The Chinese economy is in trouble: “What we’re going to see with China, for the first time anyone can remember who’s still alive, is an economy twice the size of the US, possibly three times the size of the US, and it’s going to be really weird to live in China. that world,” said Elon Musk in the podcast “All-In with Chamath, Jason, Sacks & Friedberg.”
At first glance, Musk seems correct. China is quickly catching up with America. Last year, the Chinese economy shot up 8.1%, producing $17.46 trillion in gross domestic product. The US economy clocked in at $23.00 trillion, a growth of just 5.7%.
Yes, Musk is America’s leading visionary, but this particular vision is off-target. The Chinese economy will never catch up with America’s, at least not this century.
Elon Musk makes predictions by extrapolating. Extrapolation usually works, but not now.
The Chinese economy – and the nation in general – is passing through a series of inflection points. The most fundamental is demographic: China’s population is headed for a steep decline. The most immediate turning point is economic: China is now shrinking. However, the country needs growth to pay off its monumental debt.
We start with the ‘ruthless maker and breaker of civilizations’, demographics. Demographics will break China, which according to demographers from Xian Jiaotong University will lose half its population within 45 years. By the end of this century, China could be about a third as populated as it is today.
The country is therefore facing the sharpest demographic decline in history without war or disease. Panic attempts to prevent the decline, for example from a one-child policy in 2015 to a three-child policy in 2021, have been unsuccessful in increasing the birth rate
Such an abrupt decline means that if China is to overtake America to reach the top spot, it will have to do so within, say, ten years before a declining population begins to undermine economic performance. In the next decade, however, the Chinese economy is more likely to fall apart.
It is already in distress. In April, the economy clearly shrank. Industrial production was 2.9% lower than in the same month last year. Retail sales fell by 11.1%. New car sales fell by 47.6%.
Draconian lockdowns, the result of Beijing’s “dynamic zero-COVID” policy, have essentially brought much of the eastern part of the country, the heart of the national economy, to a standstill. China’s ports and airports operate well below capacity, and river and truck traffic is much lower, about 40% off.
China cannot ship what it does not produce. Factories are closed or struggling. Even politically privileged companies have been hit hard. Tesla’s Gigafactory 3, in Shanghai, was closed for three weeks due to the COVID lockdown. Now, due to a lack of parts, it runs at only 45% of its capacity.
Beijing can eventually reverse the economic damage by abandoning misguided disease control policies. What it cannot do is escape the effects of its unprecedented debt burden. No one knows how much debt China has built up, but an estimate of 350% of annual gross domestic product sounds about right. Because of the infamous “hidden debt,” the number could be even higher.
No matter how much debt there is, China now faces a reckoning. Beijing avoided a downturn in 2008 by over-stimulating the economy, mainly with debt-funded infrastructure. Now the country must repay the debt or resolve the situation in some other way.
Many believe that the crisis will be easy to resolve because there are not many external commitments. Yes, the Chinese people owe the money to themselves, but these kinds of crises, history has shown, are the most difficult to solve, because any solution requires domestic parties – not foreign bankers – to suffer. Beijing is attempting to further delay a settlement over social stability concerns, meaning that the resolution of the case will take much longer than everyone thinks.
Meanwhile, the debt-ridden real estate sector is beyond repair. Project developers have missed payments and failed to meet obligations, especially since September last year. Evergrande Group, once China’s largest real estate developer, has accumulated a staggering $305 billion in liabilities and is struggling even with full government support. It is currently effectively rescued, but smaller developers are falling. Sunac China, now the fourth largest developer, just missed a bond payment and announced it does not expect any other bond payments.
At first glance, the situation seems manageable. The prices of new houses in 70 major cities fell just 0.2% in April compared to the previous month. However, the market was ‘frozen’, in other words, buyers and sellers were too far apart in price for trades to take place.
“We don’t see the price collapse yet,” Anne Stevenson-Yang of J Capital Research told CBS Eye on the World’s John Batchelor on Wednesday. “The Chinese government has secretly put a lot of money into the developers so they can keep their inventory off the market and get a 30, 40, 50% discount.”
Government intervention can maintain prices, but cannot force a sale. Property sales by value fell 46.6% year-on-year last month, the biggest drop since August 2006.
Developers adapt. The start of new construction, measured by floor space, was 44.2% lower in April than in the same month last year. As a result, the demand for building materials is falling.
Indications for the future of the real estate market and thus the economy do not look good. Real estate accounts for anywhere from 25% to 30% of total GDP. About 70% of the Chinese household wealth is tied up in real estate. Apartments have become more than assets in China. In China they have become a storehouse of wealth, the equivalent of money.
This type of Chinese “money” seems to lose value as trust fades. Investors withdrew a record $17.5 billion in portfolio assets – stocks and bonds – from China in March. The US-based Institute of International Finance notes that the outflow was limited to China and was not part of a broader flight from emerging markets. The pullback continued a trend that was evident in February. The capital flight, it seems, continues.
This trend is set to continue, especially as the US Federal Reserve continues to raise US interest rates, while the People’s Bank of China, China’s central bank, is unable to match the rate hikes. The Chinese monetary authorities are now in a bind. They need to force rates down to stimulate the economy, but such measures would exacerbate capital flight.
The renminbi, one of the world’s strongest currencies last year, is now weak, falling about 7% in the past three months. Last month was the worst ever for the Chinese currency.
The Communist Party, unwilling to implement structural reforms, is taking measures as a last resort. “The lockdowns have something to do with preventing people from being aware of this and preventing people from complaining about it,” said Stevenson-Yang, also author of China alone: the rise from and possible return to isolation† “This is what China usually does is prevent information from getting around rather than actually addressing the problem. And they will do that more often over time.”
Beijing is good at censoring, but the reckoning in the Chinese economy is coming anyway. China is fast approaching its death spiral, the point of no return, where fear grips markets in a final crisis.
Gordon G. Chang is the author of The Coming Collapse of China and The Great US-China Tech War. Follow him on Twitter @GordonGChang† Chang is also a Senior Editor for 1945.