Amid global turbulence, China’s GDP expanded by five percent according to the official statistics in the first three months of 2026, up from 4.5 percent in Q4 last year. It was stronger than the market consensus of 4.8 percent and at the top end of the leadership’s target of 4.5-5 percent annual growth this year. Strong investment in infrastructure and manufacturing, led by state-owned enterprises, was crucial in returning fixed-asset investment (FAI) growth to positive territory. Yet the overall picture of the economy has not changed: growth continues to rely on strong manufacturing and exports, while consumption remains weak. The government’s cautious approach to policy support may be tested in the coming months as global uncertainties increase.

That is the narrative on paper.

More importantly, that is the narrative before Operation Epic Fury and the US war with Iran roiled global energy markets.

A return to economic growth and expansion is certainly a welcome change for China, which has been mired in deflation for years at this point—provided that it really is a return to economic growth.

As is so often the case, when media narratives collide with economic realities, the narratives do not do well.

The narrative is that China, in the first quarter of 2026, exceeded expectations and turned in strong economic growth.

The economic reality is that China remains mired in deflation. China may be on the precipice of a stagflation crisis, courtesy of Iran’s closure of the Strait of Hormuz as part of their war strategy.

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Iran Upset Everyone’s Apple Cart

There can be no surprise that the data shows Iran’s decisions in its defense against Operation Epic Fury have roiled economies around the globe and are even now sending a significant energy price shock through those economies. China is far from immune to that price shock, and is even grappling with secondary price and supply shocks in a variety of petroleum-derived industrial chemicals, creating broad inflationary pressures across the whole of the economy.

Nor does recent price data on those same essential materials suggest the situation is getting any better.

Sulfur prices in China have been trending up over the past week, with prices now more than 60% above pre-war levels.

Polyethylene has also reversed and started trending up over the past week, and is now 25% above pre-war prices.

Styrene has not trended up, but its gradual decline appears to be bottoming out, at 30% above pre-war price levels.

Bitumen has had the most dramatic resurgence over the past week, pushing above 30% and closing in on a 35% price increase over pre-war price levels.

These are price and supply shocks which go well beyond energy, putting unanticipated cost pressures on most of China’s export-oriented manufacturing.

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Inflation Or Stagflation?

These cost pressures are not shy about making themselves known, as China’s Producer Price Index showed a year on year increase for the first time in over three years.

While a return to inflation after years of outright deflation on the surface is a welcome change, the signs are that the resurgent factory gate inflation is indicative of “bad inflation”—i.e., stagflation.

A number of economists are concerned that the economic fallout from the war with Iran will coalesce into a global stagflation crisis, with high prices and suppressed growth everywhere.

The war in the Middle East will likely affect the global economy and the United States, whether it continues for a short or long term, because of disruptions in the oil market that could trigger inflation and spur a recession, warn experts, economists and the International Monetary Fund.

Widespread stagflation could be the result of the war because of the long-term closure of the Strait of Hormuz, said Mohammad N. Elahee, a professor of international business at Quinnipiac University in Hamden, Connecticut.

As is proving typical among the financial “expert” class, analysts at Goldman Sachs insist that China is likely to fare better than other economies, because of its presumed “energy diversification”.

An analysis by a strategist at Goldman Sachs said China is in better shape than other major economies to withstand an oil shock thanks to its energy diversification over the past 10 years.

“China looks better placed than most in this oil shock,” Kinger Lau, chief China equity strategist, wrote in a note on March 30, which was seen by Yahoo Finance.

However, this narrative is no more convincing than Goldman’s last glowing assessment of the Chinese economy.

The reality is that price shocks of more than 30% in a variety of essential materials used throughout China’s manufacturing pipeline are exactly the sort of sudden inflation spike which can trigger a stagflation crisis.

In addition, the suddenness of Iran’s closure of the Strait of Hormuz means China has lost a major source of below-market crude oil. Even though China has been stockpiling oil, anticipating a rupture between the US and Iran, that stockpile is a problematic shield against the higher crude prices China must pay.

For economic security reasons, China was prepared for a potential energy crisis stemming from the US threats to Iran, which intensified at the beginning of 2026. In the first two months of the year, Chinese oil imports surged 16 percent for stockpiling. Russia exported around 300,000 barrels/day more to China in January and February (up to around 2.1 mbd), though for China this is by no means enough. China’s oil imports from the Gulf, now trapped in the Strait of Hormuz, are at least double the amount imported from Russia (5.4 mbd through Hormuz to China).

In other words, in the short run, China still needs to deal with the consequences of the sudden shut-off of a good part of its oil imports at below market price, in the context of a jump in the oil price, which could easily hover around $100/barrel for a sustained period. Standard modelling of China’s sensitivity to oil prices points to a 0.5 percent GDP reduction for a 25 percent increase in oil prices (Rasmussen and Roitman, 2011). This illustrates the stakes for China.

Higher materials prices and higher crude oil prices are not price shifts which can be ignored.

Those higher prices translate directly into a very real risk of stagflation within the Chinese economy.

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China’s Economy Still Underperforming

Regardless of what the narratives say, the data shows that China’s economy is still underperforming in many ways, and has only just begun to show improvement in some of them.

Although China’s official PMI gauge showed the manufacturing sector returning to expansion in March, that same gauge reminds us that China’s manufacturing sector has been in contraction for months at a time since the end of China’s bounceback from COVID Pandemic Panic lockdowns in 2021.

While China nominally turned in a quarter of strong GDP growth to start 2026, that same quarter saw China’s industrial capacity utilization falling to 73.6%, the lowest since the COVID Pandemic Panic lockdowns in 2020.

While new orders surged in March, for most of 2025 new orders were, like the rest of the manufacturing sector, contracting.

At the same time, export prices have been weakening for China since June of last year, when a steady export price rise ended and reversed.

The export picture was further darkened by slowing export growth, which resulted in China’s trade surplus abruptly narrowing to $51 Billion.

Domestically, retail sales growth continued to be sluggish, recording month on month growth of just 0.14% in March.

Year on year, retail sales growth slowed March to 1.7%, reiterating continued weakness in consumer demand.

For comparison, month on month US retail sales growth in March was also 1.7%.

The retail sales growth for an entire year in China is one month of expansion in the US.

At the same time, unemployment has been rising in China, reaching 5.4% in March.

These are not statistics which speak of economic strength and vitality. China’s economy is not in absolute collapse, but neither is it showing robust growth except on paper.

The weakness that has been the norm for the Chinese economy for the past few years means that price shocks such as the world is seeing now in energy can easily turn into a stagflation crisis of no growth coupled with high prices.

There has been a real risk of stagflation here in the United States. That risk has been even greater in China.

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China’s Housing Woes Continue

No look at China’s economy is complete without observing that China’s housing bubble is still deflating, and China’s property developers are still struggling.

China Vanke, one of the largest developers still going—and one which had until last year appeared to have avoided the debt crises which sank many of its competitors—recently announced intentions to extend yet another bond issue, the fourth such debt extension it has sought since the start of the year.

There is no mystery why China Vanke has been repeatedly flirting with debt default: China’s housing markets are still in deep decline even after years of contraction. Residential property prices have been falling without interruption since the first quarter of 2022.

New home sales in China were the weakest for the month of March since at least 2022, charting uninterrupted year on year declines.

Housing starts were also the weakest year on year since 2022.

The consequence of these negative trends for Chinese housing culminates in steadily diminishing levels of property investment since 2022.

That housing markets are still in free fall even after three or four years not only demonstrates just how large the housing bubble was when it burst, it also illustrates just how much damage deflating that bubble will do in China.

The reality of the housing bubble for China is that its collapse represents what will ultimately be a cataclysmic level of wealth destruction among the rapidly diminishing Chinese middle class.

By far the most prevalent mechanism for wealth accumulation among ordinary Chinese has been real estate. As housing prices continue to fall, the value of real estate owned by individuals continues to erode.

If Beijing is serious about letting the bubble completely deflate without intervention, it will be forced to confront the literal destruction of the vast majority of wealth for China’s nascent middle class.

How China peaceably navigates those dangerous waters remains to be seen.

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Demographics Are Still Destiny

The darkest of the clouds hanging over China’s economy remains its declining and aging population.

China continues to be hobbled with a lethally low fertility rate, the unintended consequence of the One Child Policy.

Not only is China’s population declining, the pace of that decline is arguably increasing, according to an analysis done recently by the US-based Rhodium Group, with increasingly immediate economic impacts.

Much has been written about the demographic headwinds to China’s economic growth. But these threats are typically portrayed as over the horizon, a problem for the next decade. The 2025 population statistics should force a rethink of those assumptions. What has long been described as a “gray rhino” risk—a palpable threat that is nonetheless ignored—appears to be charging sooner than expected. Last year China’s population declined by 3.4 million people, compared with a 1.4 million drop in 2024.

Within that decline, the more concerning development for economic growth was its concentration in developed coastal provinces. Migration inflows boosted population growth in eastern Chinese provinces to a greater extent than natural births.

The population decline, which has been ongoing for a number of years now, is accelerating.

China is losing population at an increasing rate.

Most alarming for China is that the population decline is the result of cultural shifts surrounding family planning and marriage. Fewer women are choosing to have babies, with even fewer opting to have more than a single child, even though the One Child policy was largely abandoned a decade ago. At the same time, Chinese couples are getting married later in life, with the average age of married people having risen to 34 years in 2024.

The increasing age of Chinese married couples, and the increasing age of Chinese mothers, results in another troubling phenomenon for China’s population: it is getting older.

China has more older people than it does younger people. That is going to be the demographic reality for at least the next few decades.

Rhodium Group cites these realities and concludes that China’s population is at a point where the word “collapse” is the word to use.

The immediate pressure on China, both economically and politically, is that the aging of the population is putting increasing pressure on the government to fund social security pensions.

But the demographic pressures on China’s fiscal balance are likely still underappreciated. In 2025, Beijing spent 2.9 trillion yuan to fill the deficit from the social security fund, accounting for 10.1% of last year’s general budget spending. The deficit is likely to widen further given the aging of the population. The dependency ratio (number of working people supporting one elderly person) was around 4.4 in 2024 but will fall to 3.5 people in 2030 and 2.8 by 2035, based on our calculations.

On the surface, the size of the social security fund grew another 1.5 trillion yuan last year to lift the total balance to 16.0 trillion yuan. But without the 2.9 trillion yuan in fiscal subsidies, the social security fund would have reported a deficit of 1.4 trillion yuan (about 11 years to deplete the current balance without assistance from fiscal subsidies). The largest hole within the social security fund is from the pension fund, with a total of 6.9 trillion yuan in spending in 2024 against 5.8 trillion yuan in income. The pension fund alone received 1.9 trillion yuan out of 2.6 trillion yuan in total fiscal subsidies.

The social security funding shortfalls also highlight another economic reality arising from China’s collapsing demographics: consumption decline.

Broadly speaking, young people tend to consume more than the elderly. Young people are where family formation typically takes place, and families drive consumption more than any other single factor in every society and culture.

Without a growing cohort of young people, China has zero chance of making meaningful improvements to its levels of domestic consumption, and zero chance of increasing the role domestic consumption plays in overall GDP.

China does not have a growing cohort of young people, and will not have a growing cohort of young people for the foreseeable future.

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Still In Decline

The grim reality of China’s economy is that it is still very much in decline. The Q1 GDP growth metrics, to the extent China’s data can even be trusted, do little to alter that conclusion.

China is still plagued by excess capacity, able to produce more of just about anything than there is demand for that item. That excess capacity is a constraint on future economic growth, because it means China cannot simply grow by producing more.

Excess capacity is a primary reason China has been grappling with broad economic deflation for the past several years. China’s core economic dilemma is that it produces too much for the world to absorb.

Excess capacity is the primary factor suppressing export prices. Although China’s economic model emphasizes exports, it cannot export at scale without driving down prices. It cannot grow export volumes for most products without encouraging price deflation in those same products.

In a perverse irony given China’s large population, that excess capacity extends into the housing market. The extent to which China has overbuilt housing is demonstrated by month after month of falling home prices even has property investment and housing starts decline. The challenge facing developers such as China Vanke is how to improve the financial bottom line when market conditions demand that developers build less rather than more.

Yet for all China’s excess production capacity, China does not produce what ordinary Chinese both want and can afford to purchase. In order for China to make meaningful progress on increasing domestic retail sales, China has to produce goods and services Chinese customers demand and for which Chinese customers are able to pay. It currently is having zero success in doing so, as the stagnant retail sales data shows.

In broad strokes, excess capacity is still the economic imbalance at the core of China’s ongoing deflation. To that the war with Iran is now adding a series of material costs, as well as price and supply shocks.

While the price and supply shocks inject new cost constraints and are pushing prices up, the price increases are not the result of increased demand for goods and services. The emergence of factory gate inflation in China is due to supply constraints, not demand expansion.

That distinction matters, because when prices rise because of increased demand, the higher prices eventually limit demand growth, effectively keeping the demand and supply sides of the economy in approximate equilibrium. When prices rise because of constrained supply, which is what is happening currently in China, the new supply constraints mean that demand must drop to restore that same equilibrium. China is already grappling with inadequate levels of demand for its economic production capacity, and the price shocks from the war with Iran are likely to push demand levels down even lower. That is the exact opposite effect from what China wants to see.

As in the United States, one month of factory gate inflation and materials price shocks does not automatically mean a stagflation crisis for China. That one month of price shocks, however, does mean all the ingredients are in place for a stagflation crisis. Whether China finds itself grappling the same sort of collision of inflationary and deflationary pressures that tortured the US in the 1970s remains to be seen, the longer materials prices remain elevated compared to pre-war levels, the more a 1970s-style stagflation crisis is likely to take shape within the Middle Kingdom.

The closure of the Strait of Hormuz is causing dislocations across the whole of the global economy. Europe is not immune. The United States is not immune. China is not immune. Contrary to many prevailing narratives, China is proving quite vulnerable to those dislocations.

The outcome of the war with Iran is going to determine how much and how fast China’s economy goes from bad to worse.

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China’s real export growth is now expected to grow by 5-6% annually for the next few years, up from a previous forecast of 2-3%, as Chinese goods gain global market share, Goldman Sachs Research economists Andrew Tilton and Hui Shan write in the team’s report.

The team nudged its forecast for China’s 2025 real GDP growth from 4.9% to 5.0%, and with even bigger increases for forecasts for the next two years, on the view that stronger exports will drive overall economic expansion. Goldman Sachs Research increased its real GDP forecast for 2026 from 4.3% to 4.8% and for 2027 from 4.0% to 4.7%. This puts our economists’ Chinese growth forecasts for 2026 and 2027 well above the consensus estimate as tracked by Bloomberg, and above forecasts from the International Monetary Fund.

I have not written about China in quite some time. Partly this has been a reflection of constraints on my research time, but it is also a reflection of the sobering reality that not much is changing in the Middle Kingdom at the moment: the politics are still authoritarian, Xi Jinping is still a Mao Zedong wannabe, and the economy is still spiraling into deflation. There are only so many ways to restate the same narrative arc without becoming hackneyed and cliche.

However, when an investment bank as hefty as Goldman Sachs releases an optimistic growth projection for China’s economy, it is time to review China’s economic data, to see if the Vampire Squid’s1 projection has merit.

Spoiler alert: it doesn’t!

The problem with Goldman Sachs’ projections for China is not merely the levels of growth guesstimated. The problem is the presumption that there will be actual growth at all. Growth in China’s economy requires the reversal of every significant current economic trend in the country. Making such presumption the basis of a projection is not merely overweening optimism, it's borderline psychotic delusion. The reality of the data just does not get us there.

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China Has Not Had A “GDP Growth” Narrative For Years

Straight away, Goldman Sachs’ projections are remarkable because they run counter to the prevailing trend of China’s economy for more than decade.

Aside from the extreme growth and contraction swings following the 2020 COVID Pandemic Panic, China’s economy has been growing by less and less each year since at least 2013.

We should note that, regardless of how we apprehend the accuracy of China’s data, these figures come to us from China’s own National Bureau of Statistics. All the data presented here are “official” China metrics (charted by Trading Economics for convenience). The claim that China’s economic growth has been slowing since at least 2013 is what China itself is saying about its economy.

Even if we look at the quarterly GDP growth metrics, we still have a downward trend in economic growth, except during the disruptive period of the Pandemic Panic.

According to the International Monetary Fund, China’s economic growth rate peaked in 2007, with real GDP growing by 14.2%.

That China’s GDP growth has come in smaller and smaller increments is a trend not just reported by China’s NBS but confirmed by the IMF.

For its part, the World Bank confirms that China’s real GDP growth has been in smaller and smaller annual increments, a downward trend resuming after digesting the dislocations of the Pandemic Panic.

Two presumptively non-partisan, non-ideological institutions confirm what China itself acknowledges about its economic growth: the growth rate has been trending slower and slower for years, even decades.

Goldman Sachs is predicting this trend will reverse significantly.

However, Goldman Sachs is something of an outlier with that prediction. UBS, another investment bank, is projecting even slower economic growth for 2025 and 2026.

Under the baseline, we expect China’s GDP growth to slow to 4.0% in 2025 and 3.0% in 2026, with the assumption that the US hikes tariffs on China’s exports starting in September 2025 and China would increase policy support in response. Net exports will likely still contribute positively to GDP growth in 2025, but we expect exports to fall sharply in 2026, bearing down on manufacturing capex and prices. We expect additional fiscal expansion in 2025-26 to help alleviate local government financial challenges, support infrastructure investment, and help to stabilize the property market. Nevertheless, we expect CPI inflation to weaken to 0.1% in 2025 and -0.2% in 2026 along with a weaker growth.

Goldman Sachs is one of the few investment banks seeing the required patterns necessary for a trend reversal to occur.

To be sure, trend reversals do happen. In economics, where events tend to follow cyclical patterns, trend reversals are almost guaranteed—eventually.

The question is whether the overall trend are leading to a trend reversal and more economic growth, or even a momentary surge for a quarter or two of economic growth.

Certainly within the overall macro data reported by China, a case for trend reversal is difficult—even impossible—to sustain.

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Per Capita GDP Growth Still Lags

One of the principal challenges facing China is not merely a question of economic growth overall, but how to raise China’s per capita GDP to align with the levels found in the United States in Europe.

Looked at in isolation, China’s Per Capita GDP has risen steadily over the past decade.

However, China’s Per Capita GDP compared to that of the United States and the European Union is quickly seen as far less impressive.

On a per capita basis, China’s economic heft compares more realistically to an economy such as Argentina—which, despite decades of economic turmoil, still is in rough parity with China.

China’s large population is how its aggregate GDP stands more in comparison to that of the US rather than Argentina.

China’s economy, per capita, is more like economies which are a fraction of its aggregate size.

Given China’s population, if Beijing were successful in raising China’s per capita GDP to even close to that of the EU or the United States, it would have the largest aggregate GDP by at least a couple orders of magnitude.

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Whither Consumption?

The significance of the per capita GDP figures can be summed up in one word: consumption.

One of Beijing’s explicit policy objectives coming out of the recently-concluded annual Central Economic Work Conference was boosting consumption.

In terms of tasks of next year’s economic work, the meeting said domestic demand will remain as a focus in building a robust domestic market.

Special initiatives should be advanced to boost consumption, and the supply of high-quality consumer goods and services should be expanded. Unreasonable restrictions in the consumption sector should be removed, and the potential of service consumption should be unlocked.

Consumption is relevant to China’s future economic prospects both for economic and geopolitical reasons.

Consumption is important economically because individual household spending is variably understood as either a proxy for economic growth or an engine of it2.

Consumption is geopolitically important for China because other nations are becoming more and more resistant to the idea of China expanding its exported output into their markets—frequently at the expense of their own domestic manufacture.

Analysts say China’s “beggar-thy-neighbor” strategy—expanding exports at the expense of other countries’ industries—is now met with growing international backlash, prompting other countries to consider new tariffs and defensive trade measures.

Intriguingly, the Wall Street Journal posits that the United States—Trump tariffs and all—has contributed more towards global economic growth because US consumption drives US imports, which powers economic growth elsewhere in the world. China historically has favored exports over imports, a policy that has had global economic consequences.

Pop quiz. Who has contributed more to the rest of the world’s growth this year: China or the United States?

The answer is the U.S., and it isn’t even close. Even as the U.S. rolls out tariffs, its imports are up 10% so far this year from a year earlier. And as China moralizes against protectionism, its imports are down 3%, in dollar terms.

In order to satisfy other countries’ concern over the impact of China’s exports on their own economies, China needs to boost domestic consumption, and absorb more of its own economic output at home.

While China has committed to doing that, it unavoidably labors under a major constraint in the form of low per capita GDP. Simply put, the average Chinese household lacks the necessary resources to significantly expand spending and consumption.

This is made immediately obvious by the slowing of retail sales growth month on month.

Nor does the assessment shift much when we look at retail sales growth year on year.

Except for a burst of sales growth during the dislocations immediately following the COVID Pandemic Panic, China has not succeeded in engineering a significant increase in retail sales. China’s households are not increasing their spending relative to overall economic growth, and the per capita GDP figures tell why: they don’t have much in the way of resources with which to spend. Chinese households certainly do not have the resources to drive spending that are found among US and European households.

This constraint is confirmed by China’s lack of import growth.

Consumption is a key driver of imports, for the obvious reason that whatever goods a nation desires but does not produce (or does not produce in sufficient quantity) must be imported.

For comparison, consumption growth in the United States since 2021 is easily reflected by growth in US imports.

In order for China to meaningfully increase consumption as a portion of overall GDP, the per capita GDP must rise. Without such an increase, China’s capacity to leverage consumption as an engine of economic growth is constrained.

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Whither Exports?

Absent consumption growth, the only other avenue for an economy to expand is through exports.

For China, this presents a problem relative to future economic growth, because China’s exports have largely plateaued over the past few years.

After a period of growth in 2021, China’s exports have been largely capped, and have not returned to the peak of $340Billion reached in December of 2021.

China’s export outlook does look a little better when viewed from the perspective of its domestic currency, the yuan.

However, that outlook must be tempered by the decline of the yuan against the dollar over the same time frame.

Any apparent increase in the yuan-denominated value of China’s exports in recent years is less a reflection of actual export growth and more a reflection of the yuan’s decline.

While global pushback against China’s exports is undeniably a factor, the economic impact is still a lack of export growth. Without export growth, and without consumption growth, China’s avenues for economic growth are largely blocked. One or the other has to expand, or China’s economic future is limited.

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China, Inc., Is Stagnating — Update

China’s latest Fixed Investment data shows that China’s economy is in fact grinding to a halt, posting a far greater than expected decline in November.

Investment for housing, public infrastructure and manufacturing fell 2.6 percent from January through November, marking another month of sharp decline in so-called fixed-asset investment, China’s National Bureau of Statistics announced on Monday. The research firm Capital Economics estimated that investment fell 11.1 percent in November from a year earlier, a second straight month of double-digit declines over 2024.

After surging in the immediate aftermath of the Pandemic Panic, China’s Fixed Asset Investment has been shrinking steadily for the past few years.

While investment growth turned negative a few months ago, November’s decline exceeded everyone’s projections.

Without investment, jobs, consumption, and overall economic growth cannot happen, especially in an economy such as China’s which is already driven primarily by exports and housing.

China is not investing in China. There is no way this can end well.

China, Inc., Is Stagnating — Starting Point

The lack of significant export growth in recent years also serves to explain another red flag within China’s economy: the decline in corporate profits.

China’s companies are earning less and less each year, and have been since 2021.

Moreover, this was a trend that was disrupted by the COVID Pandemic Panic, but which was occurring prior to 2020 as well.

China’s industrial profits year to date for 2025 are less than they were in 2017, which suggests that any stimulative effect from the Pandemic Panic on industrial profits has been expended, and China’s companies are reverting to a pre-panic mean. That is not a good sign for China’s economic future.

Whether there will be a quick reversal in the profit decline is problematic, because China’s industrial capacity utilization peaked in 2017, was starting to decline, peaked again in 2021, and has been declining ever since.

Whether goods are produced for export or for domestic consumption, if industrial capacity is being less and less utilized, the one thing that is certain about overall production is that it is not increasing.

China’s reported Manufacturing PMI confirms this is the case.

Within the PMI methodology, any index value below 50 shows contraction, and any index value above 50 shows expansion. With few exceptions, China’s Manufacturing PMI has been charting contraction since mid-2022.

While the Non-Manufacturing PMI tells a better tale, it does not tell a much better tale, particularly in recent years.

China’s non-manufacturing (services) industries are still expanding, but only just, and in November slipped into contraction. If the trend in the Non-Manufacturing PMI continues, there will be more contraction in China’s future, not less.

Nor is there an indication of a turnaround in manufacturing any time soon. The New Orders sub-component of the overall Manufacturing PMI has also been in contraction with regularity.

If the level of new orders are in decline, the expectation is that manufacturing overall will continue to decline—no new orders means no new business means no basis for expansion.

We should not be surprised, therefore, to see that China’s factory gate prices (aka producer prices) have also been in decline.

Whether due to lack of domestic demand or export demand, the reality of China’s productive enterprises is a lack of pricing pressure.

There is undeniably a lack of export demand, as China’s export prices declined precipitously in 2023.

While they have recovered somewhat from a 2024 nadir, China’s pricing power in export markets is not at all what it was in 2022.

This lack of producer and export pricing pressure is the surest sign that China has slipped into outright deflation, and appears to be stuck there.

China’s lack of consumer price inflation is a stark confirmation of the stagflation/deflation diagnosis.

A lack of inflation is a lack of pricing pressure. Either there is not an increase of circulating money causing consumers to bid up prices or there is simply not the organic consumer demand. Given that China’s monetary policies have been historically lose and are explicitly planned to continue to be loose, the lack of consumer price inflation must be seen as a lack of organic demand.

Chinese consumers are simply not interested in consuming.

Regardless of what GDP forecasts say, China’s current economic condition is demonstrably one of stagnation, stagflation, and quite probably outright deflation.

Expanded GDP growth in such circumstances can only be illusory growth which does nothing to increase the prosperity of either the people or the nation as a whole.

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Housing Is Still An Albatross

No commentary on China’s economic circumstances would be complete without touching on the state of affairs in China’s housing industry. The collapse of China’s housing industry has been the lead story regarding China’s economic situation, going back to the collapse of Evergrande in 2021.

The story has not improved since then. It has, instead, continued to deteriorate.

China’s housing prices are still in freefall.

Unsurprisingly, housing starts are also on the decline.

New home sales are likewise heading south.

Unsurprisingly, property investment in China has also collapsed.

There is no disputing the reality that China’s real estate bubble was well and truly burst in 2021, and has been deflating ever since. The size of that bubble and the magnitude of the damage it is causing to the Chinese economy is illustrated by the reality that, four years on, the bubble is still deflating.

The continued decline of housing in China is not merely a decline in pricing. It is wealth destruction on a massive, even apocalyptic scale. What wealth China’s nascent middle class has accumulated is largely tied up in real estate, and the collapse of real estate values and real estate investment means that wealth is evaporating.

One reason Chinese consumers are indifferent to consuming is they are losing the means to fund consumption, as the collapsing housing bubble sucks up all their available wealth.

Ominously, one sign the wreckage is far from complete for China’s housing markets is that China Vanke, which last year was flashing warning signs of being China’s “Evergrande 2.0”, is facing an imminent bond default.

Late last week, China Vanke sought to extend repayment of a maturing bond issue, a move which tested the mettle of investors who had already been hit with the shock of an earlier bond extension request.

Shenzhen-based Vanke, once the nation’s largest builder by sales, told bondholders Monday that it was seeking a one-year delay to pay the 2 billion yuan ($283 million) note originally due Dec. 15, people familiar with the matter said. The 3% interest would also only be paid after a year. The proposed changes would require at least 90% approval from holders, based on the note’s prospectus.

Vanke followed that up just days later with a request to extend a second bond issue due on the 28th.

Bondholders have nixed an extension on the first bond issue, putting Vanke on a countdown to outright bond default.

Bondholders rejected the proposal to delay maturity, leaving Vanke with a five-business-day grace period to pay 2 billion yuan ($280 million) under the deal terms.

The setback for Vanke, one of China’s highest-profile developers with projects in major cities, has renewed concerns that the country’s property sector could slip back into crisis.

The industry, once contributing up to a quarter of GDP, was hit by a liquidity crunch in 2021 after tighter regulations, leading to dozens of defaults.

Vanke, as I noted last year, could be particularly troublesome for Beijing, as it is one of the “state owned” developers in China’s property sector. The previous high-profile collapses, Evergrande and Country Garden, were privately owned.

What are the ramifications of a state owned enterprise failing? Those are hard to calculate, because such a failure strikes at the credibility of the state itself.

Will Beijing step in at the last minute to bail the developer out, or at least resolve the bond default? There is no reporting as of yet to indicate that Beijing is inclined to do so, but it may not have much choice. Given the contagion effect that Evergrande’s collapse had on private property developers, Vanke going under could precipitate a similar scenario among the state owned developers.

In a top-down economy such as China’s the state owned enterprises are not merely “too big to fail”, they are the ones for which failure is not supposed to be an option, ever—until it is.

Given the ongoing toxicities within China’s housing markets, the turnaround prospects for China Vanke are best assessed as between slim and none. Beijing either bails the company out or watches a fresh wave of corporate collapses roll through the real estate sector.

After four years of bubble deflation, China may have yet to experience the worst of it.

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What Is Goldman Smoking?

When one looks across the totality of the current data on China’s economy—data that comes from China itself, officially reported by Beijing—a simple question naturally arises regarding Goldman Sachs’ economic projections for China:

What are they smoking?

Indeed, one has to question the basis for charting any economic growth for China, either this year or next, or any time soon at all. Other than paper numbers propped up by government spending, growth is not the current narrative of China’s economy.

Stagnation, stagflation, and outright deflation are the current narratives.

Is China’s economy about to implode spectacularly? That is a possibility, although perhaps not a probability. What is certain is that China’s economy is still very much in the deflationary trap I described last year. Even without a complete implosion, if current trends continue there will be no significant economic growth in China, not in real terms.

If Vanke and other state owned developers collapse, could that in turn trigger a banking, liquidity, and ultimately political crisis? That is very much a possibility, as the Evergrande collapse already produced one mini-crisis, with mortgage holders protesting the situation by withholding mortgage payments.

That a fresh cycle of corporate defaults carries outsized political risks for Beijing has already been demonstrated. Whether that risk becomes an existential crisis for the CCP is at present unknowable, but the possibility has already been shown to exist.

With other countries looking askance at China expanding its exports to the world, China’s “go to” economic policies are increasingly being blocked by outside geopolitical forces. Unless other countries elect to allow China to increase exporting into their markets, increasing export volumes is not a viable path for China’s future economic growth.

Yet without exports, where China gets the economic growth to raise its per capita GDP is very much an unknown. If China does not raise its per capita GDP significantly, any increases in consumption which might be generated by various government stimulus measures will be at best transitory and will drive consumption most likely along unsustainable channels.

How the net effect of these reported, documented, official economic realities for China translates into optimistic growth assessments for China’s real gross domestic product is also very much an unknown. For China to experience good economic growth, a number of negative trends need to reverse, and at present there are no signs that any of them are about to do so.

Unlike the Vampire Squid, I am disinclined to make a discrete projection about China’s future economic growth, mainly because China’s future economic outlook is bleak heading towards catastrophic.

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Yunqing Jian, 33, and Zunyong Liu, 34, citizens of the People’s Republic of China, were charged in a criminal complaint with conspiracy, smuggling goods into the United States, false statements, and visa fraud, announced United States Attorney Jerome F. Gorgon, Jr.

Gorgon was joined in the announcement by Special Agent in Charge Cheyvoryea Gibson, Federal Bureau of Investigation, Detroit Division and Marty C. Raybon, Director of Field Operations, U.S. Customs and Border Protection.

The FBI arrested Jian in connection with allegations related to Jian’s and Liu’s smuggling into America a fungus called Fusarium graminearum, which scientific literature classifies as a potential agroterrorism weapon. This noxious fungus causes “head blight,” a disease of wheat, barley, maize, and rice, and is responsible for billions of dollars in economic losses worldwide each year. Fusarium graminearum’s toxins cause vomiting, liver damage, and reproductive defects in humans and livestock.

The couple are reported as having claimed they intended to use the Fusarium graminearum samples for “research”.

Liu initially said he didn't know what the materials were and that someone must have put them in his bag, according to the court filing. He later said he accidentally put them in there and, after further questioning, acknowledged the materials were different strains of the pathogen.

According to the affidavit, Liu said he planned to clone the different strains on the filter paper and make more samples if the experiments on the reddish plant material failed. It indicated that he said he hid the samples in his backpack because he knew there were restrictions on the importation of the materials. He said he would have free access to the U-M lab on some days, the filing continued, and Jian would give him access to the lab to conduct the research.

Such statements are on their face absolute hogwash and horse hockey. There are established protocols and procedures for the safe handling of biological materials within a research laboratory1, and any researcher conducting legitimate research at the University of Michigan or any other research facility would be required to receive training in those protocols. Suffice it to say those protocols do not allow for dangerous pathogens to be transported in plastic baggies stuffed in a person’s carry-on luggage.

Based on the official statement of the University of Michigan, Jian and Liu were not sanctioned to be conducting any research involving the smuggled fungus samples.

"We strongly condemn any actions that seek to cause harm, threaten national security or undermine the university's critical public mission. It is important to note that the university has received no funding from the Chinese government in relation to research conducted by the accused individuals. We have and will continue to cooperate with federal law enforcement in its ongoing investigation and prosecution."

It should be noted that two Chinese nationals smuggling a deadly pathogen through a US airport is not, by itself, absolute proof that Beijing has been planning a bioterrorist attack on the United States. The possibility that Jian and Liu are simply the latest example of biologists going off the rails and playing god with a potential plague cannot be completely dismissed.

It should also be noted that Jian’s devices apparently contained numerous texts and other communications asserting her loyalty to China—which is to say to the Chinese Communist Party. To call the incident “pretty damn suspicious is an understatement.

How can anyone hope to “trust the science” about anything when time and again scientists prove themselves to be completely untrustworthy?

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Update 4:30PM CDT 12 May 2025

One of the interesting asides in President Trump’s press briefing earlier today over prescription drug prices was his commentary on the “trade reset” arranged in Geneva over the weekend. In particular, he claimed there is an assurance (yet another assurance?) that China will do more to open up its markets to American companies.

“China will also suspend and remove all of its non-monetary barriers, “ Trump said. “They've agreed to do that.”

If China does agree to remove even some of its non-tariff trade barriers, that will be quite huge. That would be transformative for the Chinese economy—and for Chinese society.

The transformative nature of such an agreement for China is, perversely, the reason to be the most skeptical about the agreement. The more China opens up its economy and society, the less control over the economy and the society the CCP has. The CCP has historically never put the benefits of a liberalized economy to the Chinese people ahead of the benefits of totalitarian rule to the Chinese Communist Party.

It would be a wonderful thing and a great benefit to all sides if China did open up its economy in this way.

I will believe it when it happens.

Update 8:30AM CDT 12 May 2025

The Trump Administration has released the details of the trade deal. In a nutshell, the US and China are hitting “pause” on the trade war.

The United States will (i) modify the application of the additional ad valorem rate of duty on articles of China (including articles of the Hong Kong Special Administrative Region and the Macau Special Administrative Region) set forth in Executive Order 14257 of April 2, 2025, by suspending 24 percentage points of that rate for an initial period of 90 days, while retaining the remaining ad valorem rate of 10 percent on those articles pursuant to the terms of said Order; and (ii) removing the modified additional ad valorem rates of duty on those articles imposed by Executive Order 14259 of April 8, 2025 and Executive Order 14266 of April 9, 2025.

China will (i) modify accordingly the application of the additional ad valorem rate of duty on articles of the United States set forth in Announcement of the Customs Tariff Commission of the State Council No. 4 of 2025, by suspending 24 percentage points of that rate for an initial period of 90 days, while retaining the remaining additional ad valorem rate of 10 percent on those articles, and removing the modified additional ad valorem rates of duty on those articles imposed by Announcement of the Customs Tariff Commission of the State Council No. 5 of 2025 and Announcement of the Customs Tariff Commission of the State Council No. 6 of 2025; and (ii) adopt all necessary administrative measures to suspend or remove the non-tariff countermeasures taken against the United States since April 2, 2025.

The most important element of the “pause” is that the punitive tariff rates are being dialed back for 90 days.

Not only is Wall Street pleased, retaining most of its overnight optimism about the trade deal, but currency markets are responding favorably as well, with the dollar index climbing sharply this morning.

It is worth noting that corporate media’s alarmist headlines from last week are appearing somewhat “exaggerated” this morning.

Those stories are not aging at all well, and are now yet another reminder that the real world effects of tariffs are not nearly as simplistic as corporate media has been presenting.

Update 8:00AM CDT 12 May 2025

Wall Street is looking forward to the details of the Trump Administration’s “trade deal” with China. The Dow is anticipating a boost of over a thousand points when the trading day begins.

With no word on the actual details—or even if there is an actual deal or merely an agreement to make a trade deal—Wall Street is choosing an optimistic view of the Trump Administration’s announcement yesterday.

Will Wall Street be disappointed when the details are made public later this morning? That will the question of the morning.

Starting Point

Has Donald Trump scored another diplomatic win, forging a trade deal with China?

That is certainly what the Trump Administration is suggesting.

“I’m happy to report that we’ve made substantial progress between the United States and China in the very important trade talks,” Treasury Secretary Scott Bessent said in a brief statement Sunday in Switzerland, where the talks were held, calling the talks “productive.”

US Trade Representative Jaimeson Greer was even more optimistic.

Greer described the Geneva meetings' conclusion as "a deal we struck with our Chinese partners" that will help reduce the $1.2 trillion U.S. global goods trade deficit.

"And this was, as the secretary pointed out, a very constructive two days," Greer said. "It's important to understand how quickly we were able to come to agreement, which reflects that perhaps the differences were not so large as maybe thought," Greer said.

Exact details are to be released on Monday, May 12.

Even the usually effusive Commerce Secretary Howard Lutnick was unwilling to divulge those details in an appearance on “State Of The Union” with Dana Bash.

Is there a trade deal?

If I were to hazard a guess, I suspect the actual answer is “yes and no.”

“Yes,” the US and China most likely have reached an agreement in principle to cut the US trade deficit with China, and in particular to improve imports to China of a number of US-made goods. That agreement in principle most likely includes commitments to lower tariffs on both sides to some degree.

“No,” the two negotiating teams have almost certainly not finalized all the fine details over intellectual property protection, Chinese dumping of products on the export market, and countless other non-tariff trade barriers China erects with the outside world.

Donald Trump has never been shy about hyping his Administration’s policy wins, big or small, and Cabinet officials like Howard Lutnick share that tendency. We should not be surprised if this turns out to be the case here.

The Trump Administration has almost certainly made significant progress—perhaps even enough progress to downshift the more onerous reciprocal tariffs in place currently—but I have a strong suspicion that when the details are released corporate media will spend most of its energy trying to undermine the Trump Administration’s claims about a major trade deal having been concluded.

How successful they will be in that effort will depend on the details which actually get released.

Liberation Day was also President Trump’s declaration of a trade war with China.

Both in response to what President Trump deems to be China’s unfair trade practices as well as China’s role in America’s fentanyl crisis, Trump imposed what eventually amounted to a total tariff rate of 145% on products imported from China.

Corporate media and Wall Street have had a serious case of the vapors over the potential fallout from this trade war to the US economy, given the volume and variety of goods the US currently imports from China.

Yet how does this trade war impact China? How well can China hope to respond to the tariffs as well as Donald Trump’s usual bluster?

Last fall I wrote at some length regarding the steady deflation of China’s economy—a deflation that does not bode well for the Middle Kingdom if Trump’s trade war lasts for any significant length of time.

President Trump may have lit the trade war fuse, but it could very well be that it is China’s economy which will burn.

With tariff and trade war very much a current and almost certainly future reality for China, a review of China’s economic situation is very much in order.

Is China Ready For A Trade War?

Unsurprisingly, corporate media takes a dim view of President Trump’s tariffs, and an even dimmer view of his trade war with China, with several outlets going so far as to speculate that China is likely to prevail in the economic test of wills.

A recent op-ed piece in the Financial Times went to some length to detail why China would weather Trump’s tariff tantrum, arguing that the tariffs, the trade war, and President Trump’s economic policies were little more than the chaotic bumblings of a rank amateur.

The president’s team is scrambling to rationalise the chaos as a master plan to build a coalition to defeat Chinese mercantilism. But any such plan is doomed to fail. To understand why, we first need to get at what Trump really wants from tariffs. The usual claims — that he wants to crack down on unfair trade practices, eliminate trade deficits, reindustrialise America, confront China — do not hold up. Trump often invokes these goals. But these stated aims often contradict each other, are contradicted by other policies or are obviously unachievable.

We should note, however, that such pieces are pure propaganda, and in this instance pro-China propaganda. That is made plain by the sweeping generalizations the article makes about how the world views President Trump’s tariffs, as a sign that the US is an unreliable actor on the world stage and that Trump is isolated in his stance against China.

Most countries now understand that the various economic rationales offered by Trump’s advisers are just window-dressing. So long as Trump is in charge, the US is unreliable, and no sane leader will join him in a crusade against China.

Such claims are by their nature mere opinion on a good day, and jingoistic rhetoric on every other day.

Yet the author makes another claim in particular which warrants further scrutiny, regarding China’s ability to withstand trade sanctions from the United States.

China may be losing demand from the US, but this can be replaced by domestic consumer demand, which has been abnormally weak thanks to overly tight monetary policy, and an obsession with pouring state resources into manufacturing. Xi Jinping has reversed course and is now serious about boosting domestic demand.

This claim is questionable on its face, because if China has had the capacity all along to boost domestic demand, why has it only recently attempted to do so, as the author claims?

Does China’s own economic data support such a claim? It would take a generous reading of the economic data for that to be the case.

Remember, China has been mired in deflation for quite some time. Domestic demand is not something China has had in abundance, and we can see that by looking at their Consumer Price Index data.

While China’s CPI does fluctuate up and down, since 2023 it has done so largely in a range around 103. It is not appreciably rising or falling very far from that value, having risen to that value from mid-2021 through 2022.

Price levels and even inflation are occasioned by the demand for goods and services, and while much of the rhetoric of consumer price inflation revolves around variables such as the money supply and the relative scarcity of goods, the dynamic of a marketplace is invariably that prices rise when there is demand for goods which exceeds supply, and prices fall when the supply of goods exceeds the demand.

What a stable Consumer Price Index tells us is that there is not a significant un-tapped demand within China’s domestic market. If there were unmet needs and wants, we would see that in the CPI as a general rise in prices. Since 2023 we have not seen a rise in general prices.

With respect to core consumer goods and services, the presence of a falling price index indicates weaker and even weakening demand within domestic Chinese markets.

Since 2022, the core consumer price index for China has trended down, indicating diminished or diminishing demand for core consumer goods in China.

According to the Financial Times, this is the product of poor monetary policy, which Xi Jinping is committed to revising.

To be sure, the People’s Bank of China has injected a fair bit of fresh liquidity into their monetary system, boosting the M1 money supply by roughly ¥4 Trillion in March alone.

However, it would be inaccurate to characterize China’s monetary policies as “tight”. While Beijing did expand the money supply beginning in January, China’s monetary policy has always been far looser than US monetary policy, as the data going back to 2001 clearly shows.

When a country expands its money supply five times as much as the US has expanded its money supply, that country’s monetary policy is not at all “tight”, let alone “overly tight”.

Moreover, the pace at which China has increased its money supply suggests that China’s CPI data could actually indicate falling demand which is then being counteracted by monetary inflation.

If we proceed from the Friedmanite thesis that inflation is a monetary phenomenon, then we should expect to see major inflation in China, all things being equal. However, we have not. We see barely any inflation, and in core prices we are seeing either disinflation or even deflation. This is taking place in an environment where the money supply is expanding fairly rapidly. If we insist that the money supply produce an upward pressure on prices, then China is experiencing a downward pressure on prices that very nearly neutralizes the upward pressure.

If that’s the case, then Beijing’s additional goosing of the money supply is not going to have much impact on consumption, and the op-ed piece in the Financial Times is wrong.

We can further confirm the laxity of China’s monetary policy simply by looking at the balance sheet of the PBOC over time.

When the central bank increases its assets, it is expanding the money supply and loosening monetary policy. Debt instruments (assets, to a bank) are how central banks increase the money supply. If China’s money supply were the result of a tight monetary policy, we would not see a steady rise in the PBOC balance sheet.

That is confirmed by the steady rise in assets among private banks as well.

China has demonstrably had a very loose monetary policy for decades, yet it still has not been able to stimulate consumer demand!

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What About Global Demand?

Global demand for Chinese products is hardly any better.

While export prices surged for China in 2021 and 2022, in the aftermath of the global lunacy of the COVID Pandemic Panic, since then they have retreated and largely stabilized.

Even with exports, the basics of demand and supply hold true, and a languishing export price index means there is not a lot of demand for Chinese goods on the world market at the moment.

Import prices tell a similar story. Where prices rose sharply in 2021 and 2022, they fell and then stabilized in 2023 and 2024.

With neither export nor import prices do we see signs of significant rising demand for Chinese goods and services.

When we look at the exchange rate for the Chinese yuan against the dollar, which has declined some 3% in recent years, we see even more indication that there is a lack of demand for Chinese goods, and further confirmation that monetary policy has been fairly loose.

A weakening currency generally has the same inflationary effect as expanding the money supply—the two phenomenon are often highly correlated within monetary policy. With a steadily weakening yuan in global foreign exchange markets, price levels should have responded by rising. They have not—or perhaps the monetary inflation is neutralized by demand deflation.

We should always remember that the constant caveat when describing the effects of individual economic phenomena—”all things being equal”—is always just a theoretical construct. In the real world all things are never equal, and the actual movement of prices is always the resolution of multiple forces pushing prices up and down.

At best, the behaviors of China’s export and import prices tell us that there is stable global demand, but not rising global demand for Chinese goods.

At worst, the behaviors of China’s export and import prices, coupled with the backdrop of currency depreciation, tell us that there declining global demand for Chinese goods.

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About Manufacturing

The reality of a deflating economy is that manufacturing is never in good shape.

When we look as China’s Manufacturing Purchasing Manager Index data, we see that China’s manufacturing sector is very much not in good shape.

The key detail in understanding PMI metrics is that any value over 50 represents an expansion, and any value below 50 represents a contraction.

When we look at China’s official Manufacturing PMI metric, we see that the sector has been in contraction for a substantial portion of the past two years.

Already the top-level data is not looking good.

This does not mean that China is not producing goods. While the top-level metric has printed contraction, the production PMI metric has printed far more expansion.

We should note that, in recent months, both of these metrics indicate expansion. More production is always a good thing for the manufacturing sector.

However, the data doesn’t quite add up. While production has been largely in expansion, inventories for China have largely been in contraction.

Orders—both new orders and in hand orders—have likewise been largely in contraction, with the New Orders Index only just breaking through to expansion for the first time in months in November of last year.

Even worse for China has been the employment metric for manufacturing, which has been in almost unrelenting contraction since at least 2021.

Regardless of what China hopes people will infer from the headline PMI data, the detail does not say anything positive or upbeat about the state of China’s manufacturing economy.

These metrics are perfectly aligned with an economy that is trapped in deflation still—China has not succeeded since last I looked at this data in breaking out of that trap. These metrics are not at all aligned with an economy capable of withstanding any significant level of trade sanctions.

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Housing Still In Crisis

We cannot discuss China’s economy and not talk about housing.

What is remarkable about China’s housing crisis is how long it has gone on.

Even as far back as 2021 it was apparent that China’s economy was being dragged down by its housing problems, and it was housing that turned the Chinese economy into “the sick man of Asia.”

Since then, the “sick man” has only gotten sicker, as sales of apartment units have declined steadily.

Sales of houses have also diminished.

That the market is nowhere near done falling is underscored by the diminishing housing starts each year since 2021.

Property investment in China remains very much in freefall, and has for going on three years now.

From the first quarter of 2022, housing prices have declined, and continue to decline.

Even more distressing is that the price declines in the most recent quarter are the most significant price declines. The deflating of China’s property bubble appears to be accelerating, which means it still has quite some distance to go before it is done with the deflation.

Perversely, China’s official Construction PMI data serves to illustrate why the housing bubble is so large, and why it is taking so long to fully deflate:

With the Construction PMI printing expansion almost continuously since at least 2021, even in the face of collapsing home prices, China has persisted in building out still more housing, despite the housing sector being tremendously overbuilt.

With housing in China amounting to 25% of China’s overall GDP, the collapsing housing bubble is a principle reason China’s economy is mired in a deflationary downward spiral.

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Who Wins A Trade War?

Does this data mean that China is fated to lose its contest of wills with President Trump?

Hardly.

As I have commented many times before, the US economy has its own challenges, and has its own vulnerabilities. There is an entire section of my Substack devoted to exploring those very issues.

The data here shows that China is not in great shape for fighting a trade war. That should not be taken to mean the United States is in great shape for fighting a trade war.

Xi Jinping himself articulates an important point, in a recent op-ed piece he published in Vietnamese media while on a trip to Vietnam: no one really “wins” a trade war.

He wrote:

“Our two countries should resolutely safeguard the multilateral trading system, stable global industrial and supply chains, and open and cooperative international environment.”

This is, of course, the classic articulation—as well as the classic defense—of the global maritime trading order that has emerged in the post-WW2 era, and especially after the 1992 collapse of the Soviet Union.

Xi’s statements are, of course, completely self-serving. Yet for all their grounding in Xi’s self-interest, they do drive home the point that the best outcome of any trade dispute is improved, balanced, and equitable trade among nations. The ideal outcome to this trade dispute is that the United States enjoys improved relations, is able to manufacture more, export more, and import more—all without incurring a permanent and substantial trade imbalance.

Whether that will happen is far from likely, and for all of Xi’s paying lip service to the virtues of engagement and improved trade relations, his remarks come while he is on a trip to curry favor among the nations of Southeast Asia particularly on trade relations. Xi is looking for trade allies and is hoping that Trump’s Liberation Day tariffs will help him find some. Even corporate media is willing to concede that point:

The timing of the visit sends a “strong political message that Southeast Asia is important to China,” said Huong Le-Thu of the International Crisis Group think tank.

She said that given the severity of Trump’s tariffs and despite the 90-day pause to "reciprocal" duties, Southeast Asian nations were anxious that Trump's policies could hinder their development.

Whether Trump’s policies are alienating countries or instead motivating them to negotiate with the Trump Administration over tariffs is a very much an open question. Obviously, if Xi is able to secure allies among the nations of Southeast Asia he can blunt at least some of the impacts of the Trump punitive tariffs imposed on China.

Contrary to the pontifications of corporate media—and even a fair amount of the alternative media—we do not know yet what the final outcome of President Trump’s trade dispute with China will be.

If Xi Jinping and China are less able to withstand the pressures being applied by President Trump and tariffs, Xi will be compelled to seek rapprochement with the United States on President Trump’s terms. Nominally, the United States would “win” the trade war under those circumstances.

If President Trump and the United States are less able to withstand the pressures being applied by Xi and his tariff responses, then it will be Donald Trump who will be compelled to seek rapprochement with China on Xi’s terms. Nominally, China would “win” the trade war under those circumstances.

Yet as this trade dispute drags on, there are sales by US companies in China that are not going to happen.

There are sales by Chinese companies in the United States that are not going to happen.

From a geopolitical and national security perspective, there are arguments for the United States to completely decouple from China, but from the economic perspective, such a decoupling of trade means trade overall is diminished.

There is no way a reduction in trade relations does not amount to a reduction in GDP for both the United States and China. Similarly, there is no way the disruption in trade relations that is the trade war itself does not amount to a reduction in GDP for both the United States and China.

That is the price that will be paid by both the United States and China as the cost of this trade war.

Whether China’s economy is in any shape to be paying such a price is, by the numbers, very much in doubt.

Far from becoming the world’s next number one economy, China is now trapped in a deflationary swamp, and the numbers say things will get much worse before they get better.

The release of China’s latest official Purchasing Manager Index data, which printed yet more contraction in manufacturing and continued softening in non-manufacturing sectors, underscores what is now obvious to one and all: China’s economy is not growing, but contracting.

The National Bureau of Statistics (NBS) purchasing managers' index (PMI) released on Monday nudged up to 49.8 in September from 49.1 in August, still below the 50-mark separating growth from contraction but beating a median forecast of 49.5 in a Reuters poll. The reading was the highest in five months.

It’s an odd sort of success when the economic data “beats” expectations by merely being less bad than anticipated. Yet such is the state of China’s economy that “less bad” is the best available.

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As bad as the economic situation in the United States is—and it’s not at all good—the data shows China’s situation to be considerably worse.

As already noted, China’s PMI data shows the economy to be contracting across multiple sectors.

The headling Manufacturing PMI has been printing contraction for months.

Any PMI number below 50 represents a contraction, and with few exceptions China’s Manufacturing PMI has been contracting since early 2023.

Yet it’s not just the topline Manufacturing PMI that is in contraction. Drilling into just about every component of manufacturing also shows contraction.

Factory orders are on the decline.

Inventories are on the decline.

What is most disconcerting abot these subordinate PMI metrics is that they are showing steady contraction—the numbers are stubbornly below 50 consistently. The contractions are not transient aberrations but are instead long term trends.

Even purchasing activity is in contraction within China.

Less purchasing, less inventory, fewer orders — these are not the long term industrial trends from which growth and prosperity can emerge.

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When we look at intermodal freight activity in China, we another alarming trend — freight activity has largely plateaued during 2024.

When total ton-kilometers is constant or declining, it means that China is not moving a growing number of goods, and an economy that doesn’t move more stuff cannot be growing.

Again, when we drill into the subordinate metrics, we see the trend being sustained.

Rail freight is actually declining.

Highway tonnage is also down.

Waterway traffic itself has largely plateaued, with a moderate trend downward.

No matter what the narratives might suggest about the state of China’s economy, how can there be substantive economic growth if the same volumes of goods or less are being moved around the country?

Nor is China getting much help from the non-manufacturing sectors of the economy.

With the topline number right on the bubble, printing at a neutral 50, new orders is showing contraction just as it is examining the underlying data for the manufacturing PMI.

With businesses booking fewer and fewer orders, there is no stage being set for future economic growth. Rather, the stage is being set for ongoing economic contraction.

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With manufacturing businesses especially doing less business, there is no surprise to find that profits are down in China—way down.

The 17.8% drop was the steepest since an 18.2% drop in April 2023, according to official data accessed through Wind Information.

The statistics bureau attributed the large decline in August to a high base in the year ago period. In August 2023, the same monthly figure expanded 17.2% from a year ago.

The drop dragged down industrial profits for the year. In the first eight months of the year, profits at large industrial firms grew by 0.5% to 4.65 trillion yuan ($663.47 billion), compared with a 3.6% increase in the first seven months.

Spin aside, the reality is that China’s businesses have been experiencing profit shrinkage for months.

Even the year on year change in profits has been consistently negative.

Fewer orders mean less business mean less profits. The economic math on this point is simple, blunt, and brutal.

While it would be an exaggeration to say that China’s economy is in a state of collapse, it is equally and exaggeration to speak of China’s economy growing. No matter what the GDP data might show, virtually every other indicator is flashing contraction. Not only is China not likely to meet its 2024 GDP growth goal of 5%, in reality the Chinese economy has almost certainly contracted thus far in 2024, and with zero signs that there will be any expansion at all in the coming months.

Small wonder Beijing decided to fire its “stimulus cannon” at the economy. Even more remarkable, however, is the panicked way in which Xi Jinping is unleashing stimulus, matching it with calls within the CCP rank-and-fil for policy “innovation”.

“The vast number of party members and cadres must have the courage to take responsibility and dare to innovate,” said a readout from the meeting, which was chaired by Xi.

The readout also mentioned the term “three exempts” – exempting well-meaning officials who make mistakes due to lack of experience; exempting officials who make mistakes in experiments, especially those in new domains without clear restrictions; and exempting officials who inadvertently err when promoting development.

“The fact that this ‘responsibility and punishment waiver’ is reaffirmed at today’s Politburo meeting, at which Beijing issued the most urgent call-out to fire up economic growth, is significant,” said a political scientist with Peking University who declined to be named as they were not authorised to speak to non-state media.

As I wrote in a Note the other day, given the extent of Xi’s cult of personality within the CCP, such a call for policy innovation is tantamount to policy failure at the top of the CCP leadership.

But the cry for policy “innovation” is itself remarkable in a system that has been marked by top-down thinking even before Xi assumed control, and has only become more centralized during his tenure. Asking mid-level bureaucrats to “innovate” means the top-level people have run out of ideas. By definition any time someone asks someone else to innovate there is a lack of ideas on one side of the equation.

After over a decade of “anti-corruption” purges which have effectively removed most if not all independent thinkers from the CCP cadres, exactly where Xi hopes to find this “innovative” policy thinking remains something of a mystery.

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While Xi is hoping for policy innovation within the ranks of the CCP, the current firing of Beijing’s “stimulus cannon” is proving to be a rather conventional and largely unimaginative set of measures intended to bolster China’s collapsing housing markets and stabilize that crucial economic sector.

A primary nexus of China’s economic woes is that home sales are still languishing, and are continuing to trend down despite previous efforts to revive the sector.

This downward pricing trend is carrying over into China’s rental markets, which is seeing continued rent price deflation for most of 2024.

Predictably, China’s stimulus measures are targeting these moribund markets, seeking to revive their flagging fortunes, including slashing interest rates and the required reserve ratio for banks in order to stimulate mortgage lending.

The reserve requirement ratio (RRR) – the amount of cash that commercial banks must hold as reserves – and the mortgage rate for existing housing would be cut by half a percentage point, according to People’s Bank of China governor Pan Gongsheng.

The PBOC would also support the acquisition of real estate companies’ lands by studying measures to allow policy and commercial banks to grant loans to eligible companies to acquire the land, revitalise the stock of the land and ease the financial pressure on real estate enterprises.

As more than one analyst has noted, however, these efforts fail to address the causes of falling home sales: low and falling housing demand.

The measures the CCP announced are intended to make it easier for Chinese people to access capital and buy property, but access to debt is not the problem here. People in the country do not want to spend money because they are already sitting on large amounts of real-estate debt tied to declining properties. Seventy percent of Chinese household wealth is invested in property, which is a problem since analysts at Société Genéralé found that housing prices have fallen by as much as 30% in Tier 1 cities since their 2021 peak. Land purchases helped fund local governments so they could spend on schools, hospitals, and other social services — now that financing mechanism is out of whack. Sinking prices in these sectors, or what economists call deflation, has spread to the wider economy. The latest consumer price inflation report showed that prices rose by just 0.3% in August compared to the year before, the lowest price growth in three years, prompting concerns that deflation will take hold, spreading to wages and killing jobs.

Moreover, as I mentioned in an earlier Note, spurring new home sales does not address the fundamental imbalance within the economy the housing bubble represents.

No amount of stimulus can get around the reality that China’s housing woes stem from the housing bubble previous stimulus efforts catalyzed.

Not only is China’s housing market overbuilt by a couple of orders of magnitude, but housing prices are far above what current housing demand can support.

This is a problem for Beijing, because the housing correction that MUST come is that housing prices must fall. When those prices fall, the 70% of “middle class” Chinese whose wealth is tied up in real estate will see that wealth evaporate.

After the real estate disruptions and developer bankruptcies of the past few years, the average Chinese has lost his or her enthusiasm for taking on significant mortgage debt to buy even one property—but without fresh home sales indebted developers are still unable to raise the funds to finish existing real estate projects.

Stimulating the housing markets under these conditions is always going to be counterproductive. The most that such stimulus can accomplish is postponing the inevitable household wealth destruction that China must undergo in order to bring housing markets back into any sort of equilibrium.

Yet until China moves through this inevitable—and excruciatingly painful—cycle of wealth destruction, there is no way for stimulus measures to spur new consumer demand.

Chinese citizens are saddled with housing debt for homes in which they cannot live in many cases, reflecting housing prices that are inflated by multiple orders of magnitude. Those same housing prices are also the benchmark for the average individual’s store of savings in China, where housing rather than the stock market is the principal savings vehicle.

Faced with high debt and disappearing wealth, Chinese citizens are going to be a long time building any serious level of consumer demand with which to spur the economy.

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As I noted over two years ago, by far the biggest and most intractable aspect of China’s economic woes is the extent to which the problems are all a series of “own goals”.

Zero COVID has served to accelerate trends that were causing China to lose manufacturing jobs to Southeast Asia and elsewhere even before the pandemic. For a number of years, there has been a steady migration of manufacturing away from China to labor markets with even cheaper labor—China has not been the “least cost” producer of goods for quite some time. Labor markets such as Vietnam and India now have the added benefit of not being governed by demonstrable psychopaths.

Despite China’s dogged insistence that Zero COVID is grounded in science, the reality of Zero COVID has instead been the epitome of Faucism. The policy is sustained not because of its scientific merits, but because the Chinese Communist Party, from Xi Jinping on down, dare not suffer the loss of face attendant upon admitting the policy was a mistake.

At the time, the focus was on China’s disastrous “Zero COVID” policies, but the theme of government and bureaucratic error survives into present moment. At the epicenter of all the economic mismanagement: Xi Jinping.

China’s downward deflationary death spiral largely began when Xi issued his “Three Red Lines” to rein in real estate developer debt—and by so doing cut them off from the very debt markets they needed to finish numerous housing units which the developers had already sold.

Zero COVID added to the damage by squelching what little consumer demand exists in China.

With the collapsing housing market and loss of housing wealth on the one hand, and Zero COVID having suppressed most other forms of domestic consumption on the other, Xi Jinping has painted the CCP into a corner. Xi cannot stimulate domestic consumption or resurrect the housing markets until the average Chinese citizen endures the destruction of some two-thirds of his househod savings and store of wealth.

Let that thought sink in: In order to reach a point where government policy stimulus is even feasible, Xi has to make the bulk of people’s accumulated wealth simply vanish.

China thus stands as a grim object lesson for the world’s other economic interventionists. Government meddling with an economy invariably meets with disaster.

Whether we are talking about China or the United States, or Great Britain, or even the EU, the object lesson is the same: governments cannot contend with every little variable that impacts a nation’s economy. In many instances governments are not going to even have the data, and in other instances they have the data but fail to appreciate the consequences.

In every instance the end result is the same: policy error and economic damage.

There is not space sufficient within a single Substack article to explore all the ways Beijing has wrecked China’s economy. However, it is enough to note that what Beijing has done is wreck the Chinese economy.

What every government does when it meddles in its country’s economy is wreck that economy.

Politicians who promise greater government intervention in an economy are, in every instance, championing policy error and economic disaster—and their ideas should be rejected on that basis.

Thanks to Xi Jinping’s catastrophic series of economic blunders, the world need no longer contemplate the question of when China will become the world’s largest economy. Instead, we are now faced with the question of when China will become the world’s largest economic failure.

The answer to that question is likely to be “Soon.”

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China's industrial profits rose 10.2 percent in the first two months of 2024, reversing a decline of 2.3percent in 2023, government data showed on Wednesday.

Observers said that the steady performance showed that China's industrial sector had bottomed out and entered an expansionary phase, laying a concrete foundation for GDP growth this year.

The worst is over, according to China’s state media outlets. Let the recovery begin!

Or will it?

Industrial profits are an important economic gauge, but they are not the only economic gauge.

Can rising industrial profits pull the real estate sector out of its years-long death spiral?

Or is this rise in industrial profits a momentary bump in the middle of an extended double dip recession?

The answer, as always, relies chiefly on which data you use.

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To be sure, China’s National Bureau of Statistics has reported that in January and February of this year, China’s industrial firms saw their profits increase by 10.2% year on year, printing at CNY914 Billion over the CNY887 Billion in January and February of 2023.

That is a healthy increase over the start for 2023, but it still lags even 2022’s start of CNY1.16 Trillion, or even 2021’s CNY1.11 Trillion. While it is accurate to say that industrial profits are improving, they still have quite a ways to go before they reach their prior levels.

Additionally, the bulk of that profit gain came from export-oriented firms. Industrial activity for domestic consumption did not improve nearly so much.

Activity in the manufacturing sector is largely supported by goods exports, which have regained strength since the autumn. In January-February 2024, exports even rebounded by +7.1% y/y in current USD terms. Growth in goods imports also picked up (+3.5% y/y). The increase in exports affected all trade partners and benefited a wide range of products, ranging from low value-added consumer goods to green technology products.

Meanwhile, sectors that depend on the domestic market remain sluggish. Activity in the services sector grew by +5.8% y/y in January-February 2024 compared to +8.5% in Q4 2023. Household consumption did not really improve, with retail sales up by only around 6% in real terms over the first two months of the year (after +8.7% y/y in Q4 2023). Reflecting weak domestic demand and the imbalance between supply and demand, consumer price inflation was slightly negative in Q4 2023 (-0.3% y/y) and almost zero on average in January-February 2024.

Weakness in domestic consumption was such that January’s 0.8% year on year deflation rate was only barely canceled by February’s 0.7% year on year inflation metric.

While the February CPI data coming out of China indicates the Chinese economy is at least momentarily escaping from the deflationary debt spiral, as with industrial profits it will take more than the good February numbers to overcome the deflation book in Q4 2023.

Additionally, there is reason to suspect that the consumption gains which were recorded might not be quite as substantial as Beijing would like people to believe.

In the first two months of 2024, China's Ministry of Commerce reports total retail sales for consumer goods reached more than eight trillion yuan, a year-on-year increase of 5.5 percent.

Retail sales for communication equipment and automobiles increased by more than 16 percent and 8.7 percent respectively, while catering revenue increased by 12.5 percent. Especially during the Spring Festival, travel spending by domestic tourists increased by 7.7 percent compared to 2019, and the number of cinemagoers also hit a new high.

GUO TINGTING Deputy Minister, Ministry of Commerce "We encourage trade-in programs in consumer goods such as automobiles and home appliances. We'll cultivate and expand green consumption, and promote the innovative development of the consumption of services."

People in the US might recall the concept of government trade-in programs for automobiles. That was the essence of “Cash for Clunkers”1, one of the more counterproductive ideas for dealing with the fallout from the 2008-20009 Great Financial Crisis—and the ultimate economic benefit of that program was practically nil.

A key rationale for fiscal stimulus is to boost consumption when aggregate demand is perceived to be inefficiently low. We examine the ability of the government to increase consumption by evaluating the impact of the 2009 “Cash for Clunkers” program on short and medium run auto purchases. Our empirical strategy exploits variation across U.S. cities in ex-ante exposure to the program as measured by the number of “clunkers” in the city as of the summer of 2008. We find that the program induced the purchase of an additional 360,000 cars in July and August of 2009. However, almost all of the additional purchases under the program were pulled forward from the very near future; the effect of the program on auto purchases is almost completely reversed by as early as March 2010 – only seven months after the program ended. The effect of the program on auto purchases was significantly more short-lived than previously suggested. We also find no evidence of an effect on employment, house prices, or household default rates in cities with higher exposure to the program.

The undoing of that program a decade ago was that all it succeeded in doing was pulling forward sales of cars that would have happened shortly anyway, such that the burst of new car sales it achieved created a sales slump later which entirely negated the economic benefits of the initial sales surge.

Is China making a similar policy error by incentivizing trade-ins? Are the increases in car sales (and other product sales) merely pulling forward sales that, absent the trade in programs, simply would have happened six months later?

There is, of course, no way to know this up front, but the US experience with the “Cash for Clunkers” program tells us such counterbalancing reactions in the marketplace are not only possible, but even probable.

The fact that Xi Jinping, while courting US business leaders (seeking US investment in China enterprises), promised additional “policy support” further suggests that the boost in industrial profits and the uptick in consumption may have less to do with the marketplace and more to do with government intrusion into the marketplace.

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While industrial profits might be up, industry as a whole might not be.

When we look that the NBS Purchasing Manager’s Index for industry, we see that it has been printing contraction since October.

It certainly does not speak to increasing industrial production when the unemployment rate rises a tenth of a percent every month.

A narrative of expanding industrial activity is further undermined by NBS data showing the average hours worked per week declining rather than expanding.

That industrial production rose by an incrementally smaller amount in February suggests that the Chinese economy is getting weaker, not stronger.

Industrial profits are good. There is no question about that. There is also no real question that profits are about the only bright economic spot even within Chinese industry.

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We also should not focus exclusively on the industrial base. One of the largest portions of the Chinese economy, real estate, recently got a fresh reminder that its troubles are far from over. One of China’s premier private developers, Country Garden, is once again flirting with financial distress, when it failed to publish its latest financial reports on time.

Troubled housing giant Country Garden announced late Thursday that it would delay the publication of its annual results, in the latest sign of the turmoil still coursing through China’s huge property sector.

In a filing provided to the Hong Kong stock exchange, the company said it needed more time to collect information due to the complexity of the work required amid its debt restructuring.

Country Garden’s inability to meet a deadline of March 31 to post earnings means its stock is likely to be suspended from trading Tuesday under Hong Kong’s stock exchange rules.

This just a few weeks after state-owned developer China Vanke apparently burned through most if not all of its available cash to pay off a maturing $630 Billion offshore bond.

While the property sector continues to deteriorate, the distress of developers such as Country Garden and China Vanke is having a contagion effect on China’s banking industry, as bad loans and non-performing loans have been rising.

The "Big Four" state-owned banks, Industrial and Commercial Bank of China (ICBC), Bank of China (BOC), China Construction Bank (CCB), and Agricultural Bank of China (ABC) reported this week that their total nonperforming loans reached 1.23 trillion yuan ($170 billion) in 2023, up 10.4% from 1.117 trillion yuan in 2022.

The lenders said rising bad debts don't hit their bottom lines because they have set aside abundant provisions, and they are ramping up risk controls in lending to property developers. But the spillover effects are emerging.

Bad loans to property developers rose to 183.9 billion yuan in 2023, from 180.1 billion yuan in 2022, with CCB and ABC reporting increases of 43.31% and 1.25%, respectively. ICBC and BOC reported a decline of 8.03% and 13.93%.

Additionally, bank earnings are coming under increasing pressure as the PBOC’s reduction in interest rates squeezes profit margins.

Two other top lenders warned of growing risks to debt repayments as a slowing economy threatens job security, while a drop in asset prices impacts buildings used as collateral for bank loans. Local governments, which count on selling land to repay debts, are also struggling.

Bankers make less money from new loans as lending rates go down, and selling wealth products like mutual funds are less profitable due to regulatory caps.

Rising industrial profits are not likely to be rising enough to compensate should China’s banking system tank along side its real estate sector.

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As is so often the case with any narrative, the narrative of China’s economy being poised (again) for “recovery” rests on a narrow set of fairly obviously cherry-picked data—industrial profits.

There are indications that the industrial sectors of China’s economy are doing better. Rising profits are always an indication of that.

However, industrial profits do not change the reality of China’s real estate apocalypse, nor the possibility that both Country Garden and China Vanke might find themselves heading into liquidation in the not-to-distant future, as their finances turn ever more parlous.

Industrial profits do not slow the rise of non-performing commercial real estate loans which could drag down bank balance sheets and precipitate a banking crisis on top of China’s real estate crisis.

Increases in domestic consumption are of questionable importance if they are the result of “policy support” (stimulus) from Beijing. As the US learned from “Cash for Clunkers” back in 2009, “policy support” measures often bring sales and purchases forward, particularly for durable goods, which produces a drop in consumption roughly equal to the initial surge in consumption.

If China can untangle the mess that is its property sector, and contain the contagion effect on the banking sector, it is quite possible China’s economy could rebound and even begin growing in real terms. Rising industrial profits do give China that much hope.

However, the key word is “if”. Absent a cleanup in the property sector, a true economic rebound for China is just not going to be a likely outcome.

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It turns out it managed to get neither.

After fighting for months to keep the yuan stable, Beijing was finally forced to bow to the inevitable and allow the yuan to depreciate further against the dollar.

Chinese authorities have kept the yuan in a vise-like grip for four months, but now signs are emerging that they are ready to allow the currency to weaken.

The onshore yuan on Friday slipped beyond the 7.20 per dollar line that had mostly held since November. The decline sent ripple effects across Asian markets, accelerating losses in some regional currencies and weighing on sentiment toward China-linked assets.

And by “depreciate”, I really mean “crash”. After Beijing gave up the ghost on the yuan China’s currency plunged to its lowest level against the dollar in four months.

This was not the outcome Beijing wanted. Based on currency and money flows within the Middle Kingdom, Beijing has been doing everything it could to prevent this outcome, and it could not do enough.

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What is noteworthy about Friday’s yuan collapse is that it came after Beijing apparently mounted a mostly successful intervention in Chinese stock markets. In the same period when the PBOC was not giving out any hints of stimulus, the stock market actually managed to stay above water.

There may be a reason for this. At a time when net new yuan loans are down, loans to China’s non-banking financial institutions when through the roof.

Net new yuan bank loans to China’s nonbanking financial institutions in February surged to the highest level since July 2015, a sign that some of the loans could have been used by state-backed investors to prop up the stock market, according to analysts.

The loans reached 404.5 billion yuan ($56.9 billion) last month, more than 23 times the amount in February 2023 and the highest since July 2015, when the reading was 886.4 billion yuan, central bank data show. In contrast, net new yuan loans in total in February dropped almost 20% year-on-year.

Historically, when this happens, Beijing is funneling money to select institutions to plow it back into the stock market to prevent a market meltdown.

In both February 2024 and July 2015, government-backed companies increased their holdings of stocks and equity-focused mutual funds in a bid to lift the stock market out of a slump, suggesting that state-buying could explain the spikes in new nonbanking loans, analysts said.

“Historical data show that the only time that new yuan loans to nonbanking financial institutions showed a sharp increase similar to that in February was in July 2015, when China Securities Finance Corp. Ltd. (CSF) expanded financing to boost stock market liquidity,” Guotai Junan Securities Co. Ltd. analysts wrote in a recent report, estimating that similar activities supported the increase in nonbanking loans in February.

Why did Beijing do this? One reason may be that, at the beginning of the year, the SZSE Composit index collapsed, only to stage a miraculous comeback through last Firday.

All China’s indices had a bad start to the year, but the SZSE had a spectacularly bad time of it. Then it recovered throughout February, not just regaining the lost ground the others had done but all the ground that it had lost relative to China’s other indices.

The result? The SZSE index outperformed the others by several multiples.

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However, Beijing’s support came at a price.

While loans to non-banking financial institutions soared, loans to other types of entities collapsed. On the surface, the People’s Bank of China’s decisions to tighten the money supply played a primary role in this.

One possible consequence of the PBOC’s dichotomous moves is arguably a decrease in new yuan loan growth. In February new yuan loan growth printed at a level below that of February 2023.

While there is historically a significant drop off in new yuan loan growth between January and February in any given year, that this year’s drop off left new yuan loans printing below there they were a year ago means that corporate media is likely correct that this is a sign of the Chinese economy contracting even further.

The story is even more stark when one considers China’s level of total social financing, which posted an even steeper drop month on month than new yuan loan growth

While year on year loans to the private sector are still up significantly, February’s drop off compared to January’s stellar increase is a pretty dramatic and not very welcome turnaround.

However, the non-bank financial institution data suggests there was more at play than just a tighter money supply.

Yet even if the data is being read correctly, that Beijing ordered a massive stock market intervention, it may also prove to be the case that, between draining liquidity from the banking system while directing loans for the purpose of propping up the stock market, Beijing managed to squelch its own efforts to stimulate the economy with more credit impulse.

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The cruelest irony of all, however, is that Beijing’s interventions in the stock market are the sort of intrusion into the market place which forex traders tend to reward by bidding the currency down—and they most assuredly bid the yuan down against the dollar on Friday, by a massive margin.

So rapidly did the yuan fall on Friday that several state banks were obliged to step in and sell dollars to buy yuan in an effort to staunch the bleeding.

Market sources told Reuters that state banks stepped in subsequently to buy the yuan for dollars. The yuan was at 7.2251 by midday, 257 pips softer than the previous late session close.

What triggered the yuan’s fall? Potentially, a series of small monetary dominoes falling.

The drop in new yuan loans overall (potentially catalyzed by the direction of record amounts of yuan loans to non-bank financial entities) began a whisper campaign coming out of the PBOC that bank reserve requirements were about to be cut in order to stimulate more new yuan loans. Trimming reserve requirements is one way a central bank can increase the pace of money creation. When that rumor began floating around forex markets, traders dumped the yuan, sending it into freefall against the dollar.

While Bejing was successful at stabilizing the yuan after losing roughly half a percentage point against the dollar, the question remains: can the PBOC even think about reducing the reserve requirement?

If the PBOC does not dare reduce the reserve requirement under the circumstances, what becomes of efforts to stimulate loan growth and thus stimulate the economy?

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Once again, Beijing is caught in a Catch-22. It can defend the yuan, or it can pump up the stock markets and the economy. It cannot do both.

If it intervenes in the markets, it risks further yuan depreciation. If it defends the yuan, it cannot intervene in the markets, risking further market declines.

To make matters even worse, China has been defending the yuan through policy measures for the past four months—and arguably pursuing monetary policies that are contraindicated for an economy in deflation—and yet the yuan still dropped. The end result is both economic and currency deterioration.

China managed to get the worst of both alternatives, and yet is unlikely to be able to alter that any time soon. The drop in the yuan is almost sure to force Beijing to restrain its stimulus efforts in order to restabilize the yuan at the new lower equilibrium level.

Perversely, restraining the stimulus measures may force Beijing to direct more loans to non-bank financial institutions in order to intervene still more in the stock markets, further distorting loan growth in China, pushing the PBOC to trim reserve requirements, which in turn will push state banks to sell more dollars to defend the yuan.

It is becoming more and more probable that Beijing no longer has any good options for revitalizing the Chinese economy. Every move Beijing might make triggers another unwanted response, forcing Beijing to take a contrarian move that only exacerbates economic conditions.

Only time will tell how long this unenviable downward spiral can continue in China, but the longer it goes on, the less likely it is that China will be able to salvage its economy and pull out in time to avoid complete economic chaos.

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The latest evidence of China’s economic Catch-22 comes via the recent decision by the People’s Bank of China to shrink the money supply—usually the exact opposite of what central banks do when an economy is in deflation.

China drained cash from the banking system with a medium-term liquidity tool for the first time since November 2022, extending its cautious approach of using monetary policy to boost growth and showing its willingness to support the yuan.

The People’s Bank of China withdrew 94 billion yuan ($13 billion) of cash from the banking system on a net basis to avoid excessive liquidity, while it kept the rate on its one-year policy loans steady at 2.5% on Friday. Earlier today, Beijing set its daily reference rate for the yuan, with the largest strong bias to the Bloomberg-survey estimate since November.

The rate decision will likely disappoint investors and economists who anticipate more stimulus is needed for the government to achieve its ambitious economic growth target of around 5% for this year. It also underscores the PBOC’s limited scope in further easing monetary policy — given a wide US-China interest rate differential — before the Federal Reserve’s policy pivot.

There is a perverse irony in the reality that the PBOC, despite being at the helm of a centrally managed economy, literally cannot at this juncture cut interest rates or goose the money supply as much as the data would otherwise suggest, because any such move would likely trigger a potentially catastrophic yuan devaluation.

“We expect there is limited room for PBOC policy easing before global central banks start to cut rates, as yuan stability remains a policy objective and further widening the interest rate spread with a rate cut would add to depreciation pressure,” said Lynn Song, Chief Economist for Greater China at ING. The central bank may reduce reserve-requirement ratio in coming months before slashing the rates on MLF, he said.

Beijing is stuck in a policy straitjacket, because the looser monetary policy economic conditions suggest is needed would be crippling to the Yuan, while maintaining the yuan even at present levels against the dollar means the economy is left to languish.

Heads Beijing loses. Tails Beijing does not win.

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We can see the Catch-22 in which Beijing is trapped just in the rather schizophrenic policy decisions that are being made, such as lowering some interest rates while standing pat on others.

China's one-year loan prime rate (LPR), a market-based benchmark lending rate, was 3.45 percent on Wednesday, unchanged from the previous month.

The over-five-year LPR, on which many lenders base their mortgage rates, also held steady from the previous reading of 3.95 percent, according to the National Interbank Funding Center.

Last month, China cut the over-five-year rate by 25 basis points to 3.95 percent, the largest drop in recent years. The one-year rate remained unchanged in February.

A lower LPR is expected to shore up the credit and property markets, reduce the financial cost of businesses and individuals, and contribute to a steady economic recovery.

Beijing is attempting to have its cake and eat it too, lowering certain interest rates to incentivize longer term borrowing (mainly as a stimulus measure to slow the inexorable collapse of China’s property markets), while leaving other rates unchanged and thus providing no incentive at all for other types of credit and spending patterns.

A primary reason being attributed to these paradoxical policy choices is the need for the PBOC to respond to the policy decisions of the Federal Reserve.

China's central bank left a key policy rate unchanged while withdrawing cash from a medium-term policy loan operation on Friday, as authorities continued to prioritise currency stability amid uncertainty over the timing of expected Federal Reserve interest rate cuts.

The Fed's historic monetary tightening has bolstered the dollar and pressured the yuan over the past few years. Cutting rates before a move by the Fed or other major central banks would widen yield differentials, potentially putting more pressure on the local currency.

While China’s internal economy arguably makes a case for looser monetary policy, the need to defend the yuan against other currencies (and the dollar especially), calls for a more restrictive monetary policy and a smaller money supply, in order to support the yuan in forex markets.

Deflation is only going to be made worse by a smaller money supply, and yet the yuan demands that there be a smaller money supply. There is no way to reconcile the need to cure deflation with the need to defend the yuan when the two priorities are diametrically opposed as these are.

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Thus we see in deflationary China a decline in the basic M0 money supply of CNY38.86 Billion in February.

We see a decline in the M1 money supply of CNY 2.83 Trillion.

That steep drop in the M1 money supply puts the M1 at just CNY 0.8 Billion more than in February of 2023. The PBOC wiped out an entire year of money supply growth in a single month, and at a time when deflationary shocks are already hitting the Chinese economy.

For the M2 money supply, there was an increase of “only” CNY 1.93 Trillion, vs a nearly CNY 6 Trillion increase in January.

These more restrictive money supply stances by the PBOC are in contrast to the bank’s reluctance to reduce the loan prime rate any further. While the PBOC was willing to make a substantial cut in the 5-year LPR last month, for the 1-year LPR the bank has stood firm since August of last year.

Thus the PBOC is been tolerating a measure of loosening while at the same time locking down a policy of overall tightening.

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One possible consequence of the PBOC’s dichotomous moves is arguably a decrease in new yuan loan growth. In February new yuan loan growth printed at a level below that of February 2023.

While there is historically a significant drop off in new yuan loan growth between January and February in any given year, that this year’s drop off left new yuan loans printing below there they were a year ago means that corporate media is likely correct that this is a sign of the Chinese economy contracting even further.

The story is even more stark when one considers China’s level of total social financing, which posted an even steeper drop month on month than new yuan loan growth

While year on year loans to the private sector are still up significantly, February’s drop off compared to January’s stellar increase is a pretty dramatic and not very welcome turnaround.

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Nor are Chinese equities particularly pleased with the latest policy announcements from the PBOC. Every index but Hong Kong’s Hang Seng posted a lost as the PBOC made its rate announcement yesterday.

Yet perhaps what is most concerning—or should be most concerning—for the Chinese economy is that the PBOC’s dramatic trimming of the M1 money supply in particular produced little more than yuan stability against the dollar in forex markets.

Why the stability of the yuan against the dollar would be a primary policy concern for the PBOC is easily seen from the historical prices for the yuan against the dollar. Throughout much of 2023, the yuan steadily lost value against the dollar, and the PBOC historically prides itself on keeping the yuan within relatively narrow trading bands most of the time. A weakening yuan is never something China is particularly pleased to have.

Yet the stability of the yuan in recent weeks against the dollar underscores the dilemma Beijing faces with its economic challenges. Were Beijing to unlease the massive levels of monetary and fiscal stimulus that reinvigorating the economy arguably needs, the yuan would crash through its previous low against the dollar, making a complete pig’s breakfast of Beijing’s yuan strategy.

The price of keeping the yuan stable, however, is a lack of stimulus measures for the economy. In a highly regulated and centralized economy such as China’s, lack of government-led stimulus is tantamount to an inevitable economic slowdown. China’s economy is, as we are seeing, extremely dependent on government actions and government policy maneuvers in order to achieve any sort of growth. Market forces are considerably weaker in China than they are in the United States or in Europe (even though both the Fed and the ECB are arguably far too involved in their respective economies for there to be healthy market functions taking place).

As I have commented previously, the crux of China’s economic challenge is how to restructure and reform the economy while maintaining the Chinese Communist Party’s near total grip on power.

It is somewhat facetious to say that China desperately needs economic reform. The challenges facing China’s property sector alone are a call for root-and-branch reform. Yet China is on the horns of a dilemma: how to reform the economy while maintaining the totalitarian control of the CCP? When government and economy are inextricably intertwined, how can a nation reform its economy without also reforming its government?

The data makes it painfully clear that China has multiple severe economic challenges ahead of it. The narratives, propagandistic though they may be, suggest that Beijing fully intends to do “something” about those challenges, although it is highly problematic whether Beijing understands the nature of the challenges well enough to respond productively, and it is equally problematic whether Beijing is prepared to admit the magnitude and scope of those challenges.

The decision by the PBOC to hold the line yet again on the 1-year LPR while simultaneously shrinking the M1 money supply in dramatic fashion shows that Beijing is still uncertain about “what” to do in order to stimulate the economy, while fully cognizant that “something” needs to be done. Shrinking the money supply and sustaining interest rate levels during a period of deflation are moves more calibrated to further deflate the economy rather an inflate or reflate it.

However, given the fragile state of the yuan against the dollar, there are few alternatives to these particular policy choices. China’s export-oriented economy needs at least a stable yuan, and the stimulus measures that are the typical policy response for China’s current economic woes would completely destabilize the yuan.

China’s economic dilemma is that the stimulus coin toss cannot end well—heads China’s economy deflates and possibly collapses, and tails the yuan undergoes shock devaluation which again possibly collapses the Chinese economy.

Eventually, Beijing is going to have to decide which particular economic poison it wishes to endure. Whether the CCP can endure either economic poison is a question that will only be answered once the choice of poisons has been made.

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That has been a question rumbling through global media over the past week, as China Vanke, China’s number 2 property developer, has been battling rumors of a metastasizing liquidity crisis, with concerns mounting over its large debt burdens.

China Vanke, the country’s second-largest property developer, has pledged to repay its outstanding offshore debts that are coming due soon, as its shares and bonds tumbled amid rumours about liquidity distress.

The company has prepared all the funds needed for the repayment of a US$630 million bond due next Monday, and is pushing forward with the process of repaying its debts in an “orderly” fashion, it said in a statement to the Post on Tuesday.

The statement came amid market rumours that Vanke is facing a liquidity crisis and has started a new round of negotiations with state insurers to extend the maturities of some private funds it borrowed.

The concerns began to mount as China posted its tenth straight month of declining property sales in February.

Property sales in mainland China declined for the tenth straight month in February, as lower demand during the Spring Festival holidays weighed and expectations are the beleaguered sector’s woes will continue, pressured by low homebuyer confidence.

China’s top 100 developers posted total contracted sales of 185.7 billion yuan (US$25.8 billion) in February, a decline of more than 60 per cent year on year, and a fall of close to 21 per cent month on month, according a report published on February 29 by the China Real Estate Information Corp (CRIC), a research firm.

Those concerns reached a fever pitch earlier this week, as Moody’s cut China Vanke’s credit rating to junk status. Moody’s fundamentally has lost faith that the developer can successfully restructure and manage its debt.

“The rating actions reflect Moody’s expectation that China Vanke’s credit metrics, financial flexibility and liquidity buffer will weaken over the next 12-18 months because of its declining contracted sales and the rising uncertainties over its access to funding amid the prolonged property market downturn in China,” said Kaven Tsang, a senior vice-president at Moody’s.

While the developer has managed to make a required $630 million payment on its debt, it apparently has used up most if not all of its available cash—and there are future debt payments yet to be covered.

While a Chinese property developer slowly being strangled by its own debt load is nothing remarkable—after Evergrande and China Garden that narrative has already become something of a cliche—what is noteworthy about China Vanke is that the government is part owner. China Vanke is one of the China’s “state-owned” firms.

The more significant asset that it has relative to other developers, however, is that it is more than 27 per cent owned by the Shenzhen local government, which is its largest shareholder. It has had a lengthy and successful relationship with the dynamic technology hub, with Shenzhen directly involved in the negotiations to refinance the property group.

That state presence on its register is a major differentiator from the other big billionaire-controlled developers that Beijing has steered clear of.

It is comparatively easy for Beijing to leave Evergrande and Country Garden twisting in the financial wind. The propaganda necessary to spin the blame for those developers’ woes on their billionaire owners is childishly easy to devise.

It is rather more tricky to explain how a government owned entity falls victim to the same corporate mismanagement as the private sector firms. Yet that is quite possibly an explanation Beijing may soon have to make.

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Unlike Evergrande, which Beijing ultimately allowed to fall into default and bankruptcy, and is now facing liquidation, government officials are reported to be working behind the scenes with several Chinese state-owned banks to rework the company’s tremendous debt burden.

Investors have been dumping Vanke's shares and bonds this month after reports that the company was seeking to extend the maturity of its debt with insurers — an indication it's in a cash crunch.

On Friday, Vanke said it had deposited funds to repay $630 billion in notes due on Monday. Beijing has also asked banks to boost financing for Vanke and called on creditors to extend debt maturity, Reuters reported on Monday, citing two unnamed sources with knowledge of the matter.

Authorities are coordinating Vanke's discussions with banks to help the developer avert a default, Bloomberg reported on Tuesday, citing unnamed people familiar with the matter.

There are certain advantages to government ownership—and a cadre of bureaucrats willing to put pressure on banks to renegotiate and restructure debt is definitely among them.

However, government influence may not be enough, as two of China’s largest banks, Industrial & Commercial Bank of China and China Construction Bank, are pushing back on completing a syndicated loan of HK$1.5 Billion to help bail out the developer.

Industrial & Commercial Bank of China Ltd. and China Construction Bank Corp. had yet to sign off on the syndicated loan as of last week even as smaller rival Bank of China Ltd. has internally approved its own HK$1.5 billion portion, said the people, asking not to be identified discussing a private matter.

ICBC and Construction Bank have asked Vanke to provide sufficient collateral to back the new loan but the developer was unwilling to do so, one of the people said. Without collateral or other forms of credit enhancement, the lenders would need clearing from regulators to proceed, the person added.

The reluctance of ICBC and Construction Bank to complete the bailout loan is particularly ironic, given that the banks are themselves state-owned enterprises.

What does it say of a state-owned firm when state-owned firms don’t want to do business with it?

The issue is clouded even further after China’s housing minister Ni Hong, during the “two sessions” meeting of the National People’s Congress, declared Beijing’s willingness to let insolvent developers go bust.

Last week, Ni Hong, China’s housing minister, told reporters during the National People’s Congress that regulators will support the “reasonable” financing needs of real estate developers.

He reiterated a “whitelist” mechanism that was recently established to inject liquidity into the crisis-hit sector. More than 6,000 property projects across the country have been matched with development loans by banks.

But he also said Beijing will not bail out developers that are “seriously” in trouble.

“For real estate companies that are seriously insolvent and have lost their operating capabilities, [we should] let them go bankrupt or be restructured,” he said.

With a Hong Kong court having already ordered Evergrande’s liquidation in January, Ni Hong’s words about letting developers collapse take on even greater relevance.

Yet the government stake in China Vanke rather raises the bankruptcy stakes considerably. Will the government and the CCP dare allow a state-owned company to fail?

While the answer to that question may not be exactly “yes”, that the government so far has not led with even a loan guarantee suggests that Beijing either won’t or can’t prevent China Vanke from defaulting and sliding into bankruptcy.

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China Vanke’s woes are by now a familiar narrative. While Vanke’s balance sheet suggests the firm was somewhat better run than Evergrande, at the same time Xi Jinping’s imposition of the “three red lines” for developers seriously reduced Vanke’s market capitalization, which has hurt its ability to roll over its debt load.

At its last available balance date it had about 1.75 trillion yuan of assets and 1.3 trillion yuan of liabilities. While its market capitalisation has fallen dramatically since the “three red lines” restrictions on developers’ leverage was imposed in 2021 – from the equivalent of about $13.3 billion to about $2.7 billion – investors are betting with their Hong Kong dollars that it still has substantial value.

While Vanke’s balance sheet nominally looks good, with CNY101 Billion of cash against CNY34 Billion of short term debt, like many other developers it has significant liabilities in the form pre-payments made by homebuyers on homes Vanke has not yet finished..

As of September, Vanke had 101 billion yuan of unrestricted cash, which should be sufficient to cover its short-term debt. It will have around 34 billion yuan of bonds due before June 2025, according to Moody’s. However, just like everyone else, Vanke relies heavily on pre-sales, where apartments are bought before they are built. As of September, it had about 408 billion yuan in contract liabilities, mostly comprised of deposits consumers had paid for unfinished homes. Seen in that light, Vanke’s cash position is not so sound.

This is where China’s real estate sector runs into an insurmountable problem. The business model driving the real estate sector is that of the “pre-sale”. Chinese home buyers put down their down payment and make mortgage payments while the home is being built. At most if not all real estate developers in China, those pre-sales funds have largely been spent, and many housing units ostensibly purchased with those funds have not been completed.

This was how the “three red lines” policy tripped up developers and started the bursting of the China real estate bubble. With limited ability to raise fresh capital as debt, first Evergrande, then Country Garden, and now Vanke did not have the capital to complete housing projects that had already been sold. There are no good scenarios that unfold when a developer “sells” homes and then fails to build them, and yet that is what has been happening in China on a fairly large scale.

That developers would fall like dominoes after Evergrande was an easy prediction to make in 2021, and Vanke is showing how true that prediction is.

This is ultimately the real crisis brought into focus by Evergrande: China’s real estate firms are over-extended, underwater, and with or without an Evergrande bankruptcy face existential threats from loss of financing and liquidity resources. Many of these firms will follow Evergrande into bankruptcy.

There is a straight line that can be traced from Evergrande’s initial liquidity woes to Vanke’s current cash crisis.

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A big part of why Vanke’s cash crunch is not easily resolved is the reality that, as developers have proven unable to deliver on previously sold projects, home buyers are increasingly reluctant to purchase new housing, which is driving down housing revenue along with housing prices.

With the exception of two months last summer, China’s housing prices have been falling since May of 2022.

Falling prices naturally leads to reduced sales, which is exactly what China has experienced over the past two years.

Between home buyer reluctance and developer lack of capital, China’s property markets are also seeing a tremendous slowdown in new housing starts since 2020.

Thus we see how China’s property markets are collapsing. It is not merely that prices are falling, nor that overall revenues from home sales are falling. Developers are building less because home buyers are less interested or less able to purchase homes in the economic aftermath of Xi Jinping’s “Zero COVID” polices.

Reduced construction activity is reducing China’s demand for steel, which is being reported as leading to a decline in iron ore prices.

Futures for iron ore have been sliding last week in Singapore, as have Chinese futures and steel contracts in Shanghai. Inventories at major Chinese steel mills jumped more than a quarter over the past few weeks.

Overcapacity has long been a problem, despite Beijing’s efforts to limit steel production, with about 500 steel mills in the country. Demand from the local property sector — which, as the hungriest sector, accounts for over a third of China’s total steel consumption — remains depressed with no end to the real estate crisis in sight.

Not only is demand for construction inputs such as steel falling, but land sales are diminishing, dropping by more than 13% in 2023 alone.

Revenue from the sale of land-use rights in China, a critical source of income for local governments, fell by 13.2% in 2023 as the country's deep real estate recession hit municipal finances hard.

The data, released Thursday by China's Finance Ministry, shows that sales dipped to their lowest since 2017. Sales declined for a second consecutive year for the first time since 2012, the earliest data available.

Lack of land sales is eviscerating local government finances, and even financial hub Hong Kong is facing mounting budget deficits as a direct result, according to Hong Kong finance minister Paul Chan.

The minister had predicted the city would record a deficit of HK$54.4 billion during last year’s budget, but he updated the figure to HK$101.6 billion on Wednesday. The government’s revised revenue stood at HK$554.6 billion, which was HK$87.8 billion – or 13.7 per cent – lower than the original estimates.

“Revenue from land premium is HK$19.4 billion, substantially lower than the original estimate by HK$65.6 billion and also far lower than the previous year,” he said.

China’s housing slump is having contagion effects that are moving throughout China’s economy, and Beijing has no way to prevent it.

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This, then, is the challenge for Beijing that China Vanke’s liquidity issues poses: as a state-owned enterprise, if Vanke defaults on its debt, Beijing will be seen as effectively defaulting on government debt. Already China Vanke’s crisis is creating a new crisis of confidence in China’s property developers, this time including even the state-owned firms.

If Beijing does nothing to bail out Vanke, and the firm collapses a la Evergrande, real estate activity is almost sure to dry up, as home buyers become increasingly reluctant to buy homes on pre-sale.

If Beijing does step in to bail out Vanke, the central government will have to take on significant additional debt—at a time when central government debt already outpaces that of the United States.

Coming so soon on the heels of Evergrande’s forced liquidation, Vanke’s debt troubles are in many respects far more serious to China.

Vanke’s cash crunch is coming after the real estate crisis has been unfolding for multiple years; Vanke amplifies and extends that crisis. Because of Vanke, the world has positive confirmation that not only is the real estate crisis nowhere near ending, the worst of the crisis has yet to unfold.

Without fresh capital, Vanke will leave multiple housing projects unfinished in the same manner Evergrande has—a situation that is a property crisis all on its own. Even with fresh capital to resolve its outstanding debts, as with Evergrande more capital on top of that is needed to complete unfinished projects.

No matter how China Vanke’s debt crisis resolves—as a state-owned enterprise it is unlikely Vanke will be forced into bankruptcy—that the crisis is happening at all is the strongest signal yet that China’s economy is not merely slowing, but is quite literally falling apart.

There is no talk of “soft landings” for China’s economy. China Vanke proves that none are even remotely possible. That landing is going to be hard, is going to be painful, and is going to do lasting damage.

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China on Thursday released the statistical communique on national economic and social development in 2023, reaffirming that the Chinese economy maintained recovery momentum and made solid progress in pursuing high-quality development despite internal and external challenges.

Coming just days before China kicks off the annual two sessions, one of the most important political gathering each year, the communique, which drew a more comprehensive picture of the Chinese economy in 2023, laid a solid foundation for economic recovery in 2024 and provided valuable signals for where the Chinese economy is headed and top policy priorities for the year, analysts noted. 

With the annual meeting of the National People’s Congress happening this week, such narratives are to be expected from the Chinese media. Just a few days before the Global Times paean to the Chinese economy, China Daily, another CCP media mouthpiece, touted Xi Jinping’s commitment to Chinese technology and innovation as the key to long-term security and self-sufficiency for the Middle Kingdom.

Xi, who is also general secretary of the CPC Central Committee, underlined the key role of new productive forces in underpinning China's high-quality development, stressing that sci-tech innovation is the core element for developing new productive forces.

The theory has struck a chord with the nation's legislators and political advisers as they are set to convene in Beijing next week for the upcoming annual sessions of the nation's top legislative and political advisory bodies.

Pan Jiaofeng, president of the Chinese Academy of Sciences' Institutes of Science and Development and a deputy to the National People's Congress, said the development of new productive forces will present key opportunities to transform traditional sectors and spur the growth of emerging industries.

Xi's latest theory will serve as a short-term and long-term guideline for China to beef up innovation in science and technology and various sectors, he said.

If we take the CCP media narratives at face value (I do not recommend doing that!), then China’s economy is poised to expand by leaps and bounds.

Yet with even western media outlets prepared to tout China’s economic “strength”, how does a person parse the narratives to understand even a glimmer of what is really taking place in China?

The answer, of course, is to simply follow the data.

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We should not be surprised that the CCP media outlets indulge in propaganda—one only has to read this Substack to know how prevalent propaganda is even in the West!

Yet it is also worthwhile to take note of the level of propaganda being circulated in China. Even the Washington Post would be challenged to keep up with some Chinese news outlets when it comes to generating fact free propaganda.

Beijing is countering reports of deepening structural problems and economic hardship with articles in state media about how the long-term outlook is positive as measures begin to pay off.

In the latest of such efforts, a commentary in the Chinese Communist Party mouthpiece Guangming Daily headlined “Smearing the East won’t deter its rise or prevent the downward trend of the West,” argued that although the United States’ proportion of the world’s GDP increased in 2023 as China’s shrank, it does not mean that the Chinese economic outlook is bleak or that the pattern of a “rising East and declining West” will stop.

Zhang Yongjun, deputy chief economist of the China Center for International Economic Exchanges, who wrote the commentary pointed out that China's economic growth of 5.2% last year was more than double the U.S.’s 2.5%. Furthermore, the Chinese currency’s depreciation against the dollar and falling prices versus America’s inflation and stronger currency were causal factors of a contracted GDP contribution.

However, that does not mean that Chinese propaganda cannot be found in Western publications as well. One only has to read a recent op-ed piece in Forbes to see that even the most business-centric media entities in the West can propagate propaganda.

Nowadays the vast majority of companies that defined the internet boom of the late 20^th/early 21^st century are gone, but not the fruits of this powerful jump into a better future. The internet defines life as we know it for the much better, and it does precisely because government didn’t step in to prop up the thousands of mediocre to bad businesses that went under in and around 2001.

It’s something to think about as U.S. economic pundits start to write post-mortems on China’s economy, while making their cases that “a China-dominated world is even less likely than it ever was.” The words in quotes are from an editorial published at the Washington Post about China’s “tanking economy.” One guesses that similar pieces were written by foreign and domestic editorialists back in 2001 about the U.S. Which is why economics writing can be a bit of an ass.

There is a particular irony in the Forbes editorial, as it suggests that there will be free-market solutions to China’s economic problems. This is an absurdity, as China is about as far removed from free market principles as can be had in the world—which is why it is possible for Xi Jinping to singlehandedly inflict enormous economic damage on the country.

It is equally absurd as it overlooks the extent to which China’s economic woes are very much an “own goal” by Xi and the CCP, having set much of the problems in motion by ham-handed policies such as Xi’s “Three Red Lines” reforms for property developers.

Yet even if we ignore such nuance, we are still challenged to consider the wisdom of the calls of even western economists for Beijing to unleash more fiscal and monetary stimulus to resuscitate the flagging economy—presuming that such stimulus is even possible in the current macro-economic climate.

Market economists also point to shorter-term factors and the lack of macro stimulus. The property policy tightening in 2020-21 and Covid-19 helped trigger the property market downturn from its unsustainable levels of construction and debt. Fiscal policy tightened in most of 2023 as local governments cut general spending and were unable to increase debt to fund investment. Weak demand exacerbated excess capacity issues, leading to declines in price and earnings, which in turn weakened corporate investment.

Both short-term macro policy support and medium-term structural policies are now needed to boost the economy and confidence. Stabilising the property market is key to restoring confidence and preventing more menacing spillover effects on the economy and financial system. Credit support to property developers will improve buyer confidence, as well as allaying defaults.

The irony becomes deliciously perverse when the same publication (the Financial TImes) argues that exact point: that massive macro stimulus is simply not an option for China any more.

Most economists agree that if it needed to, China could launch a big bazooka. The level of debt on the central government’s balance sheet is low enough for Beijing to finance a stimulus similar to the 2009 splurge that sent growth rocketing to 9.4 per cent a year.

But, with the exception of a relatively small stimulus for property, such strenuous fiscal interventions are no longer in Beijing’s preferred playbook, nor do they fit with a Xi mindset that elevates security and self-sufficiency above all, says Zongyuan Zoe Liu, a fellow at the Council on Foreign Relations. “Beijing has been emphasising ‘high-quality growth’, which is a subtle way to acknowledge the reality of slower growth,” she says. “It is unlikely to do debt-fuelled stimulus, which would exacerbate the structural imbalances, impair China’s credit rating outlook and constrain long-term growth.”

Indeed, that 2009-10 stimulus is still blamed in Beijing policy circles as a root cause of the current slowdown. The flood of cheap liquidity contributed to the continuing local government debt crisis, nurtured a network of underground banks, inflated property prices to unsustainable levels and spurred overcapacity in a host of industrial sectors.

Simply put, the contrarian view to the call for massive stimulus by Beijing is the argument that prior rounds of massive stimulus by Beijing have resulted in such an accumulation of government debt as well as fueling unparalleled asset bubbles that any new round of massive stimulus carries an outsized risk of destabilizing and destroying what remains of the Chinese economy.

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Indeed, it is difficult to see where Beijing could benefit from either fiscal or monetary stimulus at this point.

While exports are still in a multi-year downward trend, over the past few months they have seen some increase—which may indicate that at least some “recovery” is in the offing.

The challenge will be if China’s need for exports will be hampered by the larger global economic contraction currently unfolding.

It will be especially challenging if China’s imports continue to decline as they have been since the end of 2021 just as with exports.

Without fresh inputs, there is a finite amount of increase feasible in China’s export capacities. Without imports there are no inputs to manufacture goods for export.

A strategy of stimulus is similarly hampered by the extent to which the PBoC has expanded its balance sheet in prior stimulus rounds.

As we have seen even with the Fed’s own monetary policies, there is a limit to how much debt any central bank can accumulate without impairing the functioning of said central bank.

In truth, just about any form of government stimulus or policy micromanagement by government is a bad idea.

That stimulus is simply not an option for China is driven home by their growing problem of producer price deflation perpetuating a downward spiral for prices.

Yet at the same time, that China’s economy is already suffering from deflation in key areas is on any other day would be a good argument on its own for some level of stimulus. A major reason why China is experiencing deflation is that, according to China’s National Bureau of Statistics, manufacturing activity has been declining for ten of the past eleven months, and would have declined persistently throughout that period but for a single month of marginal expansion last September.

Indeed, one of the phenomenal challenges facing Beijing is that, despite a decade of loose and getting looser monetary policy, China is facing not persistent inflation but persistent deflation, with inflationary pressures getting steadily weaker since 2020.

Loose monetary policies are a powerful inflationary force, not a deflationary one. Yet China is grappling with deflation, and is unable to generate any meaningful inflation within its economy. That China is experiencing anything besides hyperinflation more serious than what has recently occurred here in the United States, given the length and looseness of its money policies, alone highlights the magnitude of China’s economic collapse.

If monetary policy cannot produce inflation, monetary stimulus cannot work, as inflation is what makes monetary stimulus effective.

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The challenge when reading the diverse narratives on China’s economy is that many, perhaps even all, have at least some grains of truth.

China’s previous economic recovery playbook has involved massive macro stimulus, and so it is rational that some would call for a repeat of those measures. However, it is also true that because of those previous rounds of stimulus, China has saddled itself with so much debt it no longer has room on the PBoC balance sheet for stimulus debt.

It is also true that Xi Jinping’s “three red lines” targeted the worst abuse by property development companies—that of spending the monies received from home pre-sales on things other than the building projects, resulting in the accumulation of massive debts while bleeding away the capital necessary for those projects. Yet it was government rigidity and inflexibility in enforcing the “three red lines” that catalyzed the debt crises that destroyed Evergrande and threaten to destroy Country Garden.

And it is equally true that the stimulus efforts within western economies—and in the United States in particular—have not been a smashing success either, as readers of this Substack will know full well.

It is impossible for a country of 1.3 billion people and an established industrial base not to have significant economic potential. If the economic potential of each of those 1.3 billion people could be leveraged to the fullest, China’s economy would easily dwarf that of the United States, and by several orders of magnitude. That much is little more than simple math.

China’s dilemma is that it quite obviously is not leveraging the economic potential of each of its 1.3 billion people to the fullest, and its structural issues and challenges are such that it is finding it increasingly difficult to leverage even that portion of its economic potential that is has been thus far.

It is somewhat facetious to say that China desperately needs economic reform. The challenges facing China’s property sector alone are a call for root-and-branch reform. Yet China is on the horns of a dilemma: how to reform the economy while maintaining the totalitarian control of the CCP? When government and economy are inextricably intertwined, how can a nation reform its economy without also reforming its government?

The data makes it painfully clear that China has multiple severe economic challenges ahead of it. The narratives, propagandistic though they may be, suggest that Beijing fully intends to do “something” about those challenges, although it is highly problematic whether Beijing understands the nature of the challenges well enough to respond productively, and it is equally problematic whether Beijing is prepared to admit the magnitude and scope of those challenges.

Based on the current data, China’s economy is in a downward spiral of collapse. It will take much more than technology and innovation to pull the country out of that spiral. Only time will tell if the upcoming annual sessions of the National People’s Congress will provide what China needs.

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There is also no denying that the surge in aggregate travel, tourism, and consumption spending throughout the holiday period is unlikely to catalyze greater domestic consumption in the longer term. That simply has not been the historical norm for the holiday upticks in consumer spending.

And there is no denying that China’s economic picture outside of the growth of holiday spending is grim, if not downright apocalyptic. The latest indicator of China’s ongoing economic collapse is the steep decline in Foreign Direct Investment (FDI), which China’s State Administration of Foreign Exchange (SAFE) reports is at a 30-year low.

Investment in China by companies based abroad has sunk to the lowest level in 30 years, according to official data released on Sunday, in a sign that foreign corporations are leaving China due to tougher crackdowns on spying and U.S. sanctions.

China's foreign direct investment totaled $33 billion on a net basis in 2023, according to the State Administration of Foreign Exchange, down about 80% from 2022. The figure was positive as new investment surpassed outflows. But FDI declined for the second straight year and is less than 10% of the peak of $344 billion marked in 2021.

There is no word for an 80% decline in foreign direct investment in the space of a single year other than “collapse”. Non-Chinese companies are not only curtailing their new investments in China, but are steadily repatriating the earnings from previous investments.

The magnitude of China’s FDI collapse is driven home by the reality that it has taken just two years to undo nearly 30 years of investment growth.

According to the latest data released by SAFE, since hitting a peak in 2021 of $344 Billion, China has shed more than 90% of Foreign Direct Investment assets by the end of 2023. $22.5 Billion (RMB1.6 Trillion) of that outflow came just in 2023 alone.

While SAFE is reporting data that is considerably more extreme than the Ministry of Commerce, even that data shows China is experiencing the most dramatic outflow of capital at least since the 2008 Great Financial Crisis.

Foreign direct investment (FDI) into China fell by 8% year-on-year to CNY 1.13 trillion or $157.1 billion in 2023, signaling foreign investors have not fully returned to the mainland after Covid-19. New actually utilized foreign capital shrank in manufacturing (-1.8%) and services (-13.4%). Conversely, it increased in high-tech manufacturing (6.5%), namely medical equipment and instruments (32.1%) and electronics and communication equipment (12.2%), technological achievement transformation services (8.9%), construction (43.7%), and R&D and design (4.1%). Investment in high-tech industries accounted for 37.3% of total investment. FDI climbed from France (84.1%), the UK (81.0%), the Netherlands (31.5%), Switzerland (21.4%), and Australia (17.1%)

As a result of these outflows, even the Ministry of Commerce data shows an 8% decline in overall FDI for 2023.

Nor is the investment outflow limited to just direct capital investment. Foreign companies are also repatriating their earnings from prior investments in China, and have been for some time—so much so that in the 3rd quarter of 2023 China experienced its first-ever deficit in direct investment liabilities, much of which was attributed to earnings repatriation.

"Some of the weakness in China's inward FDI may be due to multinational companies repatriating earnings," Goldman Sachs wrote, adding China's interest rate differentials with developed countries also played a part.

"With interest rates in China 'lower for longer' while interest rates outside of China 'higher for longer', capital outflow pressures are likely to persist."

China’s economic and geopolitical challenges—e.g., rising tensions with the United States and with Europe—are making it an increasingly less attractive place for global firms to want to do business, and they are expressing their view of China by pulling their money out of the country.

Indeed, “capital outflow pressures” are actually increasing, for while much of the rest of the world’s central banks have been raising rates, the People’s Bank of China has been cutting rates, and on Tuesday reduced a key lending rate for homebuyers yet again.

China's move to slash borrowing rates for homebuyers underscores how authorities are trying to prop up a weak housing market with few tools at their disposal.

The People's Bank of China lowered the five-year loan prime rate, a mortgage benchmark, by 25 basis points on Tuesday to 3.95% from 4.2%. Shanghai-listed stocks rose in response to the move.

Continued downward pressure on interest rates by the PBoC is intended to spur lending and in particular homebuying, with a view towards stabilizing China’s imploding property markets.

The move was another step in China’s broad campaign to prop up a crumbling housing market and support an economy battling deflation, slowing exports and moribund consumer confidence. 

Investors reacted to the news with a shrug. China’s benchmark CSI 300 index was slightly lower in morning trading, while the Shanghai Composite Index was barely changed. China’s stock market is in a yearslong slump, as foreign investors have shifted elsewhere and small investors in the country have lost their nerve.

The problem with the lower rates is that they make Chinese investments less attractive than other options in the globalized financial marketplace. Thus, even without the rising geopolitical tensions between China and the US, and China and Europe, foreign capital is likely to leave China simply to chase higher yields. In a high-rate global economy, low-rate China is just not that attractive an investment for global capital.

This is an existential problem for China. Investment is the basis for tomorrow’s revenue. Investment is the foundation for the future of any economy (or business’ or individual’s fortunes). Without investment, it is not possible for anyone or any nation to have any meaningful prospects for an economic future.

Foreign direct investment is a measure of how other nations apprehend a country’s prospects for its economic future. Nations which offer the best opportunities for economic growth and return on that investment will inevitably attract investment capital from other nations. Conversely, nations with dim prospects for economic growth and return on investment will inevitably experience a withdrawal of that same capital from other nations.

China’s Lunar New Year holiday spending is good news for today, and will be throughout the holiday period. That spending will be a welcome boost to an economy mired in deflation and stagnation.

Unfortunately, as the foreign direct investment data has been showing, that good news is simply not likely to extend past today. Investment is tomorrow’s economic news, and the pace at which China is shedding investment from abroad makes the economic news for tomorrow not at all good.

Money is leaving the Chinese economy, and thus that money will not be available to aid in resuscitating the Chinese economy. Without money, all any economy can do is collapse—which is what China’s economy is increasingly doing.

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After months of consistently negative press about deflation, a bursting property bubble, a shrinking industrial sector, China’s Lunar New Year holiday finally delivered the surge in travel and tourism, as well as consumer spending more broadly, that analysts and China watchers have been waiting to see.

In a sign that Chinese consumer sentiment has improved, there was a resurgence in travel over China’s Lunar New Year holiday.  According to official reports, more than 61 million rail trips were made on the first six days of the national New Year holiday, a +61% increase in the same vacation period in 2023 and the highest in data compiled by Bloomberg News in the last five years.  The main question is, will the pickup in consumer spending point to a sustainable improvement in the Chinese economy?

According to state media reports citing the Ministry of Finance, hotel sales on Chinese e-commerce platforms surged more than 60% from a year earlier.  However, some analysts remain concerned that this year’s increase in holiday travel cannot be counted on as an early indication of economic improvement.  HSBC Holdings Plc said even though spending by Chinese consumers exceeded expectations, surpassing 2023 was a “low bar” given the country was still contending with a rampant outbreak of COVID-19 at the time.

Nor was the spending spree confined to travel expenditures. In Shanghai, the consumption rebound included both local residents and tourists.

The Chinese New Year holiday in Shanghai saw a remarkable rebound in consumption as various leisure activities appealed to local residents as well as overseas visitors.

According to UnionPay's payment data, the total consumption of inbound visitors from February 9 to February 16 jumped 21.6 percent from a year ago to 15.5 billion yuan (US$2.1 billion) and the number of payments reached 144.5 million times, a 41.8 percent surge from a year ago.

Yet the question remains: can China build any forward momentum toward lifting its economy out of the deflationary doldrums in which it has been mired for months, if not years? Will the holiday spending surge be sufficient to ward off looming “Japanification” for the Chinese economy?

Unsurprisingly, the data gives less cause for optimism than the narrative.

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While the early reports on China’s Lunar New Year holiday spending have been unreservedly good, it would be difficult to overstate just how important it is for Beijing that those reports be unreservedly good. In the current state of affairs, China needs some positive economic sentiment even more than it needs positive economic data.

Economic data released just before the country went on holidays showed China’s consumer prices fell last month at the fastest pace since 2009, piling pressure on the government to support the country’s stumbling economic revival.

Deflation is also weighing on corporate earnings, fuelling a sharemarket meltdown that prompted President Xi Jinping last week to sack his top markets regulator to try to halt the slide.

“The economic situation facing Chinese households has worsened as government support measures have failed to stabilise the economy. We think that households are less willing to consume and invest, giving rise to a self-sustaining downward spiral,” Barclays said.

So grim has been the economic news in China of late that Beijing earlier this month took the remarkable step of abruptly replacing the head of its securities regulatory agency in the hopes of halting an extended stock market decline.

China has ousted the head of its securities watchdog, replacing him with a veteran regulator with a reputation for tough action as policymakers struggle to stabilise the country’s sharemarkets.

The cabinet has replaced Yi Huiman as chairman of the China Securities Regulatory Commission (CSRC) with Wu Qing, who has led the Shanghai Stock Exchange and served as a key deputy in Shanghai’s municipal government, the official Xinhua news agency said late on Wednesday.

Even with such measures, heading into the holiday consumer confidence in China was definitely on the wane.

Consumer confidence in China has been waning recently due to its ongoing property crisis and slumping stock market.  The slide in consumer confidence has also undercut sales of big-ticket items. According to the China Association of Automobile Manufacturers, Chinese passenger car sales fell by 26% in January compared to December.  Gary Ng, senior economist at Natixis SA, said it remains to be seen if the increase in consumer spending over the new year holiday is sustainable, saying, “It is uncertain if this can fully offset the consumption shift away from durable goods, and the downgrade trend for some residents.” 

The lack of consumer confidence is hardly surprising, given that decline and deflation have been stalking virtually every sector of the Chinese economy.

As Father Time drew the curtains on 2023, the one thing that was indisputable about China’s economy was that it was in a seemingly unstoppable state of collapse. The stimulus measures attempted by Beijing had to date proven utterly unsuccessful at reversing declines in manufacturing and real estate, as well as persistent consumer price deflation.

Heading into the Lunar New Year holiday, Chinese consumers simply did not have much if any reason to feel confident about their economic futures.

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Yet while the general trajectory of China’s economy prior to the Lunar New Year has been down, there remained at least a cadre of economists and China watchers certain that rebound was due at any time.

While analysts and China watchers acknowledge that China has been in a deflationary phase, there is still a prevailing narrative of “rebound” and “recovery” being just around the corner.

China’s economy first entered deflation last summer, with prices falling at a faster pace since then. Its factories have also cut prices, with the latest producer price index pointing to a 2.5% drop in annual prices in January, after a 2.7% fall in December.

However, ING’s chief economist, Lynn Song, said it was worth noting that the latest data may be skewed due to the fact that lunar new year falls in February, rather than January, this year. It means that household demand for food such as pork could bounce back once next month’s data takes the holiday season into account.

“While a far cry from the above-target inflation levels seen in many other economies, these numbers do not imply China is stuck in a deflationary spiral,” Song said.

“Considering the more favourable base effects for February’s data, we see a high likelihood that January’s data could mark the low point for year-on-year inflation in the current cycle,” she added.

Indeed, for this same cadre, there has been a growing expectation that the New Year holiday would the start of a broader and long-lasting economic “rebound.

To be sure, the early reports suggest that the holiday is providing at least some sort of economic “bounce”. By February 10, “cross-regional” trips were reported to be up even over 2019 levels.

Chinese travelers have made more than 230mn “cross-regional” trips as of Tuesday, the most recent figures available, for the new year break, the ministry of transport said on Friday. This was up 5.8 per cent compared with the same period in 2023 and up 1.1 per cent compared with 2019, before the pandemic.

One major aspect of this year’s holiday season that makes the data important: this is the first year since the initial outbreaks of COVID in Wuhan, China, where COVID has not been a factor in holiday travel. Even though China officially ended its Zero COVID policies in 2022, the wave of COVID infections which swept through China immediately afterwards extended Zero COVID’s dampening economic effects through the 2023 Lunar New Year holiday season.

Thus it is important to look not just to year on year data patterns, but to examine economic impact of the 2019 holiday season with the 2024 holiday season.

It is being reported that, so far, this year’s holiday season, ushering in China’s Year of the Dragon, is by some measures exceeding 2019.

China’s Year of the Dragon opened with a surge in consumer spending and travel during the holiday period, marking a boost for the country’s sagging economy.

The country’s culture and tourism ministry said there were 474mn domestic trips during the eight-day lunar new year festival, up 34 per cent year on year and 19 per cent on pre-pandemic levels in 2019.

Consumption spending is also apparently enjoying a holiday “surge”.

As the Spring Festival holiday ended, car trunks across China bulged with not just luggage, but also love and local specialties gifted by parents to their returning children. Online, netizens shared photos and videos of their overflowing trunks, sparking lighthearted comparisons and discussions about the bittersweetness of departures.

Beyond the usual haul of groceries like vegetables, meat, eggs, and flour, some have taken this tradition to the next level.

In a recent video that gained traction on a video-sharing platform, a car was spotted with two woven bags hanging from the rear trunk, each containing two live ducks. The video sparked widespread interest, accumulating over 100,000 likes, and netizens even claimed to have seen the same car on the highway, jokingly stating that "it seemed like two ducks had fallen off halfway."

The driver of the car surnamed He explained that on Feb 14, as they were returning from their hometown in Hunan province to Zhejiang province for work, their trunk was filled with various local specialties from their parents, including cured meat, steamed pork, pickled long beans, and eggplants. Concerned about the ducks potentially getting suffocated, they decided to hang four live ducks in bags at the back of the car. Addressing speculations that two ducks were left behind, He clarified, "Upon reaching Jiangxi, we gave two to relatives, and the remaining two are still being raised at home."

Online spending likewise appears to be enjoying a fairly dramatic surge.

The average daily consumer spending on Meituan’s online platforms during the holiday period jumped some 36% from the same period last year, according to a report from the delivery giant. The report didn’t give the actual value of consumption, but said it exceeded pre-Covid levels in 2019. There was also strong growth from restaurant spending in the first five days of the Chinese New Year break, with overall order volume from groups rising by 161% from last year.

While there will undoubtedly be a few revisions to the initial estimates and reports, at present we are left with a view of the Lunar New Year holiday as being very good for the Chinese economy.

Will it be “good enough”? Will it produce the long-awaited “bounce”? Unfortunately, not all of the current data paints this same rosy picture of China’s economic present. Additionally, the historical data argues against any meaningful “bounce” happening.

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One item to remember when assessing China’s travel data is that, at least per a CNN analysis, while overall spending is up, individual spending—and in particular spending per trip—appears to be down.

China has reported a record upsurge in travel and consumption during a longer-than-usual Lunar New Year holiday season, touting the gains as signs that the world’s second largest economy is regaining its footing thanks to the government’s supportive policies.

But according to CNN calculations based on official data, the average tourism-related spending per trip was below pre-pandemic levels, as consumer confidence remains weak amid deflationary pressure.

Nor is CNN the only outlet making such reports. Similar findings were discussed by the Wall Street Journal as well.

Still, travelers appear to have grown more budget-conscious about their travels, a worrying signal for an economy facing deflationary pressures.

The average traveler spent 9.5% less than in 2019, a steeper decline compared with the 2.5% drop recorded during last year’s National Day holiday, a sign of “consumption downgrading,” economists from Goldman Sachs wrote Sunday.

Foot traffic at major shopping malls was 8% lower from a year earlier, according to Nomura calculations based on mobility data from Chinese technology giant Baidu—despite a low base of comparison as a wave of infections roiled the country after the scrapping of all curbs in early 2023. Apart from hotels and airfare, most consumer goods prices, including pork, remained weak, Nomura economists wrote.

While spending may be up in the aggregate, individual consumer behavior is reported as being, on average, considerably more restrained than in 2019. Thus the improved consumption data does not reflect an improved level of consumer confidence.

Moreover, China’s own National Bureau of Statistics does not provide an historical perspective which allows much hope for the holiday spending surge to generate a long-lasting bounce.

When we look at passenger travel in China since 2018, we see that the holiday surge generally recedes in the subsequent months.

Even when we look at total passenger-kilometers traveled, we do not see much evidence of the holiday travel period producing a longer lasting increase in travel.

Travel simply does not beget travel, not even in China.

While retail spending may be on the upswing during the holiday period, since 2018 there has been only one year where post-holiday spending continued to increase (2020). Every other year has seen a post-holiday spending decline.

2020, of course, was the first year of the COVID “pandemic”, and the first year of the draconian lockdowns which would metastasize into Zero COVID. In every other year since 2018, total retail sales have decreased in the first months. There is zero indication this year will deviate from that historical pattern.

Online sales show a similar post-holiday decline in consumer spending.

In no year is there any indication of travel, tourism, and consumer spending during the holiday period—all of which generally trend up—generating any sort of longer-lasting spending growth.

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Therein lies the difficulty in accepting the prognosis that the Lunar New Year will be sufficient to turn China’s deflating economy around. The current data does notargue very well in favor of that possibility. History argues very strongly against the possibility.

In most years since 2018, travel has ticked up during the holiday period, and ticked down afterwards.

Even when one goes by Passenger-kilometers, there is no indication of a holiday spending spree morphing into a longer-lived upward trend. Quite the contrary: the holiday surge in travel usually leads to a post-holiday decline in travel, tourism spending, and overall consumer spending.

None of which is to say that such an event could not result in longer-lasting periods of higher consumer confidence, higher consumption spending, or increased real estate activity. Such an outcome is possible at the very least.

China is going to have a few good news cycles to bolster its economic outlook. That much seems almost certain. There will be good news related to the Lunar New Year holiday.

Yet the holiday period will end, and with it the increase in travel, tourism, and consumer spending. Barring some other stimulus to the economy, whether from te government or from some other source, when that holiday-induced spending ends, the broad-based decline across the Chinese economy will continue.

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China’s consumer prices slid deeper into deflationary territory last month, suffering their biggest drop since the global recession in 2009 and underscoring the huge challenges facing the economy.

The country’s Consumer Price Index (CPI) dropped by 0.8% in January from a year ago, according to the National Bureau of Statistics (NBS) on Thursday. It was the steepest fall since September 2009 and marks a fourth straight month of decline.

It is unlikely that Beijing would admit to ongoing deflation if there was any way to spin the data otherwise, especially given their long-standing reputation for economic mendacity.

Subject matter experts have long questioned the veracity of Beijing's economic reports in general, including former Chinese premier Li Keqiang, who in 2007 dismissed his country's economic data as "man-made."

Nor is it just consumer prices which are showing persistent declines. China’s Producer Price Index notched its sixteenth straight month of declines in January.

In other data published on Thursday, factory gate prices also fell, with the producer price index slipping 2.5% in January from a year ago, compared with a 2.7% decline in December, a modest improvement but underscoring weaker energy prices and subdued domestic demand.

There is no question that the Chinese economy is mired in deflation, and that it has been mired in deflation for some time now. What is a question is whether this deflation is becoming an economic “death spiral” or whether a rebound is imminent.

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While analysts and China watchers acknowledge that China has been in a deflationary phase, there is still a prevailing narrative of “rebound” and “recovery” being just around the corner.

China’s economy first entered deflation last summer, with prices falling at a faster pace since then. Its factories have also cut prices, with the latest producer price index pointing to a 2.5% drop in annual prices in January, after a 2.7% fall in December.

However, ING’s chief economist, Lynn Song, said it was worth noting that the latest data may be skewed due to the fact that lunar new year falls in February, rather than January, this year. It means that household demand for food such as pork could bounce back once next month’s data takes the holiday season into account.

“While a far cry from the above-target inflation levels seen in many other economies, these numbers do not imply China is stuck in a deflationary spiral,” Song said.

“Considering the more favourable base effects for February’s data, we see a high likelihood that January’s data could mark the low point for year-on-year inflation in the current cycle,” she added.

One reason for this belief is the sentiment on Chinese bourses, just as on Wall Street, that the grim economic data means Beijing will be forced to do more fiscal and monetary stimulus to prop up the economy.

However, the prospect of fresh economic stimulus from Beijing to counter weaker demand was enough to send Chinese stocks higher on Thursday, with the Shanghai Composite rising by nearly 1.3%.

“While a very concerning sign for China’s economy, which could be becoming entrenched in a debt and deflation cycle, the markets arguably responded in a positive way to the news,” said Kyle Rodda, senior financial market analyst at capital.com.

“Perhaps markets see the terribly low number as a potential catalyst for more muscular monetary or fiscal stimulus from the central government, which, up until this point, has been moderate in applying countercyclical policy.”

Economist Michael Pettis, Senior Fellow at the Carnegie Endowment, summed up the case for China optimism in a series of tweets.

The crux of the case for optimism is simply that the numbers are not as bad as they might first appear, and that there are signs of things will turn around due to the stimulative effect of the Lunar New Year holiday.

Yet what do the numbers really say?

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One challenge to the “turnaround” narrative is the reality that China’s economic data has been less than stellar for a number of years, stretching well back before the Zero COVID lockdowns which began in 2020.

Export growth was already showing signs of hitting a plateau (and potentially stagnating) as early as 2013.

While exports genuinely surged in 2020 and 2021, from early 2022 onward that surge has been steadily receding.

Import growth shows a similar pattern—largely plateaued or posting minimal growth from 2013 through 2019, followed by a post-pandemic surge which is now receding.

We should also note that China’s factory gate prices were showing deflation as early as 2019.

While producer prices did recover and even grow in 2021, by early 2022 that growth had run its course, and factory gate prices have been moving down ever since. As a rule, factory gate prices are a leading indicator to consumer prices, and when there is a strong deflationary signal in factory gate prices—such as what we have had in China since early 2022—the general presumption for consumer prices is also going to be deflation.

Moreover, China’s factory gate prices have posted three significant periods of deflation since 2013.

While the middle one can arguably be traced to the COVID “pandemic” and the resultant economic lunacies imposed by Beijing, the deflation in 2013 through 2016 and the current deflation cannot be explained away by that rationale.

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Similarly, China’s consumer prices peaked at the beginning of 2023, and have been declining ever since.

Yet even with that relatively late peak in consumer prices, inflation—the rate at which consumer prices rise—peaked far earlier, in the initial lockdown period during 2020.

While inflation rebounded somewhat during 2022, by late 2022 disinflation had set in, which turned into outright deflation in late 2023.

However, if we peel back the layers and look at China’s core consumer prices (in every country, core consumer prices are with food and energy prices stripped out, as they are typically far more volatile than other prices), we see that core consumer prices peaked all the way back in 2018.

As a consequence, China has had core consumer price deflation in various months since 2018.

Contrary to the narrative that China has only recently entered deflation, the reality is that China’s consumer prices, much like its factory gate prices, have been displaying significant softness even extending back before 2020 and the Zero COVID lunacies.

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Perhaps the biggest indicator of China’s latent economic weakness is the fact that China’s export prices experienced an extended period of decline in 2018 and 2019.

Only the Zero COVID lockdowns temporarily reversed that decline, and even though export prices reached a peak in 2022, they have collapsed considerably since.

The export price decline has been helped along by a similar decline in import prices.

We must note, however, that import prices are the one area where deflation is not the narrative of the moment, as import prices have staged a mini-recovery in recent months. Will the rise in import prices (which are in turn input prices for Chinese exports) be enough to bring some upward price pressures on exports and on consumer prices? That is a possibility, although we have not seen any indication of that happening yet.

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The singular flaw in the optimistic narrative on China deflation is that it relies too heavily on the most recent data and ignores longer trends which extend back before the time of Zero COVID.

It is tempting to ascribe most if not all of China’s recent economic woes to COVID and the Pandemic Panic mistakes and lunacies which ran roughshod over China’s economy from 2020 onward. However, regardless of the very real damage done by China’s Zero COVID policies, the reality remains that there were significant signs of economic weakness well before the SARS-CoV-2 virus emerged from a Wuhan lab. The dislocations and rebounds brought on by Zero COVID may have helped to postpone confronting the weaknesses that were already starting to show in China before COVID emerged, but it was never going to erase those weaknesses and give China the option of ignoring the many structural flaws in its economy.

The awkward reality of China’s economy is that deflation was a major risk in 2019, and only the dislocations and disruptions of Zero COVID from 2020 through 2022 succeeded in postponing the realization of that risk. With Zero COVID having faded from the scene over a year ago, the same forces that were pushing China towards a deflationary crisis are once again rising to the top, and are once again pushing China towards a deflationary crisis.

Is China’s deflationary episode soon to be over? While there is always a possibility that such will be the case, it is far more likely that, as the pre-pandemic forces continue to gather, deflation still has some ways to go before it is through tormenting the Chinese economy.

The deflation cycle in China will end, and may even end this year. However, we should not look for this deflationary episode to turn the corner and move the Chinese economy into a true rebound and recovery phase any time soon. It is far more likely that China will see further deflation in January 2025 than resurgent inflation.

China is not yet hit bottom. More pain is yet in store for the Middle Kingdom.

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The most immediate piece of economic bad news to hit the Middle Kingdom was a Hong Kong court ordering that Evergrande, once China’s largest property developer, be liquidated.

Property developer China Evergrande Group has been ordered to liquidate by a Hong Kong court, bringing an end to the yearslong saga of a company whose default rippled through the world’s second-largest economy.

The liquidation order came despite an 11th-hour push by the company’s creditors to reach a deal over the weekend, according to people familiar with the matter. It comes more than two years after the company defaulted on its dollar bonds, becoming one of the first dominoes to fall in China’s beleaguered real-estate sector.

“The time is for the court to say enough is enough,” said Judge Linda Chan in Hong Kong’s high court.

The Evergrande saga has been far more than just the story of one corporate bankruptcy. As I detailed when the company’s problems began to attract global notice in 2021, the company was the leading indicator of the extent to which China had become—actually had always been—the “Sick Man of Asia”.

Even if all of Evergrande’s assets are purchased by China’s SOEs, that would not provide enough cash to make all of Evergrande’s creditors whole; that would not provide enough cash to sustain the many businesses whose existence is threatened by Evergrande’s non-payment of bills. No matter what diktats Xi Jinping issues, without cash, a good portion of Evergrande’s suppliers and creditors will go under.

Evergrande is a stark demonstration of the limits of Beijing’s economic power, and a stark reminder of how markets are corrupted by ignoring the limits of government to rescue them from their own excesses.

Evergrande has been a corporate collapse story that has been equal parts Lehman Brothers and Enron, and like both of those titants of American business, its day has finally ended in a bankruptcy court being sold off to the highest bidder.

Yet, as the world has seen since Evergrande began its long death spiral into non-existence, the company not been the only a symptom of a much larger rot within the Chinese economy. In virtually every other aspect as well, China’s economy is not merely contracting, but collapsing.

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The “front line” of China’s economic collapse has been well documented as being China’s former economic mainstay, its housing sector.

The unwavering belief of Chinese home buyers that real estate was a can’t-lose investment propelled the country’s property sector to become the backbone of its economy.

But over the last two years, as firms crumbled under the weight of massive debts and sales of new homes plunged, Chinese consumers have demonstrated an equally unshakable belief: Real estate has become a losing investment.

This sharp loss of faith in property, the main store of wealth for many Chinese families, is a growing problem for Chinese policymakers who are pulling out all the stops to revive the ailing industry — to very little effect. The troubles of the country’s real estate sector were laid bare on Monday when a Hong Kong court ordered China Evergrande to wind up operations and liquidate the company, which is saddled with over $300 billion in debt.

The property sector began to unravel in 2020, when Xi Jinping introduced his now recanted “Three Red Lines” for property developers, seeking to rein in speculative indebtedness by those same firms. Unfortunately, Xi closed the barn door long after the horse had fled clear into the next county, forcing the government to steadily walk back the restrictions on corporate indebtedness.

In an effort to stave off a broader banking crisis spurred by a growing wave of mortgage defaults (the inevitable consequence of refusing to make payments), the China Banking and Insurance Regulatory Commission has asked lenders to extend still more credit to embattled developers, in order to facilitate completion of housing projects and thus halt the boycott wave.

China’s banking regulator has asked lenders to provide credit to eligible developers so they can complete unfinished residential properties after home buyers stopped paying mortgages on at least 100 projects across 50 cities.

There is no small irony in Beijing making this move, as the developer crisis was catalyzed by the introduction in August of 2020 of the “Three Red Lines”, a set of financial metrics meant to curb debt growth among real estate developers.

By the summer of 2022, it ws clear that the collapsing property sector was going to claim more than just Evergrande, as one of China’s other large developers, Country Garden, also began to show signs of insolvency—and which is even now trying to sell of large assets in a somewhat desperate attempt to raise cash.

Embattled Chinese property developer Country Garden is selling properties in Guangzhou, aiming to raise 3.8 billion yuan ($530 million), according to an asset transaction platform.

The properties include a hotel resort, four office towers, a shopping mall as well as five rental apartment buildings, according to listings dated Jan. 19 on Guangzhou Enterprises Mergers and Acquisitions Services.

A growing sentiment among professional investors is that the handwriting is on the wall for Country Garden as it has been for Evergrande.

Now, the question is whether Country Garden will also be liquidated in the coming months. I believe that a court will order the company to be wound up because of its huge debt, weak sales, and substantial losses. Besides, the company has already defaulted on its debt and has been downgraded by key ratings agencies like Moody’s and S&P Global.

A company in such a situation has several options. In most cases, it could sell assets in a bid to raise capital. In Country Garden’s situation, it has already sold one of its malls in a $420 million deal and used these funds to pay some of its debt. The challenge is that the outstanding debt is so high that asset sales may not be enough. 

Ultimately, the answer is very likely “yes”, and for the same reason—Country Garden’s liabilities greatly exceed the market value of their assets.

Compounding the problems surrounding the Chinese real estate market—the single largest real estate and asset market in the world—is the reality that 70% of all Chinese household wealth is tied up in real estate. The collapse of China’s real estate market means within that 70% of household wealth is a level of wealth destruction that exceeds anything experienced in this country either during the 2008 Great Financial Crisis or the 1930s Great Depression.

It does not take any Nobel Prize in economics to realize this has grave implications for the stability of China.

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Nor are China’s problems confined to just real estate. Over the past 12 months, China’s stock markets have lost nearly one-quarter of their value.

By comparison, the US stock markets have risen in value over the same period.

So have European stock markets out performed China over the past 12 months.

What is driving the downward trend in Chinese stocks? There are several factors, but the most recent challenge has been a contraction with China’s manufacturing base.

China's manufacturing activity contracted for the fourth straight month in January, an official factory survey showed on Wednesday, suggesting the sprawling sector and the broader economy were struggling to regain momentum at the start of 2024.

The official purchasing managers' index (PMI) rose to 49.2 in January from 49.0 in December, driven by a rise in output but still below the 50-mark separating growth from contraction. It was in line with a median forecast of 49.2 in a Reuters poll.

Since early 2022, China’s manufacturing industries have been in a near constant state of contraction, according to their own National Bureau of Statistics.

By comparison, while the US manufacturing sector has been in contraction for most of 2023, post-pandemic manufacturing in the US actually enjoyed something of a renewal.

One consequence (and also cause) of the Chinese contraction in manufacturing: a decline in export value and volumes.

This data does not take into account the increase in shipping rates on Chinese goods brought on by the Houthi missile mischief in the Red Sea.

Where freight rates are moving substantially higher is in the Shanghai Containerized Freight Index, which tracks shipping rates outbound from ports in China—another presumptive Iranian ally.

If we drill into the index, we see that the increase is largely due to increased shipping rates to Europe, with US West Coast shipping showing a much smaller increase.

Problematic passage through the Red Sea and the Suez Canal due to Houthi activity is the obvious explanation for the different trends in shipping rates. With much of the Asia shipping traffic to the US East Coast having been rerouted through the Suez Canal instead of the Panama Canal in 2023 due to a drought in Central America, even shipping to the US East Coast has risen dramatically since the beginning of December.

Increased shipping costs means Chinese export volumes will fall even further as 2024 gets underway, further straining the Chinese manufacturing sector. When no one wants to buy or pay for incresed shipping, sales drop, and that means for China that exports also drop.

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China’s youth employment data is another area where the numbers continue to look grim even after Beijing’s “corrections”.

The Chinese statistics bureau reported last week that unemployment among the 16- to 24-year-old demographic was 14.9 percent in December.

This would be a considerable improvement over the 21.3 percent reported for that age bracket last June, compared to 5.2 percent for the general population.

China's statistics bureau didn't immediately return Newsweek's request for comment.

A major flaw in the data: China arbitrarily excludes students and counts those young people who work as little as one hour per week.

Not so fast, said Elliott Fan, graduate director of National Taiwan University's Department of Economics. "The decline [in unemployment] was caused by China's National Statistics Bureau removing students from the sample, not because of any solid improvement in the youth's labor market," he told Newsweek Friday.

Fan listed three more swaths of society whose exclusion further throws the data into doubt.

1. Those working as little as one hour per week were still considered to be employed, which "does not accord to international standards for calibrating unemployment rate."

2. The report excluded people who, discouraged by dim job prospects, have given up.

3. The statistics bureau surveyed only those living in urban areas.

This suggests a crisis that is here for the long-haul, Fan said. "The Chinese government does not have any powerful tool to address unemployment, even if they want to. The surging unemployment is going with the adverse macroeconomic shocks, which are structural and likely long-lasting."

If China does not have an effective means to reduce youth unemployment, that means that China does not have a means to ensure the next generation has adequate job skills to ensure productive civic society can be maintained.

Even with the corrections, China’s youth unemployment is still an eye-watering 14%.

Given the size of China’s population, a youth unemployment rate of nearly 15% means several million Chinese youth are out of work—a distinctly bad omen for any economy. Without youth employment China cannot sustain the manufacturing and export economy that has powered the Chinese economy for decades—and right now China cannot sustain youth employment.

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Aside from the moribund stock market, China’s most visible sign of economic decay has been the lack of inflation and the emergence of outright deflation in the Chinese economy.

Indeed, deflation has been a persistent theme within China since 2020.

What makes this deflation particularly noteworthy is that is happening despite Beijing’s steady infusion of more and more money into the economy, with both the M2 money supply and the M3 money supply showing steady growth at a time when deflation is stalking the Chinese economy.

In fact, China has recently injected near record levels of liquidity into their financial system, with no apparent inflationary impact in consumer prices.

Despite this, Chinese loan growth rates have fallen in recent months.

As a percentage of total loans, the growth rate has fallen dramatically throughout 2023

Despite the poor performance in loan originations, China has been pursuing a financial strategy distinctly contrary to what the Federal Reserve is pursuing here in the United States. China’s central bank has, unlike the Federal Reserve, greatly expanded its balance sheet in 2023.

The Federal Reserve, on the other hand, has focused on shrinking its balance sheet.

The People’s Bank of China is deliberately pursuing policies which prevailing wisdom, such as it is, says are calibrated to produce runaway inflation—and are failing to produce anything but deflation.

That can only mean economic collapse is well under way in China. When even inflationary central bank policies cannot produce inflation, the central bank dare not even think about restraining such policies, as that would produce even greater deflation. The PBOC is quite literally trapped in a cycle of permanent quantitative easing—and has arrived there well before the Federal Reserve finds itself compelled to follow suit.

The Fed’s policies are proving marginally superior to those of its Chinese counterpart, but only just, and only because the PBOC has been more explicitly manipulative.

The Federal Reserve may have just won the central banking race to the bottom by virtue of the PBOC getting there first.

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One major net effect of China’s unfolding economic calamity: capital has been increasingly fleeing China, producing a steady net outflow of investment capital.

Note that capital flight has been a staple of the Chinese economy since the early 2000s. Again, the contrastng capital flows for the United States over the same period is nothing short of miraculous for the US.

It is relatively easily to keep an economy seemingly afloat even when most of the fundamentals are have a negative outlook provided one has a net inflow of capital. As long as there is new money flowing into an economy, even when it is in a recession it will not produce a runaway collapse such as what we have taking place in China.

Despite the numerous flaws and weaknesses in the US economy, it is at least still able to attract net inflows of investment capital. China has never seen sustained net inflows of investment, and has always seen rising capital flight. When Chinese investors want to invest anywhere but in China, there is no possibility for sustained economic growth of any kind.

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There is literally no part of the Chinese economy that is doing well at present. Investment capital is fleeing the country, manufacturing is not expanding, with the result that exports are declining—and will decline further as increased shipping rates on goods from China thanks to Iran-backed Houthi missile mischief in the Red Sea.

As much as Beijing wishes to avoid yet another round of government intervention into the economy, it has steadily been ramping up more and more stimulus measures—only the measures are not stimulating. The economy has been absolutely resistant to any sort of inflation or showing any of the usual signs of economic expansion even as Beijing has unveiled ever increasing amounts of stimulus.

The simple truth is that China has never recovered from the economic lunacy of Zero COVID. Between Zero COVID and the unraveling of China’s property markets due to Xi’s “Three Red Lines” diktat from 2020, literally all the economic supports in China have been knocked out. Manufacturing has been disrupted, construction has been disrupted, real estate has been disrupted—and nothing is left to resuscitate the economy.

The reality is exactly what was predictable in 2022, during the height of Xi Jinping’s Zero COVID paranoia: Xi would lead China right over the economic cliff.

In 2024, the probabilities are growing almost daily that the world will see just how steep that cliff is for China, and just how far it will fall before it hits bottom.

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This is quite literally the CCP’s official narrative for the Chinese economy as of November 2023.

In November, under the strong leadership of the Central Committee of the Communist Party of China (CPC) with Comrade Xi Jinping at its core, all regions and departments strictly implemented the decisions and arrangements made by the CPC Central Committee and the State Council, adhered to the general principle of pursuing progress while ensuring stability, and fully and faithfully applied the new development philosophy on all fronts. All regions and departments accelerated efforts to foster a new development pattern, took solid steps to promote high-quality development, endeavored to expand domestic demand, optimize structure, boost confidence and fend off risks. As a result, the macro-control policies continued to show effects, production and supply increased steadily, market demands kept improving, employment and prices were generally stable, people’s well-being was robustly and effectively guaranteed, transformation and upgrades were advanced solidly, and the national economy further consolidated its good momentum of recovering and turning for the better.

How lucky the Chinese people are to have such perceptive and agile stewards of the Chinese economy watching over them!

Oh…wait…we must look also at the data—those pesky facts again.

When we do look at the data, this little narrative of the CCP starts to look more than a little delusional. Prices are only stable because they are stagnant, and employment is stable because no improvement on unemployment has been realized in the past few months (and we no longer know the true state of youth unemployment as Beijing declines to release those numbers).

The narrative says growth. The data says not. Which one do you think I am going to trust first even from China? Which one should you trust?

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How bad is China’s data? On the surface, not that bad. Industrial production did rise 6.6% year on year, the largest increase since February of 2022, per China’s National Bureau of Statistics.

While the NBS Composite Purchasing Manager’s Index (PMI) edged down in November, it remained above 50 (expansion territory).

Fixed Asset Investment did grow by 2.9% for the second month in a row, according to the NBS data.

Retail Sales printed a 10.1% increase year on year in November, 2.5 percentage points higher than October per the NBS.

Broadly speaking, these are good numbers. Where is the problem?

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One of the major caveats we must apply to these nominally good numbers is one of context. Last year China was just emerging from the horrors of Zero COVID, which had a suppressive effect on consumption as well as a lot of industrial production. Posting large gains from that low threshold is not exactly a challenge, as was noted last week in the Wall Street Journal:

But the headline numbers for industrial and retail sales growth—which shot up to 6.6% and 10.1%, respectively—are heavily distorted by comparison with last November, when China’s Covid-19 lockdowns became much worse. On a month-on-month, seasonally adjusted basis, retail sales actually declined slightly, for the first time since July.

That’s right, month on month retail sales are actually down for November.

Additionally housing prices are still in decline, with November being their fourth straight month in the negative.

Falling housing prices is hardly a sign of a robust economy, particularly one with as large a real estate sector as China’s.

Moreover, China’s “stable” unemployment is still at 5%—there has been no improvement in the official number per the NBS in three months.

For context, China’s lowest unemployment rate post COVID was 4.9% in the fall of 2021. If anything, this is an indicator China’s unemployment rate has bottomed out and may very well rise in coming months.

It also bears noting that China is still suppressing its youth unemployment data, which it last reported in June when it had risen to an eye-popping 21.3%.

At best we may infer that youth unemployment has not improved significantly if at all since that last report.

More telling is the sobering reality that China’s businesses have been posting declining profits all year, and for a good part of 2022 as well.

Shrinking corporate profits cut very much against the grain of a narrative of economic growth. Economic growth implies larger profits, not smaller ones. With profits shrinking since July of 2022, the clear implication is that China’s economy has been contracting for about that long.

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As much as Beijing wants to put out a positive economic narrative, the official data keeps getting in the way. So apparent are the deficiencies in the data that even corporate media is finding itself unable to overlook them, as well as most China analysts.

“This data indicates that China’s economy clearly slowed down in the fourth quarter,” said Larry Hu, chief China economist at Macquarie Capital.

“The downturn in property and the private investment did not surprise the market – after all, this is the core headwind Beijing is facing.”

Regardless of how Beijing wants to spin the numbers, the reality of the property investment data is that monthly investment in real estate has been declining since June of 2021.

While Beijing wants to spin China’s consumer prices as “stable”, the reality is “deflation”.

In general, and in key areas such as housing, food, and transportation, consumer prices in China have been on the decline since June of 2022.

The month on month percentage declines confirm that prices have been declining broadly since then, and the deflation has spread across sectors during that time.

So drawn out has been the deflation that even the year on year data is printing negative.

While consumers generally apprehend falling prices as a good thing—everyone rationally will choose to pay less rather than more—extended periods of deflation are at least as detrimental to an economy as extended periods of inflation. Deflation distorts demand and can directly suppress demand, as consumers are incented to save and postpone consumption in anticipation of even lower prices later.

This is a particular problem for China, which desperately needs much greater levels of domestic consumption to compensate for declining exports, yet even Beijing’s central economic planners, which met recently to figure out how to goose the economy in 2024, are struggling to find ways to increase domestic consumption.

The meeting, which was hosted by President Xi Jinping, was more “pro-growth” than in previous years, said Larry Hu, chief China economist at Macquarie Group.

With a more “proactive” tone, policymakers may set “4.5-5%” or “around 5%” as the GDP growth target for next year, Hu said, broadly similar to the goal for 2023.

But other analysts questioned whether this level of growth could be achieved without stimulus measures directly targeting consumers, which was not mentioned.

“[There was] no hint for massive consumption support policies,” Citi analysts said Wednesday. “There was no detailed discussion on increasing household income.”

The world’s second largest economy is facing deepening troubles, with weak consumption a major drag.

When even the normally supine corporate media is willing to disregard China’s official economic narrative to this degree, one has to conclude that China’s economy is in very deep trouble!

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We do well to remember that a great many China “experts” as well as the corporate media have often genuflected to China as the “coming” economic and geopolitical superpower. Some of them still are willing to do that, talking rather fatuously about China’s “rise”.

Napoleon warned that China was a sleeping giant and the world would shake when it awoke. It has, and accommodating its rise is one this era’s central challenges.

Given the realities of the data, such perspectives by western financial analysts are simply pro-China propaganda, and are about as useful. At present, China is not rising but receding. Despite Beijing’s claims, the data shows the economy is on many fronts contracting rather than expanding. While China’s population could be a global economic force nonpareil, the reality of China’s low per-capita GDP figures are a structural impediment to greatly expanded domestic consumption.

While China as a country is widely regarded as having the 2nd largest economy in the world based on Gross Domestic Product, because of its large population on a per-capita basis China is well off the pace, ranking 63rd in the world according to the World Bank. For comparison, on a per-capita basis the United States is ranked seventh in the world.

When the individual consumer does not have a lot of money, the individual consumer is not going to be doing a lot of consuming. There is no getting around that economic reality.

This also makes deflation an even bigger problem for China than it would be for some other countries. Deflation’s structural disincentives for individual consumers to consume, multiplied by China’s large population, translates into a significant barrier to increasing consumption.

While official data should always be taken with a grain of salt, especially where China is concerned, there is no escaping that China’s official economic metrics according to their own National Bureau of Statistics paints the Chinese economy in a very bad state. Even if China was massaging the data (and at least some entities within China may very well be doing just that), we can plausibly presume that any fudging of the economic data would be slanted towards making the economy appear stronger rather than weaker. We may therefore with confidence apprehend China’s official data as a “best case”. The reality may be worse than the official data shows, but it is unlikely to be any better.

Such are the limits of government narratives even for totalitarian regimes nominally in command of everything. Just as Canute could not command the tides, neither can the most authoritarian governments on earth command economic realities. Despite what Beijing may say about China’s economy, the data is telling a far different—and far gloomier picture.

Despite the optimism of Beijing’s official narrative on the economy, the world’s number two economy is mired in deflation and stagnation, and is declining rather than expanding. Because China is the world’s number two economy, that does not bode well for the global economy as a whole.

The world is heading into recession, and right now China is leading the way.

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Zhongzhi Enterprise Group, one of mainland China’s largest shadow banks, has warned investors that it is unable to repay its debts, setting off alarm bells in the trust sector which invests a large portion of investors’ money in real estate projects.

The Beijing-based wealth management company said late on Wednesday its total liabilities had mounted to between 420 billion yuan (US$59 billion) and 460 billion yuan, while its total tangible assets stood at just 200 billion yuan, implying a shortfall of as much as 260 billion yuan.

Readers may recall that Zhongzhi first came to notice in August, when a Zhongzhi subsidiary, Zhongrong International Trust, missed multiple payments on trust products.

Anxious Chinese retail investors are bombarding listed companies with questions about their exposure to Zhongrong International Trust Co after missed payments by the trust company triggered fears of contagion across the country's financial system.

Investors had submitted more than 100 questions to dozens of Shanghai- and Shenzhen-listed companies via investor relation platforms asking whether they had bought Zhongrong's products, after two listed firms disclosed late on Friday that they had not received payment on maturing trust products from Zhongrong.

Last week the contagion fears from August seem to have been confirmed.

Yet a question arises from the timing of Zhongzhi’s insolvency declaration: why now? What has happened to push the private wealth management company (i.e., “shadow bank”) into bankruptcy?

As it turns out, the answer to that question may very well be “Beijing’s liquidity injections and debt stimulus programs.”

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Unsurprisingly, the initial contagion fears emerged from property developer Country Garden’s inexorable death spiral into debt default, with Zhongrong’s missed payments being preceded by missed interest payments by Country Garden.

Given the long-standing preference by purveyors of various trust and wealth management products for real estate investments, this synchronicity is only to be expected.

Defaults by Zhongzhi surfaced in sync with the mainland’s intensifying property crisis which involved mainland China’s biggest developers such as China Evergrande Group and Country Garden Holdings, as real-estate sales dived and cash flows dried up. Many trust products had invested heavily in real estate projects.

“We expect private trust companies to continue struggle, with more possible failures, but state-owned trust companies we believe will receiving more funding from their parent financial institution to prevent the loss of retail client investments and confidence,” Everbright Securities International said in a research note on Thursday.

Indeed, contagion from China’s collapsing property sector has been regarded by many as a near certainty, so much so that it is perhaps remarkable that Zhongzhi held out this long after Country Garden’s final tumble into debt default last month.

Yet it should also be noted that Beijing has been steadily ramping up support for China’s ailing property sector, including new policies encouraging banks to extend more loans to Country Garden and other distressed developers.

Beijing has stepped up efforts to solve China’s property crisis, calling on formal banks to increase their support for 50 large developers including Country Garden, the country’s largest real estate company, which defaulted for the first time last month. Country Garden’s share price rallied after Beijing’s intervention, which was reported by Bloomberg on Wednesday but has yet to be announced officially.

While as of this writing the policy has yet to be officially announced, the emergence of a draft list of developers eligible for additional bank support represents the latest incremental effort by Beijing to rescue ailing real estate markets.

As part of a package of new measures to backstop the real estate industry, regulators are considering allowing banks to issue so-called working capital loans to some developers, the people said, asking not to be identified discussing a private matter. Unlike other types of loans available to builders that typically require land or assets as collateral, the new financing facility would be unsecured and available for day-to-day operational purposes, potentially freeing up capital for debt repayment, the people said.

Officials are also weighing a mechanism that would allow one lender to take the lead on supporting a specific distressed builder by coordinating with other creditors on financing plans, the people said.

Perversely, the mode of support for distressed developers may very well have played a role in Zhongzhi’s final fall from grace.

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To understand how this might be the case, we have to take a brief look at a recent transitory liquidity crunch in China.

At the beginning of November, China’s money markets literally ran out of cash, and Beijing was the ironic likely reason why.

A brief cash squeeze rattled China’s money markets earlier this week, illustrating how the nation’s tightly-managed financial system is under strain from the government’s deluge of debt sales.

Interest rates on an overnight interbank loan soared to as high as 50% in isolated transactions for non-bank institutions on Tuesday, worsening a usually mild month-end funding crunch. A confluence of factors, from capital requirements for banks to tax payments and large government bond sales, were behind the surge in demand.

The surge in interest rates for non-bank borrowing occurred at least in part because Beijing has recently authorized a surge of new debt issuance both by the central government and by local governments and their financing vehicles.

Money market rates climbed in late October as banks came under pressure to meet regulatory requirements, companies faced tax payments and China’s central and local governments sold a record amount of bonds. A bank trader said at that time that cash demand was too high for large banks, the main providers of funding, to satisfy.

Put simply, Beijing’s newly authorized government debt issuances threatened to crowd out non-bank institutions, effectively stranding them without access to liquidity at the very moment Beijing was injecting a significant amount of liquidity into their finanaicl system.

“As bank balance sheets get clogged up with all this government bond issuance, leveraged, non-bank investment companies will likely continue getting squeezed,” Adam Wolfe, an economist at Absolute Strategy Research, wrote in a note. “So we continue to expect more liquidity support from the PBOC, including a cut to banks’ required reserve ratio.”

In other words, central and local government debt is depriving non-bank institutions of important access to fresh liquidity at the precise moment that liquidity is most needed to cover the growing shortfalls from their now significantly underperforming real estate investments.

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That Beijing notionally takes liquidity issues seriously is easily demonstrated by the record level of liquidity injected into the financial system by the People’s Bank of China—a record 1.45 trillion for the month of November alone.

Even in the daily reverse repo markets, Beijing has been injecting a rising amount of liquidity over the past week.

Yet so great has been the central government’s own recent borrowing spree that it consumed all available liquidity and then some, thus producing record interbank interest rates and a true if temporary liquidity crisis—which according to some reports impacted the shadow banking industry most of all.

State broadcaster China Central Television blamed unidentified financial institutions for disrupting the market Tuesday. “Some institutions, with the aim of maximizing profits, depend too much on rolling-over financing, borrowing short and investing long — creating their own liquidity risks, which disturbs the market and creates a tense mood,” CCTV said in a report.

The jump in overnight borrowing costs Tuesday was seen mostly in over-the-counter borrowing by non-banks, traders said, asking not to be identified as they aren’t authorized to speak publicly. Those loans aren’t captured in public data.

Even the timing of Beijing’s latest debt issuances suggests they play a role in Zhongzhi’s latest solvency crisis, as the central government is turning more and more to traditional stimulus to reinvigorate an increasingly moribund economy.

In October, China unveiled a plan to issue 1 trillion yuan ($139 billion) in sovereign bonds by the end of the year, raising the 2023 budget deficit target to 3.8% of gross domestic product (GDP) from the original 3%.

Chinese leaders have pledged to "optimize the structure of central and local government debt", suggesting the central government has room to spend more as its debt as a share of GDP is just 21%, far lower than 76% for local governments.

Apparently, in the process of “optimizing” central government borrowing, Beijing overlooked non-bank actors such as Zhongzhi, and their own need for liquidity access.

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Fans of government regulation are convinced that the real problem for China has been a lack of strong regulatory oversight of the shadow banking industry, decrying its predilections for “excessive leverage”.

By the end of 2021, Zhongzhi’s cash pools, not including that of its trust affiliate Zhongrong, had reached 300 billion yuan. They were backed by about 150 billion yuan worth of underlying assets, reported financial media outlet Caixin. No surprise then that, when new fundraising dried up, Nacity’s money was not returned at maturity. 

The government, of course, frowns upon this practice. A polite description is excessive leverage, while a more crude one is a Ponzi scheme. However, because of their complex nature, regulations covering cash pool products have only been loosely enforced, according to CreditSights. Officials don’t get to see the lending documents — they are, by definition, private. They don’t have the resources to sift through and understand the tailor-made borrowing terms either. 

However, this perspective overlooks the obvious market saturation effect when 1 Trillion yuan of new central and local government debt is in the process of being dumped on financial markets. With or without regulatory oversight, there is only so much appetite for debt. As shadow banks as a rule do not deal in government debt, they are invariably pushed to the back of the line, and the fundraising and borrowing efforts which keep many trust products viable suffer the consequences.

There is even some indication that Beijing recognizes the dilemma the structure of these latest debt stimulus proposals presents. While the liquidity issues presented by imbalances in various borrowings are ultimately transitory, they are also anticipated to be a recurring theme through at least the end of the year.

Liquidity is expected to tighten after Beijing said last week it’s raising the fiscal deficit ratio and authorizing the sale of 1 trillion yuan of debt in the remaining months of the year.

“The PBOC may not target to address brief liquidity tightness among some market participants,” said Frances Cheung, a rates strategist at Oversea-Chinese Banking Corp. “Rather, we expect liquidity injection to buffer the broader liquidity demand arising from bond issuances.”

The issue the PBOC is simply choosing to overlook is the piecemeal imbalance among borrowing entities brought on by the surge of new debt issued by both the central government and various local governments.

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The cautionary lesson to be learned is that even in tightly controlled centrally planned economies such as China, there is no escaping the consequences of government policy.

While Beijing can opt to issue however much debt it wishes, it cannot expand the overall market for debt issuances. The more the government borrows, the less credit is available for private borrowers, the higher the cost of that credit to private borrowers, and the more likely it is that private borrowers will be caught short as they are unable to utilize previously viable fundraising policies and practices.

Ironically, with Beijing on the verge of instructing the formal banking sector to extend even more credit to distressed developers, such a policy has the potential to exacerbate the funding imbalances which have caught out Zhongzhi, leaving them structurally insolvent, as the more the formal banks lend to developers, the less they will be able to lend to shadow bank players needing to avoid a funding crunch.

Country Garden’s debt and solvency woes may very well have been the catalyst for Zhongzhi’s own spiral into insolvency, but Beijing’s response to Country Garden has very likely helped that insolvency along. If this is in fact the case, then just as Country Garden is but the latest developer to fall from grace, Zhongzhi will only be the first of several shadow banks to grapple first with liquidity pressures and then ultimately insolvency.

Beijing may very well be on the verge of jumping out of the real estate frying pan into the shadow banking fire. Every debt solution it tries to solve one economic dilemma is likely to cause or exacerbate other problems.

The end result is likely to be an ongoing serial set of financial crises where the solution for each crisis succeeds only in magnifying subsequent ones.

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Investors are noting China’s problems and are responding predictably: they have started pulling their investment capital out of China.

The world’s second largest economy is struggling to attract foreign companies and investments, despite Beijing’s efforts to address its myriad economic challenges, according to new data from China.

A gauge of foreign direct investment (FDI) into China has slipped into the red for the first time since 1998, underscoring the country’s failure to stem capital outflows.

Direct investment liabilities, a measure of FDI, stood at minus $11.8 billion in the third quarter, according to data published by the State Administration of Foreign Exchange (SAFE) on Friday. In the third quarter of 2022, China’s direct investment liabilities was at $14.1 billion.

If foreign capital is a global vote of confidence in a country’s economy, China is getting a vote of “no confidence”.

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While the FDI deficit for the third quarter of 2023 is only the second such deficit since China began tracking the data in 1998, the deficit itself is hardly a one-time anomaly. China has been losing foreign investment capital for months, in large measure because of China’s increasingly business-unfriendly economic policies.

China’s main measure of FDI, which is released by the Commerce Ministry, showed a decline of 8.4% in the first nine months of this year, accelerating from a 5.1% drop in the first eight months.

While rising geopolitical tensions are partly to blame for the exodus, foreign companies and investors have also grown wary of increasing risks in China, including the possibility of raids and detentions.

Overall, China’s aggregate store of foreign capital now stands at around $125 Billion, a significant decrease from the third quarter of 2022.

By comparison FDI increased in the US for the third quarter by a total of $74.634 Billion.

Whatever flaws the US economy has—and it has many—it is apparently preferable to the moribund and sclerotic Chinese economy.

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To be sure, China’s problems are not merely economic in nature. It is also facing considerable geopolitical headwinds as conflict with the United States heats up. This is making many companies skittish about remaining invested in China, and are opting to repartriate their capital rather than leaving it inside China.

Wang Tao, chief China economist for UBS Investment Bank in Hong Kong, said the fall in foreign investment has been driven by factors such as “de-risking” efforts by Western governments and the high costs of borrowing in the US dollar.

“All foreign firms are concerned about political and commercial pressure from their governments, as well as other risks. Even though it might not be economically beneficial, they may still consider reducing their participation in China, moving towards the so-called China-plus-one strategy, by adding exposure to other countries,” Wang said at a seminar on Wednesday that focused on the current investment pattern and development prospects in China.

This is reflected as well by the reality that many Chinese firms are also trimming their investments in the United States.

Chinese businesses are reducing their investments in the U.S., driven by worsening bilateral relations and challenging business conditions. Rhodium Group reports that investment from China has plummeted from $48 billion in 2016 to a mere $2.5 billion in 2021.

A survey conducted by the China General Chamber of Commerce reveals that over 80% of Chinese companies, including Wanxiang America, identify the deadlock in bilateral relations as their primary obstacle. Unstable U.S. foreign investment policies have also raised concerns among these businesses.

In one respect, these investment shifts are unsurprising in the current geopolitical climate. We should remember that, in the last Republican Presidential Debate, all of the candidates were rather gung-ho about disinvesting and “de-coupling” from China.

Even in the clown show of a debate hosted by the RNC at the end of September, de-coupling from China was very much an idea at least candidate Nikki Haley thought whose time had come.

It is tough to attract investment capital when your best customer does not really like you!

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However, by far the greater concern is China’s economic performance, about which investors are increasingly disbelieving of the “official” narrative. While China insists it will meet its 5% economic growth target, outsiders are increasingly skeptical about how China will get there (emphasis mine).

This reversal may reflect foreign disillusionment with China’s economic prospects and policymaking. Although the country will most probably meet its official growth target of 5% this year, it could shrink in dollar terms, according to the imf’s latest forecasts. China’s government has unnerved many investors with its overbearing reaction to the covid-19 pandemic, its regulatory crackdown on technology companies and its investigations of foreign due-diligence firms, including Bain, Capvision and Mintz.

Let that sink in for a moment: China is saying that it will meet its GDP growth target, but analysts and non-Chinese economists are speculating on the possibility of economic decline.

If the statistics are honest (“if!”), it should not be possible for the Chinese economy to grow by five percent per official metrics and decline by any amount in dollar terms. That such an outcome could even happen in China means investors are giving up on China ever providing realistic assessments of its own economic performance.

Bear in mind that, as I discussed yesterday, by the data China is releasing, its economy has already tipped into deflation. If inflation correlates to economic growth, deflation necessarily correlates to economic shrinkage.

Yet even without the “official” data, one only needs look at China’s stock markets to appreciate why foreign investors are giving up on China. With the Hang Seng index deep in correction territory, and the CSI 300 index closing in on correction territory, Chinese stocks are not having a very good year.

This is coming on the heels of China’s premier real estate developer, Country Garden, defaulting on some $11 Billion of dollar-denominated offshore bonds.

That default was largely the consequence of the Chinese real estate sector completely collapsing over the past two years.

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Meanwhile, China’s exports declined yet again in October.

Nor is this merely a recent developing weakness in the Chinese economy. China’s export engine has been sputtering even before COVID hit in 2020.

With such data being released by Beijing itself as the “official” economic data for the country, it was not hard last month to predict that China would slip into deflation, as it clearly is starting to do this month.

Even without the obvious geopolitical concerns, the economic concerns facing China make foreign investment problematic and even unwise for many globally invested companies. It should come as no surprise that they are repatriating their capital to invest it elsewhere.

Yet what makes the loss of investment capital particularly challenging for China is that, with moribund domestic consumption, it will be facing an uphill battle to get that investment capital back. While China’s large population on paper makes them an attractive market for any global enterprise, that population is not buying stuff nearly in proportion to their share of the global population. That limits the upside for any new investment from outside China.

With deflation taking hold in the economy, with declining exports and a collapsing property sector, China is starting to feel the effects of a “perfect storm” of economic challenges. Any one of these crises by itself would be a major battle for any economy. China is having to battle all of them simultaneously.

It is far too soon to say the Chinese economy is collapsing outright. However, China’s economic crises are getting worse, not better, and are likely to get worse still before there is any improvement. Whatever the level of “worse” is where terms like “collapse” become fitting for the Chinese economy, things are at the very least moving closer to that level, and will continue to do so.

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Even the corporate media was no longer able to ignore the obvious about China after it posted its latest consumer price index and producer price index data last week.

China's consumer prices swung back into contraction and factory-gate deflation persisted in October as domestic demand struggled, weighing on the outlook for any broader-based recovery in the world's second-largest economy.

The corporate media narrative is still pinning its hopes on China’s economic “recovery”, but that hope is increasingly looking like a pipe dream. It makes the hopium over Federal Reserve monetary policy seem almost realistic by comparison!

China is sliding into deflation and it is increasingly unlikely that Beijing has any capacity to halt the descent.

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Before Beijing published its latest inflation numbers, corporate media was predicting there would be some slowing of inflation—i.e., “disinflation”—but that outright consumer price deflation would be avoided.

Attention in Asia on Wednesday turns to Chinese inflation data, with investors expecting disinflationary pressures to have picked up in October but not at such a pace that would deflate the recent rebound in optimism about the economic recovery.

Corporate media was profoundly disappointed. Consumer prices are down quite literally across the board in China, let primarily by food prices. At a time when much of the world is grappling with food price inflation and its attendant food price insecurity, China is facing in many instances food price deflation.

That is certainly the case for most forms of meat sold in China.

Prices on foodstuffs such as rice, wheat, corn, and soybean have also retreated as of late.

Even cash crops such as cotton have been showing deflation for most of the year, and crops which have not have recently been showing disinflation.

With essentials such as food plummeting in price, it is a foregone conclusion that demand is sufficiently soft so as to ensure other consumer prices go along for the ride, which they very much have done in China.

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It is a measure of how delusional (and deluded) corporate media has become to have been talking about a China “recovery”. If we look at the broader Consumer Price Index for China, it is readily apparent their economy has been stuck in the doldrums for quite a while now. This current episode of deflation is the second one to hit China since the COVID-19 pandemic in 2020.

Year on year inflation literally collapsed in 2020, plummeting from a high of over 5.4% in January of 2020 (right before the first of China’s many lockdowns) to -0.5% by November

Now that same deflation has returned, and might even end up going deeper than that first bout of inflation.

Indeed, if we zoom in to focus on 2022 and 2023, we see China experiencing another collapse in price levels starting in September of last year.

China’s “recovery” from its Zero COVID lunacy lasted maybe one month—January of this year, and then prices simply began retreating.

We see confirmation of this when we look at China’s consumer price inflation data month on month. January there was a surge in prices, and then a retreat which has not yet stopped.

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While it is tempting to ascribe China’s problems to the results of its Zero COVID policies following the initial outbreak of the SARS-CoV-2 virus, the reality of China’s economy is that it has been an uneven performer even before then. If we look at the broader Consumer Price Index, we see that China has had multiple bouts of deflation just since 2018.

In 2018 and 2019, China experienced at least three episodes of intermittent consumer price deflation. This was before COVID.

The first outbreak of COVID itself sent China’s consumer prices plummeting, and price levels did not recover until around January of 2022. Perversely, 2022, a year spent entirely in the thrall of Zero COVID lunacy, produced some of the most stable consumer price inflation China has had for years.

When Zero COVID ended, mild consumer price inflation became persistent consumer price deflation.

Yet even before Zero COVID ended, it was plain that Xi Jinping’s policies—both pertaining to the pandemic and to the country overall—were taking China over an economic cliff.

Zero COVID obscured the damage for a time, but as the population grew restive within Zero COVID’s confines, last November Xi was eventually obliged to abandon the policy, in large part because China could no longer afford to maintain it.

Zero COVID has been the nail in China’s economic coffin, but, as even the Manufacturing PMI data shows, China’s economy has been heading into rough waters since well before COVID.

Not only has the headling PMI data been showing a decline since 2018, but crucial sub-indices such as finished goods and “in hand orders” have been contracting since 2018 (for the PMI data, and index measurement below 50 indicates contraction).

When a manufacturing economy’s stock of finished goods, export orders, and in hand orders are all posting multi-year declines, that is a manufacturing economy that is not doing at all well.

Layer a collapsing real estate sector on top of a stagnating manufacturing sector and the result is an economy that has nowhere to go but down.

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Earlier this fall I projected that China had two potential economic outcomes: outright deflation or slow steady stagnation.

It has been apparent just looking at China’s own data—and this data is all courtesy of China’s National Bureau of Statistics, and is the “official” economic data China releases to the world—that China’s economy has never been exactly healthy, and has not been on a path of recovery at any time since the start of the COVID-19 pandemic in 2020. Between declining manufacturing and an unstable real-estate sector, China’s economy has always been headed for a decline of some sort. It was always going to experience either outright economic contraction (deflation) or was simply going to go into “Japanification” stagnation.

With China’s latest consumer price index data and China’s persistent lack of any real consumer price inflation, it is becoming increasingly apparent that China’s economic horizon is deflation. China’s economy is not actually growing, and is not actually going to grow.

China’s economy is shrinking, and Xi Jinping is powerless to stop it.

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The first sign of the growing desperation came two weeks ago when the National Administration of Financial Regulation began urging banks to loosen lending practices, in particular to goose purchases of durable goods such as cars.

The National Administration of Financial Regulation in a notice told lenders to relax application conditions for auto loans, lower down payments and extend loan terms to make cars more affordable. It urged lenders to simplify auto loan applications by promoting instant online processing. The regulator specifically called for increasing financing support for used cars to encourage consumers to upgrade their autos.

To bolster support for new-energy vehicles, it is necessary to develop and design exclusive financial products and services that meet the characteristics of the vehicles, the notice says. Lenders should also provide credit support to the construction of electric vehicle charging infrastructure in rural areas.

China is feeling pressure to take such steps because Chinese consumers just aren’t consuming. Households lack confidence in the future path of the economy as well as significant purchasing power to direct towards consumption.

At the same time, China’s local governments are facing an increasing amount of pressure servicing their debts.

As such, some local governments are facing increasing debt-repayment pressure after years of hefty spending on low-return infrastructure projects. The Politburo, the centre of power within the Communist Party, said in July that there would be a “comprehensive” plan to resolve local government debt risks, but no details of the debt-resolution plan have been officially announced.

A number of policy advisers to Beijing have been urging the central government to bail out indebted local governments, pointing to how a prolonged property market downturn could further weaken finances at local governments, which play a critical role in supporting the national economy.

With two of the largest private real estate developers, Evergrande and Country Garden, locked in a death spiral down into liquidation, not only have housing markets collapsed, but developers are not buying land from local government entities as in the past—thereby depriving those same local governments of a much needed revenue stream at a time when they have outsized debt loads to service.

No local government or local government financing vehicle (LGFV) has defaulted on a debt issuance…yet. However, absent major debt relief from some direction, it is likely only a matter of time before defaults happen.

Consequently, last week Xi Jinping began to load the stimulus cannon, preparing to resort to debt-financed stimulus spending to lift the economy out its seemingly perpetual doldrums.

President Xi Jinping signaled that a sharp slowdown in growth and lingering deflationary risks won’t be tolerated, making a series of rare policy moves to boost sentiment in the world’s second largest-economy.

Within a 24-hour window on Tuesday, China increased its headline government deficit to the largest in three decades, unveiled a sovereign debt package that marked a shift from its traditional growth model, and Xi made an unprecedented trip to the central bank — sending a powerful message about his focus on the economy.

The message Xi Jinping is sending can be summed up in one word: Panic!

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China’s economy is not firing well on any cylinder at the moment. Year to date all major stock indices are down significantly, with Hong Kong’s Hang Seng index deep into correction territory (down more than 10%).

At the same time, yuan loan growth printed at the lowest level in over a year.

Outstanding yuan loans in China rose 10.9% from a year earlier in September 2023, the least since April 2022 and missing market expectations of 11.1% growth. source: People's Bank of China

The lack of loan activity is having an unexpected consequence: money supply growth is constrained.

Beijing’s monetary policy has always been fairly loose, with steady growth of the M2 Money Supply stretching back several years.

However, as can be seen when the data is indexed to January of 2022, both the M1 and M2 Money Supply have plateaued somewhat in recent months.

In the bizarro world of government stimulus, a constrained money supply makes the use of stimulus that much more difficult. While China is not facing the same rising yields that have become the norm in Europe and here in the US, declining yields are limiting the degree to which stimulus lending can lead to either increased investment or increased consumption.

China’s sovereign debt yields have even declined in recent months.

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On the one hand, China’s relatively low debt yields minimizes the consequence to Beijing of additional stimulus lending—which may have played a role in Beijing’s decision to authorize an additional 1 trillion yuan in sovereign debt issuance.

Within a 24-hour window on Tuesday, China increased its headline government deficit to the largest in three decades, unveiled a sovereign debt package that marked a shift from its traditional growth model, and Xi made an unprecedented trip to the central bank — sending a powerful message about his focus on the economy.

The one-trillion-yuan budget boost and willingness to exceed a long-adhered to 3% debt-to-GDP limit displayed a determination by Beijing to shore up growth for 2024 and avoid complacency. That comes even after strong economic data published this month put the government on target for its 5% goal this year. China will next week hold a twice-a-decade financial policy gathering that may provide more policy clarity.

On the other hand, low yields in the offshore debt markets makes other nations’ sovereign debt issuances more attractive to investors, which has not helped alleviate China’s ongoing capital outflow.

It is difficult if not impossible to generate significant economic growth when investment capital is leaving the country—and investment capital has been fleeing China since the right after the start of the COVID-19 Pandemic Panic.

This creates additional headaches for Beijing, as China’s debt is already at eyewatering levels.

China’s debt-to-GDP ratio rose to a record in the second quarter, and concern is mounting over borrowing by local governments and their financing platforms. “Because Chinese debt is high already, totaling roughly 280% of GDP, so we cannot bring a huge, oversized generous stimulus,” Zhu said in the BTV interview.

Despite this, the People’s Bank of China has been steadily expanding its balance sheet since the pandemic—and is now planning to expand it even more.

China needs to unleash a significant blast of debt-financed stimulus in order to get the economy growing again, but lacks the headroom for an unlimited amount of debt.

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China’s position is further exacerbated by its steadily weakening currency, which has been losing ground against the dollar since the beginning of the year.

With additional soveriegn debt on the way, Beijing will have its work cut out for it if it wants to keep the yuan below 7.5 yuan to the dollar—which would be a decline of more than 11% year to date.

Even Russia’s ruble has been gaining ground on the yuan over the past month.

This is coming at a time when the ruble has lost 42% of its value against the dollar.

China isn’t even gaining any benefit in improved exports from its depreciating currency.

As a general rule, a weaker currency makes a country’s exports more attractive to importing nations. However, as China’s yuan has weakened offshore, exports have by and large declined.

The weaker currency certainly has not helped its domestic consumption patterns either, which are still lagging prior years’ activity.

Flagging export demand and sluggish domestic demand equates to an economy stuck somewhere between deflation and stagflation, which is exactly where China’s economy has been stuck for quite a while now.

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As much as China strives to keep the brave face about its economic situation, the reality is that China is increasingly stuck between a deflationary rock and an inflationary hard place. It cannot unleash dramatic amounts of sovereign debt-financed stimulus spending, even currency devaluation has failed to stimulate export demand, and Chinese consumer stubbornly refuse to consume.

While the overall impact of still more debt-financed stimulus remains to be assessed, at the levels Beijing is preparing to roll it out, it is not likely that Beijing will greatly alter the economy’s overall trajectory. This may prove to be a blessing in disguise, as it means that China may manage to avoid creating yet another asset bubble while attempting to boost its economy.

Xi Jinping did not want to go the sovereign debt-financed stimulus route. Since 2020 and his now-infamous “Three Red Lines,” Xi Jinping has tried to utilize almost every other mechanism for getting more capital and more spending into the economy—two prerequisites if there is to be any economic growth of any kind. None of them have worked.

Now Xi is choosing to give the old economic playbook a second chance. Beijing will issue 1 Trillion yuan in sovereign debt and hope that the resulting spending will lift China’s economy off the rocky shoals against which it has been flung repeatedly.

Will that 1 Trillion yuan be enough? Can China get the necessary economic boost from the related spending? If—or perhaps when—the stimulus spending fails to lift the economy, what does Beijing do then?

Beijing is running out options for getting its economy moving again. No wonder Xi is panicking.

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