In today's Finshots, we explain why the Chinese economy is currently going through a massive economic crisis.

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The Story

China has 3 rules right now.

  1. Don’t talk about deflation or falling prices — it’s at -0.3%
  2. Hide data about how many of its youth are unemployed — 1 in 5 of them don’t have jobs.
  3. Bury information about the housing crisis — land sales have dropped by 50%

Yup, the big red economic machine is stuttering and sputtering and the government does not want people to know how bad things are. In fact, while the rest of the world is increasing interest rates to temper demand and battle high inflation, China is at the other end of the spectrum. They’re opting for emergency rate cuts to prop up the flailing economy.

So what on earth is going on? How did the country get into this mess?

Well, understanding China is always hard. The country probably hides more than it actually reveals when it comes to its economics. But the consensus opinion seems to boil down to a few things that occurred in the recent past.

Let’s start with what people say is the main culprit — the collapse of decades of unbridled real estate expansion. See, in 1998, the Chinese government tweaked some rules. They finally leased state-owned land to private developers. And developers went berserk in building massive residential facilities across the country. Needless to say, this was financed by copious amounts of debt. They borrowed like there was no tomorrow.

And as people speculated on house prices, it shot up. At one point, real estate prices tallied up to more than 50 times the average national income.

Then the government stepped in a few years ago. It cut off the debt tap. And that precipitated a collapse. Developers began to default. Remember the massive $300 billion default by a company called Evergrande in 2021? Well, there could be another $200 billion default by a company called Country Garden that’s on the cards now as well.

House prices began to drop precipitously. And people who’d parked their money in real estate began to see their wealth evaporate too. Panic set in.

In the meantime, China began cracking down on its tech sector. The most famous example is when the government basically scuttled Ant Group’s IPO after its founder Jack Ma openly criticized the Chinese government. China felt that tech companies were getting too big for their boots and wanted to show them who’s boss. So they tightened the screws on everybody — video gaming, edtech, e-commerce…everyone.

Naturally, this hurt revenues. And as the money vanished, so did jobs. Tech startups slashed tens of thousands of jobs.

Thus leading to all the youth unemployment.

And of course, there was China’s zero-Covid strategy which strangled the economy.

See even at the end of 2022, China was the only country in the world that was relying on lockdowns, isolation, and mass testing. Every time a case popped up, the country went into overdrive and shut everything down — schools, offices, parks, everything.

Imagine what that would’ve done to the economic growth, eh? Companies had to keep stopping and restarting operations. No one knew what would come next or when it would all end. So instead of a recovery shaping up, the Chinese public developed a fear of the unknown. So even after the lockdowns were finally lifted earlier this year, none of that revenge spending came to the fore. They kept the money in their bank accounts. And deposits have reached a record 133.1 trillion yuan.

That’s why the government is doing everything in its power to prop things up now. It wants people to spend again. It’s slashing interest rates to improve sentiment. It has even dropped the “Housing is for living in, not for speculation” mantra from official documents. Basically, it wants people to speculate on housing again. The industry makes up nearly 30% of its GDP, after all.

But here’s the big worry. None of these efforts might bear fruit. And that’s because economists think that this is a “balance-sheet recession”.

What’s that, you ask?

Okay. Imagine that companies and people borrowed heavily for many years to splurge on all their whims and fancies. Their balance sheet is loaded with this debt. But then, the bubble bursts — could be real estate. And prices of their assets fall. That’s when people finally realize that their balance sheet is in terrible shape. Their asset side has fallen in value. But their liabilities side or the loans still have to be repaid. So they hunker down and start repaying what they can. They don’t do anything else. They don’t spend. So even if the government slashes interest rates to zero, people won’t borrow and spend. They’re too worried to do anything. And as the consumption drops, the economy craters.

As a consequence of this, deflation pops up. And that’s quite a worrisome affair.

Yup, that’s right. Falling prices aren’t always a good thing for the economy.

Because people might think that prices will get even cheaper in the future. They’ll believe that the trend will continue. So why buy now when you can wait and buy at an even cheaper price in the future, right?  But the moment everyone starts postponing consumption, the demand plummets and that’ll hurt the companies that make and sell products. Their revenues will take a beating and they won’t be able to afford high wages. They’ll cut back on their expenses too. Maybe they’ll cut jobs.

You see the viciousness of this cycle, don’t you?

And this issue could be exacerbated by another factor — China’s demographic.

You see, for decades China has had a rule. Each family could only have one child. But the unintended side effect of that is China’s share of elderly in their population pie is rising rapidly. This is not a demographic that’ll go on a consumption spree either. And despite China relaxing its child policy a decade ago, people aren’t having more kids. They’re worried about rising costs of living and education. So the population slump could continue and affect economic growth.

So yeah, it’s no wonder everyone thinks China is in that exact situation that Japan faced in the 1990s —  a debt binge followed by 3 decades of lost economic growth.

Will China be able to turn things around? We’ll just have to wait and see, won’t we?

Until then…

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