Published on May 9, 2024

Is China’s Economy on the Brink of Collapse?

China’s 2024 GDP Target of “Around 5% Is Ambitious but Might Not Be Enough

Young people in China are having trouble finding high skilled jobs, leading to lower consumer confidence. Deflation is making it harder to service debt.2 The population is aging, and people aren’t having enough babies to maintain replacement levels. China’s economy is in trouble.3

At the end of 2023, Moody’s changed their outlook of China’s economy from stable to negative, citing that country’s weakening property sector, and predictions that the central government will bail out deeply indebted local governments and struggling state-run enterprises.4

After years of COVID-related isolation and closed borders, China is again opening its doors to the West. Americans can now visit parts of China without a visa, and the Chinese government has already waived visas for visitors from several European countries. Travel will also continue to get easier—as many as 100 scheduled flights have been approved between the US and China, about 27% of 2019 levels.5

But it's unclear if this recent opening-up will lead to a resurgence of international interest in China’s economy. Even with China starting to make it easier for foreigners to travel to that country, their foreign direct investment at the lowest level its seen since 1993.6

Economic Propaganda

China's Economy:

Data about China’s economy is often evaluated with a heavy dose of skepticism, both inside and outside the country’s borders. A 2007 WikiLeaks memo revealed that even China’s then-prime minister used indicators like energy consumption and bank loans to evaluate regional economies, rather than official GDP data. Around the world, think tanks and publications like the Economist have created their own methods of trying to see through fuzzy numbers, using data like auto sales, sold floor space in commercial buildings, and rail freight.7

While these resources are accessible on the internet around the world, most of these metrics are blocked on the Chinese Internet. The Great Firewall, the massive policies and technologies that make China’s internet the most censored in the world, only lets users access the central government’s official published data.8 Their state security agencies have started blocking social media posts and accounts that reference negative observations about China’s economy, even if they’re accurate.

This concerns analysts outside of China, who worry that increased suppression of bad news about the economy will only weaken Chinese consumer and investor confidence.9 So when China’s current prime minister announced a goal of 5% annual GDP growth at a large government meeting in March 2024, economists thought it ambitious, though unsurprising.10

Deflation

Since 2021, China’s stock markets have lost $6.3 trillion, leading to concerns about their hefty debt burden at home and around the world.11 Their currency, the renminbi (CNY), is hovering around five-year lows against to the USD.

Analysts have argued that further weakening the CNY by lowering interest rates would help strengthen China’s economy. But this would make Chinese goods even cheaper, risking riling trading partners who are already frustrated by Chinese goods whose prices are artificially lowered by government subsidies.

Prior attempts to weaken the CNY relative to the USD have led to a spiraling loss of investor confidence in China. Perhaps the most notable reason this is unlikely to happen is because China’s Pres. Xi publicly said that a strong currency is necessary for China to become a global financial superpower.12

As prices decline, consumers in China’s economy have held off spending money, anticipating that big-ticket items will continue to get cheaper. Feeling the deflationary profit squeeze, businesses have slowed investment and hiring.13

Nevertheless, state media maintains that there are “no signs of deflation seen amid recovery.” They cite economists from state-run agencies and international business leaders who run joint ventures with state-run companies.14

Property Market

While China’s massive state security agencies can scrub content from the internet, they can’t hide the abandoned ghost cities filled with unfinished apartment buildings and villas. China’s economy is being hit hard by their property market crisis.

The collapse of over-leveraged firms like Evergrande and Country Garden may be just the beginning of a larger problem that could have an impact around the world. Cash-strapped developers, unable to sell new units, are increasingly unable to repay offshore bonds, let alone deliver completed homes to consumers who’ve already purchased them.15

While analysts predict that Evergrande victims are likely to get their homes simply because of the significant attention given to the company’s collapse, it’s unclear what protections will be available to future consumers. In the long term, the Chinese central government is considering buying distressed, often unfinished housing projects. This would, in effect, nationalize as much as 30% of the housing stock for low-cost rentals or sales. It would also expand the Chinese Communist Party’s control over the Chinese private sector.16

Meanwhile, housing prices in China’s first and second-tier cities, which tend to have the highest-paying jobs, are unaffordable. When comparing home price to income, homes in large Chinese cities cost about four times what they would in New York and Los Angeles.

Traditionally, the Chinese tend to purchase most of their property in cash, using real estate as a presumably safe investment to store assets. Yet the crumbling real estate market has already hit homeowners hard. Consumers who didn’t buy their homes in cash often now owe banks more than their property is worth. This doesn’t put people in the mood to go shopping, and China’s economy is feeling the impact.17

Demand Shortage

Following the COVID-19 Pandemic, local and provincial Chinese governments doled out consumer stimulus in the form of digital coupons that could be redeemed for food deliveries, hotels, and restaurants. While effective at stimulating local economies, China’s consumers didn’t come raging back to spend the cash they saved during lockdowns as American consumers did. Chinese who are still flush with cash have decided to invest it overseas or hoard it, causing a liquidity trap.18

Tariffs from the EU, the U.S., and India are leading multinationals to look for new sources in their supply chains. These pressures have led to Mexico recently overtaking China as the largest source of goods imported to the U.S. (possibly caused by Chinese exporters looking to ship goods through Mexico to avoid tariffs).19

China’s shrinking population looms as the biggest hurdle of all. For the second year running, China has had more deaths than births. While its aging population may present new opportunities for China’s economy, consumers over age 60 aren’t likely to be as productive or spend as much as their younger peers.

Young adults, angsty about not being able to get jobs themselves and still jittery from snap lockdowns during COVID, are hesitant to bring children into the world.20 Marriages in China are at their lowest number since 1986.

Women are increasingly choosing to remain single, citing the financial and cultural pressures of being a working mom. In a country that already has about 31 million more men than women, this poses a challenge for population growth.21

As the Chinese economy continues to contract, young people coming of age are learning to lower their economic expectations. Perhaps international investors should as well.22

Conclusion

There are significant concerns about the near-term future of the Chinese economy. In recent years, emerging market stock performance has been, in large part, powered by China's returns, as China has grown to nearly 1/3 of the index overall. But moving forward, there may be more breadth. Perhaps countries like India or Brazil will overtake China and become the new leaders in emerging markets.

We believe the best approach is to outsource the decision-making around allocating to specific countries to established managers, those with deep teams, boots-on-the-ground experience, and the know-how to decide where exactly they should be long and short within Emerging Markets.

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