded economists say a few trillion yuan (hundreds of billions of dollars) financed by central government borrowing would stimulate consumption.
But Beijing is unlikely to accept those proposals. For China’s leaders “the best way to support consumption is through supporting employment, which is believed to be best done by supporting the corporate sector,” via tax cuts, said Wang Tao, UBS Group AG’s chief China economist.
This is not an unfamiliar debate.
