A stumbling Chinese economy can be a major drag on world aggregate demand.
A stumbling Chinese economy can be a major drag on world aggregate demand.
A nyone who thinks that China will not be a drag on the world economy has not been paying attention to signs that China’s housing- and credit-market bubble has burst. Nor have they been paying attention to indications that deflation now threatens China’s economy or to signs that political risks are rising and investors have lost confidence in Chinese government’s ability to handle its daunting economic challenges. The Federal Reserve ignores at its peril the deflationary consequences of these developments for the U.S and world economic outlook.
At the heart of China’s present economic malaise is the grossly unbalanced nature of its economy and the dimension of its housing- and credit-market bubble. Carnegie Institute’s Michael Pettis points out that China invests over 40 percent of its GDP compared with the 25 percent in most other countries. That has led to overcapacity in many industries and to sharp reductions in Chinese export prices as Chinese companies attempt to offload their excess production. Meanwhile, according to Harvard’s Kenneth Rogoff, China’s housing market accounts for around 30 percent of its overall economy. (That is some 50 percent higher than that of most other countries, and it has led to some 65 million unoccupied housing units.)
Worse yet is the size of China’s credit-market bubble. According to the Bank for International Settlements, over the past decade, credit to the non-financial private sector grew by 100 percent of GDP. That is a faster pace of credit growth than that which preceded Japan’s lost economic decade in the 1980s, or that which preceded the 2008 U.S. housing- and credit-market bust.
Among the signs that the Chinese property bubble has burst is the fact that over the past year, Chinese housing prices have been falling and the country is now experiencing its worst bout of deflation in the past 14 years. Over the past year, as other countries struggle to regain inflation control, Chinese consumer prices have fallen by 0.3 percent and producer prices by 2.7 percent. At the same time, following Evergrande’s debt default, other major Chinese property developers have been defaulting on their debt and have stopped working on unfinished housing projects. This is now causing strains in China’s large shadow-banking system and considerable public dissatisfaction with government policy.
Among the signs of a deep loss of investor confidence and a less friendly investor environment has been the meltdown in the Chinese stock market and the weakness of its currency. In January alone, Hong Kong and China’s stock markets have lost $1.5 trillion in value. That makes them the worst-performing stock markets among the major countries. Meanwhile, the Chinese currency has declined to its lowest level against the dollar in 16 years as evidence of domestic-capital flight mounts.
The Chinese government has made numerous policy errors that have contributed to this dismal state of affairs. The exit from President Xi’s disastrous zero-Covid policy left a lot to be desired, while his regulatory crackdown on tech companies has shaken investor confidence. Further undermining confidence has been the suppression of financial data and the censorship of commentary on the state of the economy. The souring of U.S.–Chinese relations over the Taiwan issue and China’s activities in the South China Sea have heightened investor anxiety.
All of this matters crucially for the world economic outlook. China is the world’s second-largest economy, and until recently, its main engine of economic growth. A stumbling Chinese economy can be a major drag on world aggregate demand. Meanwhile, as the world’s largest exporter, falling Chinese export prices and a weaker Chinese currency can constitute major deflationary forces for the world economy. As the world’s largest commodity importer, a slowing in the Chinese economy can mean lower international energy and food prices.
A striking feature of the Federal Reserve’s current monetary policy is how data-dependent and inward-looking it has become. This could be inviting a hard economic landing, particularly at a time when the world’s second-largest economy shows every sign of having run out of steam, when a domestic commercial-property crisis seems to be intensifying, and when China seems well on the road to deflation.