Introduction
The Chinese economy, once expected to experience a strong rebound, is facing challenging times. The lifting of President Xi Jinping’s failed zero-Covid policy has not resulted in the anticipated upturn. Recent data releases paint a picture of an economy grappling with deflation and the potential for a lost economic decade similar to Japan’s experience.
Concerning Economic Indicators
A series of indicators reveal the troubling state of the Chinese economy. Consumer prices have remained stagnant over the past year, while producer prices have declined by 5.4%. Manufacturing output, exports, and investment are all on a downward trend. Furthermore, youth unemployment reached a concerning rate of 20.8% in May.
Imbalanced Growth Model Consequences
China’s policymakers pursued an imbalanced growth model for the past decade, which has led to significant repercussions. The economy is currently plagued by a massive property and credit-market bubble that lies at the core of its economic woes.
Rapid Credit Expansion
According to the Bank for International Settlements, Chinese credit expansion in the nonfinancial private sector has exceeded 100% of the country’s gross domestic product since 2008. This level of credit expansion outpaces even the pace seen prior to Japan’s lost economic decade in the 1990s and preceding the U.S. financial crisis of 2007-2009.
Housing Bubble
The Chinese property sector now comprises nearly 30% of the national economy, as highlighted by a study conducted by Harvard’s Kenneth Rogoff and the IMF’s Yuanchen Yang. In contrast, developed countries like the United States have property sectors accounting for 20% or less of their economies. Moreover, home prices relative to income in various major Chinese cities exceed those in London and New York. As a result, an estimated 65 million Chinese dwellings remained unoccupied in 2021.
In summary, the Chinese economy faces significant challenges, with indicators pointing towards a struggling recovery. The credit and housing bubbles have contributed to the current economic malaise, leaving policymakers grappling with deflationary pressures and an uncertain future.
Economic Imbalance in China
Chinese local governments have become heavily reliant on land sale revenues, a trend that has contributed to economic imbalance in the country. In fact, in 2021, land sales accounted for over 40% of the local government’s overall revenues, signaling an overreliance on this particular sector.
However, recent events have caused significant disruption. Xi Jinping’s decision to end the zero-Covid policy last year had a profound impact on China’s property and credit markets. As a result, the Chinese economy experienced a sharp slowdown, with growth rates dropping to just 3%, the second-slowest in over 40 years. Furthermore, several major property developers, most notably Evergrande, have defaulted on their debts, eroding foreign confidence in the Chinese economy.
Consequently, Chinese home prices have been on a downward trajectory for the past year, leading to financial difficulties for numerous local governments heavily dependent on land sales. This situation has left the Chinese government grappling with an economic-policy dilemma. While providing additional monetary and fiscal support to the housing market could offer short-term relief, it would ultimately exacerbate the looming property and credit market bubbles and create long-term repercussions.
One potential solution could be aggressive interest-rate cuts by the central bank. However, such a move might cause the Chinese currency to depreciate further and potentially invite additional trade restrictions from the United States. Already, the Chinese currency has depreciated by approximately 7% against the dollar over the past year.
While China’s economic outlook appears grim in the long term, there are potential benefits for the rest of the world. As the largest global exporter of goods, China’s falling producer prices and depreciating currency could alleviate some of the struggles with sticky inflation faced by other countries. Additionally, as the largest consumer of internationally traded commodities, a slowing Chinese economy could exert further downward pressure on commodity prices, offering some relief in that area as well.
