About the author: Desmond Lachman is a senior fellow at the American Enterprise Institute. He is a deputy director of the Policy Development and Review Department of the International Monetary Fund and the chief emerging market economic strategist at Salomon Smith Barney.
So much for China’s strong economic recovery. A rapid development should follow President Xi Jinping’s lifting of the economically damaging zero-Covid policy. However, every recent print of data coming out of China supports the view of a Chinese economy struggling to contain deflation and one on the cusp of a Japanese-style lost economic decade.
While this hardly bodes well for China’s long-term economic outlook, it offers the Federal Reserve and the European Central Bank hope of much-needed inflation relief.
A flurry of recent economic data paints a picture of a Chinese economy in trouble. Last year, consumer prices flatlined while producer prices fell 5.4%. Manufacturing output, exports, and investment all fell. Youth unemployment rose to an alarming 20.8% in May.
China’s economic policy makers have spent the last decade pursuing an unbalanced growth model. The result is a large property and credit-market bubble that is now at the heart of China’s economic weakness.
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China’s credit expansion to the nonfinancial private sector has grown by nearly 100% of gross domestic product since 2008, according to the Bank for International Settlements. That’s a faster pace of credit expansion than the one that preceded Japan’s lost economic decade in the 1990s and the one that preceded the 2007-2009 U.S. financial crisis.
The other side of China’s credit market bubble is a housing market bubble. China’s property sector accounts for nearly 30% of China’s economy, according to a study by Kenneth Rogoff of Harvard and Yuanchen Yang of the IMF. That compares to 20% or less in the US and other developed countries. At the same time, house prices relative to income in many major Chinese cities have surpassed those of London and New York. Around 65 million Chinese households are estimated to be homeless by 2021.
Another sign of economic imbalance is the over-reliance of China’s local governments on revenues from land sales. In 2021, at the peak of China’s housing market boom, sales accounted for more than 40% of total local government revenue.
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The end of Xi’s zero-Covid policy last year helped burst the property and credit market bubble. China’s economic growth slowed to about 3%, the second slowest growth rate in more than 40 years. Meanwhile, several large Chinese property developers, including Evergrande, have defaulted on their debts, as foreign confidence in the Chinese economy has eroded.
House prices in China have been declining for the past year. Many key local governments in China appear to be in financial trouble due to declining land sales.
The Chinese government now appears to have found itself in an economic policy box. More fiscal policy support and housing market financing may provide short-term economic relief. However, that could make the coming day of reckoning from property and credit market bubbles worse. The central bank may consider aggressive interest rate cuts. But a devaluation of China’s currency could invite further US trade restrictions. The Chinese currency has already depreciated about 7% percent against the dollar in the past year.
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This adds up to a grim long-term economic outlook for China. But there may be a silver lining for the rest of the world’s struggles with sticky inflation. China is the largest exporter of goods in the world. A drop in Chinese producer prices and a devaluation of China’s currency could make a significant dent in the rest of the world’s import bill. Similarly, China is the world’s largest consumer of globally traded goods. Prices have already fallen by about 21% this year. A slowing Chinese economy could provide further easing pressure.
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