Is China’s economy about to go bust?
31 Aug 2023|

Australia is more exposed to a downturn in the Chinese economy than any other advanced country. So far, however, commodity markets provide no evidence of a Chinese recession around the corner.

The spate of gloomy commentary about the Chinese economy in the Western media reflects real concerns, but markets are not behaving as if the world’s second largest economy is on the cusp of its ‘Lehmann Brothers moment’.

China’s demand for iron ore—the key ingredient of its industrialisation and Australia’s most vital economic interest in the country—remains as strong as ever. In a column in the Financial Times, Louis-Vincent Gave, the chief executive of the China-focused economic consultancy Gavekal, noted that iron ore prices have risen by 50% from their low point last October and have rallied in recent weeks, even as the chorus of Western commentary about a Chinese downturn has grown louder.

The current price of US$108 a tonne compares with a low of less than US$40 the last time China faced an economic downturn, in late 2015.

Gave says that if a financial crisis were imminent, you would expect to see it reflected in bank shares, as occurred ahead of the Lehmann Brothers collapse and the European banking crisis a few years later. However, China’s bank shares have actually performed 12.6% better than US bank shares over the past 12 months.

He noted that Chinese government bond markets have also outperformed the traditional safe haven for nervous investors: US Treasury bonds.

China is certainly facing difficulties, but it is not yet obvious that they add up to the inevitable downfall of an economy driven by an authoritarian government, as argued by Adam Posen, the president of the Peterson Institute for International Economics, in the latest issue of Foreign Affairs.

Posen says China’s problems under Xi Jinping are no different to Venezuela’s problems under Nicolas Maduro, Turkey’s under Recep Tayyip Erdogan, Hungary’s under Victor Orban or Russia’s under Vladimir Putin.

‘China’s political economy under Xi has finally succumbed to a familiar pattern among autocratic regimes. They tend to start out on a “no politics, no problem” compact that promises business as usual for those who keep their heads down. But by their second or, more commonly, third term in office, rulers increasingly disregard commercial concerns and pursue interventionist policies whenever it suits their short-term goals,’ Posen writes.

‘What remains today is widespread fear not seen since the days of Mao—fear of losing one’s property or livelihood, whether temporarily or forever, without warning and without appeal.’

A similar theme was developed this week by Cornell University’s Eswar Prasad, who was responsible for pioneering research on China at the International Monetary Fund in the early 2000s. In an essay in the New York Times, he argues that while the numbers portray a stalling economy, the far more profound concern is that consumers and businesses are ‘losing confidence that their government has the ability to recognise and fix the economy’s deep-seated problems’. The economy is at risk of a downward spiral unless this is reversed.

Prasad says private-sector confidence has been shaken by central government edicts, such as last year’s crackdowns on technology companies, education providers and foreign businesses, and the heavy-handed efforts to rein in excesses in the property market.

‘President Xi might favour a command and control system, but he is learning that private-sector confidence is the hardest thing to control,’ he writes.

The commentary draws on a series of related troubles. The property market downturn is continuing and may be accelerating; one of the largest developers, Country Garden, is at risk of failure.

Local governments, which have been an important source of economic stimulus spending, are carrying heavy debts. Those debts have traditionally been serviced by land sales, but they’re no longer keeping pace.

The financial health of the so-called shadow banking sector, which sells investment products to consumers, is also a concern. The Economist this week warned the sector is threatening the stability of the broader financial system. One major firm has gone bankrupt because it had been reinvesting household savings in the property market. More may follow, The Economist warns.

Declining property prices and distressed wealth-management products have eroded consumer confidence. Retail sales have not bounced back as expected after last years’ Covid-19 lockdowns.

While regulators have warned Chinese share-market analysts and economists against publishing negative commentary and have been told to ‘interpret bad news from a positive light’ (according to one quoted by the Financial Times), Western commentators haven’t held back. US President Joe Biden described China’s economy earlier this month as ‘a ticking time bomb’.

So how does one explain the disjunction between seemingly unflappable commodity and financial markets? Perhaps most important is the financial health of the central government, which has the capacity to provide a backstop for the property market. A recent IMF review of China’s government balance sheet found it had total financial assets of US$12.5 trillion, the highest in the world. Its net financial assets of 7.25% of GDP give it a financial strength among the top 15% of nations.

A second line of argument is that much of the current weakness is tied to poor consumer confidence, which will turn around as business conditions improve. Gavekal economists note that both employment and household incomes have been rising and say that if this continues, household spending patterns will return to normal.

China’s vast economy, with its competitiveness in global manufacturing, its leadership of most elements of the energy transition and the world’s biggest population of middle-class consumers, has a resilience overlooked by some who risk schadenfreude in their forecasts of inevitable doom.

Some of the global commentary has suggested that a downturn in China wouldn’t matter much for the West because China is a relatively small source of demand for most nations, with notable exceptions like Australia. New York Times columnist and economic Nobel Prize–winner Paul Krugman says Chinese demand is only 1% of GDP in the United States, adding that its economic woes may help bring down US inflation.

For Australia, by contrast, exports to China represent almost 8% of GDP. Only a handful of countries like Zambia, Chile and the United Arab Emirates have greater exposure. Australia’s exposure to China has brought it two decades of rising living standards, despite weak domestic productivity.

Concern about the Chinese economy has had some impact on Australia—the exchange rate has fallen from US68.9 cents to the Australian dollar in mid-July to US64.5 cents now—but it is too soon to be bringing out the sackcloth and ashes.