After 2 decades of hot growth, China's economy has begun to slow down, even arguably entering a stalemate after the real estate crisis and the Covid pandemic. China is the only major economy in the world that has entered a period of disinflation. The cause is the decline in consumption stemming from the public's loss of confidence in the financial system. The People's Bank of China (PBOC) is continuously using monetary tools to stimulate the economy.
With PBOC's loose monetary policy, alongside tightening policies in Western economies, China is struggling with the impossible trinity: fixed exchange rate - independent monetary policy - free capital flows. In reality, China is straining to defend the CNY exchange rate, prevent capital outflows, and cannot maintain an independent monetary policy to let the market freely adjust supply-demand.
Those familiar with Japan's miraculous economic development story from the 1960s-1990s may start having déjà-vu images of China's current situation. Is China stepping into Japan's pitfall from the 1990s-2000s?
Episode 3 in Viet Hustler's Global Economic Perspective series will provide readers with an overview of the Chinese economy's situation. Accompanying it is a comparison of China's recent economic cycle with Japan's miraculous economic development cycle in the 60s-80s. From there, Viet Hustler will predict the Chinese economy's impact on the globe.
Economic situation in China
Current panorama of the Chinese economy:
China's real estate market (the world's largest by market cap) continues to freeze after Evergrande's collapse nearly 2 years ago.
About 2/3 of China's 50 largest private construction companies have defaulted.
And the remaining 16 companies will face maturing debts worth USD 1.5 billion this September 2023 (and more in the next year).
Worse still, in the last 3 months, house prices in China continue to fall:
Consumption collapse, declining market demand: leading to disinflation and deflation.
In the previous months, consumption, industrial production, and investment in China continuously declined (from Viet Hustler's old article).
Currently, retail sales and industrial production in China slightly increased in August 2023, good news for the Chinese economy.
But one month's data does not indicate a long-term trend.
The People's Bank of China (PBOC) continues injecting money into the economy to stimulate growth, especially as the economy shows some recovery signs:
Last month, PBOC cut the MLF lending rate -15bps for financial institutions. This month, PBOC continues to keep the low MLF rate (2.5%) for these institutions.
Additionally, last week, PBOC provided +191 billion CNY (~+26.3 billion USD) to the financial system via 1-year MLF loans, plus +34 billion CNY via 14-day money market loans.
At the same time, PBOC announced a cut in the reserve requirement ratio for commercial banks: releasing an additional ~+500 billion CNY in capital to the market if banks withdraw from reserves at PBOC.
Labor market worsens:
Youth unemployment rate surged in August: up to 21.3% (1 in 5 young people unemployed).
Public alarm over the unemployment rate led the Chinese government to stop publishing this data since August 2023.
For decades, wages in China's largest cities rose nonstop. But now, recruitment salaries in Shanghai have fallen -9%, in Beijing down -6% yoy in Q2/2023.
Government, finance, and tech sector employees are the first to face salary cuts.
The risk of falling wages is that workers will cut spending, detrimental to Beijing's efforts to revive the economy via consumption stimulus.
The Chinese Yuan's value nearly hit its 14-year low at end-August, due to PBOC's interest rate cut policy.
Two weeks ago, China bolstered CNY defense via direct warnings to speculators + setting a higher daily CNY-USD reference rate than the market.
This helped the CNY escape the prior record low.
Local governments' public debt surges:
Related articles on China's economic situation:
On the international trade front:
The EU is pushing to investigate China's subsidies for the electric vehicle (EV) industry due to concerns that EV consumption from China in Europe will explode like in the US.
Previously, in the US, EV consumption surged: The US took 10 years to sell the first 1 million EVs, 2 years for the next 1 million, but only 1 year for the third 1 million.
The investigation could lead to new tariffs on EVs imported from China into Europe.
Similarities between current China and Japan in the 1960s-1990s
Both economies originated from land reform movements that increased agricultural output and provided abundant food supplies.
Japan: 1946-1950
China: land reform from 1978 caused China's food production to escape stagnation and begin to increase sharply.
When people no longer worried about food, both countries recognized their next direction: promote production by
Upgrading infrastructure and machinery
Importing technology, which requires strong foreign currency, a.k.a. USD
To achieve this (obtain foreign currency), both countries implemented export promotion strategies by:
Keeping their domestic currency exchange rate low (even undervalued): limiting imports and stimulating domestic consumption + boosting exports to earn foreign currency.
Keeping labor costs low (in the early stages of economic development in both countries).
…this, although limiting investment opportunities for workers, contributed to attracting FDI capital, a.k.a. USD, and technology transfer.
Utilizing state control over banks (in Japan's case, the Japanese Ministry of Finance at that time) to direct funding towards building infrastructure and improving labor productivity:
These policies were truly effective!
Japan achieved a period of miraculous economic growth (economic miracle): 1960-70s.
China entered a period of hot growth 1992-2011:
Exports exploded. Industrial output grew double digits:
People worked hard to build the future.
China's USD reserves increased sharply:
Wages gradually increased in line with economic growth:
Finally: world-class modern infrastructure.
The flaw in Japan's policy in the early 1980s and China's in the 2010s was when they had to build large USD reserves to fund technology imports and infrastructure investment.
Therefore, to avoid appreciating the domestic currency, they had to pump JPY or CNY into the market.
But increasing money supply would lead to inflation, which Japan in the 1980s and China in the 2010s both wanted to avoid.
=> Therefore, they forced workers to save + reduce spending, while locking workers' investments at low interest rates.
This gradually caused GDP growth to slow down (due to suppressed consumption).
But in return, both countries achieved the latest technologies with remarkably advanced infrastructure. All major cities in Japan and China are super connected.
What could Japan and China do at this point? => Continue investing!
They subsidized export companies and infrastructure developers. Provided low-interest loans.
But at this point, labor productivity growth had begun to stagnate.
=> Instead of money being invested in factories, infrastructure, it was poured into financial assets like stocks (Japan in the 1980s) or real estate (China in the 2010s) in the short term:
This made Tokyo's financial market the 3rd largest in the world after New York and London from the 1970s.
While the construction sector accounted for 30% of China's economy.
The worse thing happened when their largest import partner, the US, of course, wouldn't stand still.
In 1985, at the Plaza Hotel meeting, the US forced Japan to appreciate the JPY.
Similarly, in 2018, the trade war between the US and China intensified when a series of tariffs on Chinese imports into the US increased sharply.
And everything started collapsing when asset bubbles burst:
In 1990, the Tokyo stock market collapsed.
In 2021, China's largest real estate developer in the world, Evergrande, filed for bankruptcy.
The banking system gradually realized that the collateral assets for their loans were all mortgaged with real estate - which now is worth only half. => Banking crisis!
People realize that their retirement investments in stocks or real estate are at risk of disappearing…
while China's one-child policy and Japan's childless marriage movement leave them without security in old age.
=> People start tightening their belts: consumption declines, leading to the current disinflation and deflation.
In the early stage of the crisis, the two central banks (BoJ and PBOC) were quite optimistic because:
… they still control the banks, and freely regulate capital
… have abundant USD reserves,
… and their economy is still the world's number 1 exporter.
But the problem is:
When consumption declines, even if banks want to lend, businesses have no demand to borrow to expand production.
Central banks also cannot spend too much of their USD reserves, otherwise, the appreciation of the local currency exchange rate will disadvantage their export sector.
Especially, in periods when the world economy is also cooling down, their import customers also reduce demand.
Then, workers' wages stop increasing…
Finally, Japan fell into a stalemate for 20 years: workers' wages stopped increasing, low consumer demand. The economy with accumulated assets still maintains prosperity, but no longer grows, enduring decades of economic stagnation - the lost decades.
Will this be China's situation in the next 10 years?
What impact could China's economic policies have on the world economy?
The mismatch between disinflation in China (declining consumption) and inflation in the US/Europe (consumption still growing hot) will cause capital from China to flow to markets with higher demand.
In the US, CPI continued to rise in August 2023 due to still excessively high summer consumer demand.
Meanwhile, inflation in Europe remains stuck at high levels.
Therefore, as China's domestic demand gradually cools, Chinese investors (who have accumulated quite a lot of money) will seek to invest FDI in markets with higher demand.
At the same time, as PBOC continues to cut interest rates to stimulate consumption, it will further push capital from China to countries with higher investment returns, not only the US, but also developing countries and newly industrialized countries…
This is similar to how Japanese investors poured investments into the US, Europe (especially the UK, Germany, and France…) from the 2000s.
For international trade: PBOC implementing a loose monetary policy while the Fed and ECB are tightening rates will cause the CNY value to fall across all markets.
The continuing depreciation of the CNY exchange rate will benefit China's exports.
But this will mean nothing if international consumer demand potentially declines if a recession storm hits after the interest rate hike cycle in Western countries.
In addition, Europe and the US are implementing a series of trade defense measures against goods from China: especially electric vehicles - a hot growth item in China currently.
This is the reason PBOC chooses to protect the CNY at this time.
CONCLUSION
The main concern for China now is the economy gradually cooling due to declining consumption. This could be a consequence of a series of economic events that caused consumers to lose confidence (or even their savings): the real estate bubble crisis, linked to the banking crisis, and the long oppressive zero covid policy.
From explosive economic growth in the previous phase, to outstanding development in technology and infrastructure, then decline after the collapse of financial asset bubbles, to disinflation accompanied by stagnant workers' wages, could China become a second Japan.
The only difference between China and Japan may be population size: for a populous country like China, consumer demand may not remain low forever. But this billion-population country will face accompanying risks of unemployment and job competition among young people. Can consumption grow sustainably if workers' wages stop growing, accompanied by high youth unemployment rates?
Finally, following Japan, capital outflows from China to world markets may increase in the context of PBOC loosening monetary policy ahead of Western tightening monetary policy.
However, with Western countries wary of China on the international trade battlefield through protectionist measures, China will face restrictions in exports to these markets. This will create greater pressure on China's economy. Possibly, Chinese goods and capital will push strongly to other markets. Currently, ASEAN has replaced the US and Europe as China's largest export partner.
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