There’s no denying that China’s economy is struggling. Real GDP growth slowed considerably in the second quarter, as exports declined and households accumulated savings to protect against an ongoing slump in property values. Data for July point to ongoing weakness this quarter, including exports that plummeted by 14.5 percent, the steepest decline since the onset of the pandemic, and emerging signs of deflation.
To boost the economy, China has to bolster consumer spending, tackle high youth unemployment that now exceeds 20 percent in urban areas and provide more support to the ailing property sector. But, they can’t, because China’s ratio of total debt to GDP stands at a record high of 290 percent.
The real estate sector, which accounts for roughly 25pc of China’s economy, a huge proportion, has finally tipped over and faces years of shrinkage. This was the predictable consequence of over indebtedness and overbuilding combined with worsening demographics which curtails household formation and reduces the number of first time buyers.
Personal income growth is growing at roughly half the rate that prevailed before the pandemic and, in the meantime, households have become less confident about the prices of homes, which comprise about three quarters of their wealth, and about the economy more broadly.
Future Wealth’s View
The pandemic and China’s zero-Covid policies undoubtedly weakened its economy, placing additional stress on the real estate market, on households and private firms. But Covid was not the cause of China’s current woes. It has faced a perfect storm of rapid aging, one child policy, declining fertility, a creaking financial system, dismal productivity growth and a falling working age. The root cause of all these problems is that China is a state dominated economy. Instead of promoting a vibrant private sector, the government is actively reining in the most successful technology companies.
China has not yet tumbled into deflation, as Japan did from 1995 until relatively recently. Yet there is little doubt the country is flirting with it. The deflation threat will not dissipate until or unless the Government is prepared to transfer resources and wealth to households. In the meantime, China has become uninvestable – much like Japan through the better part of two decades. It is fully possible that China may be entering its lost decade(s) like Japan.
Once again, as Warren Buffett often says “There is no better place to invest than in the United States”.