Brace for a China recession
China’s economy has been the growth engine for the global economy since 2008’s financial crisis. But now it seems possible it could enter recession, as TJ Lombard’s team warn:
“We’ve both covered the economy for our entire careers and we’ve never been more worried about Chinese growth….The full-year picture for next year seems likely to be much worse, as low as 1%-to-2%. And nominal GDP looks likely to contract”.
CHINA RISKS MOVING INTO DEFLATION
CHINA PPI %, 2017 – 2024
Their concern is supported by the collapse taking place in China’s Producer Price Index (PPI). The PPI matters because China is still the manufacturing capital of the world:
- China’s economy is essentially based on buying raw materials and turning them into manufactured goods for Western consumers
- If supply and demand are balanced, it should normally be able to pass on cost increases to its customers via PPI inflation
- As the chart show, this has happened since China joined the World Trade Organization in 2001
- The main exceptions were during 2008’s crisis and the start of Covid.
But today, the PPI has now been negative for 23 months and it turned down again in August. This suggests consumer prices will also start to fall, taking China into deflation and recession.
The reason is that people’s buying habits change when you move from inflation to deflation:
- With inflation, rising prices make it cheaper to buy today
- But with deflation, people postpone spending as prices will be cheaper tomorrow
CHINA RISKS ENTERING A DEBT TRAP
CHINA OFFICIAL, SHADOW & LOCAL GOVT FINANCING
ROLLING 12 MONTH AVERAGE, 2008 – 2024, $bn
China’s problem is essentially that it has too much debt.
The main role of debt is to bring forward demand from the future. And as the chart shows, China’s stimulus has kept on increasing since 2008, until it peaked with the end of the pandemic.
Now China risks entering a classic ‘debt trap’ where new loans are taken out to repay existing debt – not to create new demand. In other words, the debt is no longer being used to generate growth. In turn, this risks generating a downward spiral.
THE HOUSING BUBBLE IS CONTINUING TO BURST
China Home Sales Slump Worsens Again
The underlying problem, of course, is China’s massive housing bubble. It was probably the largest ever seen. And it has been bursting for some time, with home sales slumping, as the Bloomberg chart shows.
As we warned back in January 2022, when it began to burst:
- “Housing is currently unaffordable for most people, with Shanghai prices 44x average salaries in 2020
- “The real estate market is an outsize risk for the economy – it is 29% of GDP, and 70% of China’s urban wealth
- “Given China’s ageing population, it seems likely [that housing sales] volume could drop at least another 20% before the market bottoms
- “That will mean China will need to import a lot less oil, metals, plastics and everything else connected to the bubble”.
CHINA NEEDS TO URGENTLY BOOST CONSUMPTION AND DOWNSIZE MANUFACTURING
Most outside observers are clear on the solutions to the problem. But politically, these have proved impossible to implement, as it would mean Beijing abandoning its 5% growth target. As Prof Michael Pettis of Peking University noted earlier this year:
“Chinese officials have few options. They cannot (and don’t want to) revive investment in the property sector, and they are reluctant to unleash a 2009-style infrastructure spending orgy. Increased investment in manufacturing, in other words, is among the few things that will allow China to reach the 5% growth target. Without that, either it needs a major fiscal boost to consumption (something Beijing decries as “welfarism”), or it has to accept lower growth. The point is that Chinese officials understand the problem (certainly most prominent economists do), but they don’t have many acceptable alternatives. That is why trade conflict is only likely to get worse.”
Since then, the problems have indeed got worse, as he forecast. And now, China’s problems are spreading to the rest of the world.
Not only is China exporting deflation, as its Producer Prices fall but also, and understandably, consumer countries are introducing trade barriers to protect their own industries:
- This is not only happening in the US and in Europe, but also in many Emerging Markets
- Turkey is introducing 40% tariffs and Indonesia is planning 200% tariffs
- Other major economies including Brazil and Mexico are also adding tariffs for Electric Vehicles
Unfortunately, therefore, China’s move into a debt trap is now starting to create major risk for the global economy.